Understanding the different property classifications is very important for new investors. It can mean the difference between a wildly profitable year and investing in a cash flow vampire. Each classification, A, B, and C are distinguished by the degree of potential risk and return applicable to the property.
These classifications were developed by investors to make it is easier to communicate the value of a property quickly. You can use these classes to help figure out which property fits into your investment strategy, and how it will influence the stability of the investment over time.
This simple grading system allows you to gauge a properties competitive position in a marketplace while also providing you with a way to rate overall quality and key characteristics of a property. The age, location, amenities, rental income and appreciation prospects, and tenant income are all taken into consideration with this grading scale; it is generally accepted by most investors.
Class A Properties
These properties are considered to be a low risk/ low return investment. The reason being, they are newer (less than 10 years old), high quality luxury properties in a great location. You will find these properties in wealthy areas with the best restaurants, schools, etc.
Class A properties typically do not require maintenance or renovation because they already have in demand features such as hardwood floors and granite countertops. Amenities are usually best-in-class allowing to charge the highest rent prices in the respective market. But, investing in these properties usually means lower cash flow because they require higher rent pricing. The higher the demand, the higher the cost, the lower the cash flow in most cases.
Why should you invest in Class A property?
Most investors view Class A properties as “Core” investments. These properties target and attract high-quality residents with stable jobs and great credit scores, meaning lower risk for you. Class A properties also increase in value at a higher rate than B and C class properties because they are well located and professionally managed. Most investors rely on continued growth of the neighborhood and prefer to develop these properties because this can potentially mean higher profits.
Class B Properties
Class B properties are one step down from Class A because of the location, age, building quality, and available amenities. They tend to have lower income tenants and may not be professionally managed. It is possible to have a new Class B property, but more often a property is classified as Class B due to age (less than 20 years old). These properties are typically still in good condition and able to achieve above average rents. Through renovation and common area improvements the property can often be repositioned so the market may assign a higher value to the property.
Why should you invest in Class B property?
Because of the fortuity of upgrading the asset to Class A property , most investors see this as a value add investment opportunity. Investors can usually acquire these properties at a higher CAP rate, meaning the value (or purchase price) of the property is low, because these properties are viewed as riskier than Class A. By making improvements to or repositioning the property, you are able to increase cash flow overtime, making this a medium-high risk/medium-high return investment due to the appreciation in value. When you purchase a Class B it is usually not operating at its full potential, which is the reason these properties constitute such high risk. However, most investors believe these projects provide a perfect balance of risk vs. return.
Class C Properties
Class C properties are the ugly duckling of the bunch. They are typically located in less than desirable areas and need a significant amount of renovation in order to pose as a viable investment. This could include updating the building infrastructure, design, or finish to bring it up to date. Because of this, Class C properties tend to have the lowest rental rates and are considered high risk investment opportunities.
Why should you invest in a Class C property?
Keeping in mind that it is possible to move a property up in class from C to B through renovation and tenant repositioning, investing in these properties is high risk but can be considered a “value add” investment. As previously mentioned, “value add” investments usually mean higher cash flow once you make the necessary improvements or renovations to elevate the market value. If you are seeking higher returns and capital appreciation, this may be the most suitable investment strategy, especially if the property is located in a growing area.