Investors often ask us to explain the different real estate property classes and why it is an important consideration for investors when determining the risk and return on a property.
Gaining a clear understanding of why a property is labeled as Class A, Class B, or Class C can help investors plan their strategy to maximize returns and determine whether a property will complement their portfolio.
How are properties graded?
Real estate property classes are not official classifications.Rather, brokers and lenders started to use this classification system as a way to efficiently communicate the quality of property between themselves.
The three common classes—A, B, and C— are determined by the physical and geographical elements of a property. The grades take into account the property’s location and age as well as the growth opportunities, level of income of tenants, rental income prospects, and the amenities in the neighborhood.
What determines a Class A property?
A Class A property is the highest classification and represents the most desirable properties in neighborhood. They are usually either less than 10 years old or a building of historical interest that has been renovated. To qualify as a Class A property, the building must be in good condition and have very few or no maintenance issues.
Class A buildings are often located in the suburbs and typically have a higher percentage of owned properties. This direct investment in the neighborhood means that the area usually has access to good schools, shopping malls. They are typically located in areas with high employment rates and low crime rates. These factors contribute to an increase in demand and can therefore command higher rents.
Investors who are seeking a low-risk investment should consider a Class A property. It will have fewer issues and cost less to maintain. The desirability of the location means the vacancy rates will be lower—however, bear in mind the acquisition costs of Class A properties will be higher.
What determines a Class B property?
Class B properties are usually between 10 and 30 years old. They are usually in relatively good condition but are not finished to the high standards of a Class A property. This means they are likely to require some maintenance but can be purchased for less than a Class A property. Investors can take advantage of the lower acquisition costs if they understand the maintenance issues and risks associated with a Class B property.
Many Class B buildings are owned by investors and rented to tenants. Investors who prefer the house-flipping strategy are often drawn to Class B properties, as the buildings can be upgraded to Class A properties through strategic renovations and will command a higher resale price.
Often, Class B properties attract lower-income tenants, which means that the rental income will be less than it is for a Class A building. However, many Class B properties provide a steady passive income for investors.
What determines a Class C property?
Class C properties are usually over 30 years old and in need of maintenance. Most Class C buildings will need wiring, plumbing, and heating upgrades. Generally, these properties are not as well located and have access to fewer amenities than a property in a Class A or Class B neighborhood.
The rental income is even lower on a Class C building, but on the other hand, they can be purchased at a lower cost. Experienced real estate investors who understand the risks of a Class C property can make a good return on their investment—if they have the funds to make the required renovations and are prepared to commit to the ongoing maintenance.
Class C properties tend to attract tenants who are low-wage earners or supported by welfare , who often find purchasing a home challenging. This gives investors a larger pool of tenants than other classes might attract and therefore the potential for high cash flow, which can make the properties very lucrative.
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