It’s important to understand property class and area class before diving into commercial real estate investing. Understanding how property class can affect your investment will allow you to meet or exceed your goals with the right moves. You will also be able to communicate effectively with industry insiders as well as your commercial broker so they can understand what you’re looking to gain from the asset.
Investors, lenders, and brokers will often use classes to quickly summarize the value of a property. The four major property classes are ranked using the letters A, B, C, and D and a good way to understand them is by applying principles from the popular board game Monopoly.
The Monopoly board game has different properties ranging in price. You start at Baltic Avenue with a property that only brings in $20 in rent due to it’s less desirable address. That’s considered a “D” class property. As you move around the board you work towards Park Place. Park Place is the “trophy property” of the game because it brings in $200 in rent. That’s an “A” class property and with enough of those, you can win the game. Pretty simple, right?
In the real world, there are no set values like there are in Monopoly.
There are, however, some defining characteristics standard to each property class that you can look for when searching for a place to invest your money.
“A” Class Properties
These are usually less than 10 years old and are most often new, upscale apartment buildings. Other defining characteristics of this type of property are high income earning tenants and low vacancy rates. These properties typically demand the highest rents with no deferred maintenance. “A” class properties are usually owned by institutional investors and demand the lowest returns, highest per unit prices, with the most appreciation potential and lowest cash flow starting out.
“B” Class Properties
These are usually less than 20 years old and are in a desirable location with some popular amenities. Rents are a bit lower than they are in “A” class buildings and these type of properties also have low deferred maintenance. “B” class properties are typically owned by private equity firms or very high net worth individuals. They are valued at slightly higher cap rates than “A” class properties and usually have appreciation potential with decent cash flow.
“C” Class Properties
These are typically older properties, built 30+ years ago. Rents are lower than they are in “B” class buildings and usually have more deferred maintenance as well as a lower occupancy rate. These buildings are usually owned by private investors and private investment groups. They tend to provide for higher cash flow and capitalization rates, but will normally have much lower appreciation.
“D” Class Properties
These are older buildings in often challenging neighborhoods. They have high deferred maintenance, no amenities, functional obsolescence, usually with a difficult tenant base creating the need for more intensive management. These properties will usually have double-digit capitalization rates and will not have appreciation potential. “D” Class properties may not be a good fit for a new investor. While they might look like cash flow kings, that cash flow often diminishes greatly due to the need for repairs and a lack of payment from tenants.
From a management perspective, tenants of “D” class properties are the most demanding to work with. While “D” class properties are often in rough shape in a less desirable part of town, they do have the highest rent-to-purchase price ratios on paper. Class “D” properties are the cheapest to acquire so many investors would expect that they would have the best cash-on-cash returns.
The lower the property class of the building, the higher the rent ratio.
There can be higher capitalization rates with lower class properties. To factor a capitalization rate you need to compare the ratio of net operating income to the actual value of the property. This type of analysis leads one to believe that a class “D” property would be the best investment to make money.
Because we’re not dealing with Monopoly money, it’s best to consult with a professional. At Tru Realty, our commercial division is challenging industry norms and embracing the latest technology advancements for a better client experience. If you’re new real estate investing or want to take your commercial investing to the next level, contact Heather@TRUcre.com.
Heather Binder is an accomplished real estate professional with Tru Realty in her role as the Director of the Commerical Division. She is dedicated to providing her clients with an extraordinary real estate experience. Her expertise in working with clients made Heather a natural for her role as a certified instructor at the Arizona School of Real Estate and Business.