If you start immersing yourself with the real estate industry, you quickly hear people talking about A, B, and C class investment properties.
If you’re a potential real estate investor considering a rental property, you might be wondering, “What’s the difference between properties classified as Class A, Class B, and Class C? Is this like getting a grade back in high school?”
Well... sort of. Properties or neighborhoods can get labeled with a grade, but the classification is much more subjective. Investors, lenders, and brokers developed this lingo to quickly communicate the quality and overall rating of a property.
There's currently no entity regulating this current rating system, instead it’s simply a general rule of thumb accepted by industry professionals.
This whole classification method, as simple as it might sound, attempts to offer a holistic view of the property enabling investors to make informed decisions about the future of the property and properly determine its competitive position in the market.
The letter grades assigned to investment properties take into consideration a whole host of different factors: the property’s age, tenant income levels, growth prospects, appreciation, amenities, rental income and more.
Understanding the different property class level distinctions is important for real estate investors because it shows the overall level of risk and return for the particular property.
Different classes of properties might be appropriate for a particular investor depending on their investment strategy and risk tolerance.
Here, we’re going to dive into the first three class levels:
- Class A
- Class B
- Class C
Note: The number of classes may vary depending who you talk to. Some real estate investors refer to an A-C scale while others extend the classes to A-F (to stick with the high school grade analogy). But generally, classes A-D is commonly accepted. Some will even add + or -, but let’s not get crazy here.
Class A properties represents the top quality and the best kind of real estate you can find. The highest quality tenants will want to rent here and vacancy rates are usually low.
The location is often in more upscale areas of town, often surrounded by the top restaurants, best schools, nice offices, and other high cost properties.
The buildings are also the highest quality and are often built within the past 10 to 15 years. This means the overall maintenance issues are low and the amenities are high.
Class A offices typically feature things like valet parking, on-site restaurants, cafes, and bars, smart-enabled amenities, and modern design elements. Class A multifamily properties often make the living experience resemble that of a resort with relaxing pool areas, community barbeques, and on-site fitness centers.
Class A units will likely also have nicer interior aspects like hardwood floors and granite countertops.
A Class A real estate investment is usually professionally managed by a property management company and often charge the highest rent rates.
Property investors like Class A properties because there is little risk of outstanding issues to the structure requiring additional capital in the near-term.
However, Class A properties can feel the pain during recessionary times when high-income earners experience income loss or unemployment.
Furthermore, the demand for Class A properties is high and purchase costs can quickly get pushed up, creating a weaker cash flow for the investor.
Just a notch down in regards to quality, location, and amenities are Class B properties.
This is where the ‘middle class’ is typically found, along with others who pay above average rents.
Slightly older than Class A, it’s likely that the a property gets bumped down to Class B due to age.
Certain physical aspects are simply outdated and naturally bring the property down to Class B, and maintenance issues will be more common.
Often times with Class B investments, property investors envision potential renovations and upgrades to make the property a value-add real estate investment.
Through the property improvements, it might even get bumped up to Class A. Investors can purchase Class B properties more easily than Class A because the risk factor is higher, as many need some touch-ups and repairs.
Class C properties can be one of the lower rated classes and represent the least desirable properties on the market. These properties are usually older, most of the time more than 20 years old, and in need of major improvements or a rehab project to bring the building’s infrastructure up to par.
Ongoing maintenance is the status quo and future repairs are to be expected. Class C properties are typically found in lower income areas where rent rates are cheap.
The risk with Class C properties as an investment is they are commonly in the last few years of operational viability, and will be outdated and need to be remodeled in the near future.
Class C investors will take the approach of minimizing operating costs to counteract the limited upside potential.
Properties in this class are also much more affordable, with lower capital requirements for the investor.
Real estate investors can easily and quickly evaluate and categorize investment properties based on a simply, yet effective rating.
Savvy investors realize the importance of knowing where each particular class fits into the business model and which strategy is needed to generate return from the property.
Investors seeking capital preservation would probably opt for Class A property investments, as the property’s value is likely to hold while higher-income, stable tenants occupy the space.
Classes B and C might fit well in a real estate portfolio willing to assume a bit more risk.
Investors that are able to properly contextualize a property using the ratings in relation to risk and returns can effectively navigate the real estate markets.
The key is targeting properties that are competitive within their specific class and will either remain steady during the holding period, or have potential for improvement with some capital investment.