Recession Kills Class C

by Jonathan Twombly
Last Updated: July 16, 2019

A swing on the porch of an old house.

If you’re in the real estate know-how, you’ve probably heard that C class occupancy is higher than anywhere else these days. It makes sense! After all, construction is booming, and A class is all that gets built, so vacancy is rising in A. A class owners are offering incentives and poaching tenants from Class B.

C class tenants don’t usually have the economic ability to move up to Class B, so they have nowhere else to go… Yet C class tenants are doing well. After 10 years of economic recovery, the benefits of economic growth have finally filtered down to them. More C class tenants are able to afford their own apartments, so they are creating new renter households.

So, like clockwork, the brokers and gurus are saying it’s a great time to buy Class C properties.

Should you listen?

That’s the big question! With the economy humming and the real estate recovery ten years in, you pay a high premium to buy every asset. Including C class assets… When the economy slows, C class tenants will be the first to be whacked in the downswing.

(Remember that, at the peak of the last recession, unemployment peaked around 11%. But it was only about 3% for college-educated people, who rent Class A and B+ properties. That means unemployment was way higher than 11% for Class C, who tend to be less educated and work the most recession-sensitive jobs, like manufacturing and retail.)

According to the Federal Reserve, 40% of Americans cannot afford an unexpected expense of $400. Where do you think those 40% rent? What savings do they have to pay rent if they lose their job in a recession?

Some economists are predicting that the trade war could be the thing that tips the economy into a downturn. Even if it doesn’t, it makes goods more expensive for Americans to buy. The brokerage Charles Schwab recently blogged that, while all Americans pay more for essentials because of tarriffs (which are a tax), this hits lower-income (C class renting) Americans the hardest..

C class renters mostly fall into that group of Americans who can’t afford an unexpected expense of $400. The goods they need to buy to live are getting more expensive because of the trade war.

What’s left over to pay rent is shrinking. Less availability for rent payment means rent delinquency will go up tremendously. C class tenants don’t typically have extra resources to cushion themselves in hard times (A and B class tenants typically having savings, multiple incomes or a consistent residual income, etc.). The resulting C class delinquency leads to:

  • Less rent collected
  • More evictions
  • More turnover costs
  • More rental expenses due to higher turnover rates
  • Less profit
  • Less cushion between making a mortgage payment and delinquency

So, beware all the good news and hype about C class property. If you already own it, you’re very happy right now. If you invest in C class property right now, you’ll pay a premium for this good news, leaving yourself vulnerable to anything that makes C class renters more vulnerable than they already are.

If you want more honest investment talk than you’re used to getting from the gurus who tell you real estate investing is all rainbows, unicorns, and cotton-candy, then you need my Multifamily Launchpad program.

The program doesn’t open again until the fall, but the waitlist is open right now.

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