Classes of Property in Real Estate: The Key Differences Every Investor Should Know
When it comes to renting, some people look for properties with all the amenities – updated kitchens, dog parks, concierge services – while others are seeking function without all the bells and whistles. Similarly, real estate investors may be looking to add certain features to existing properties, or they may seek to limit their risk by making minor changes to already high-quality properties. The difference between these property types can be described in terms of classes.
Classes of property in real estate aren’t just important in terms of tenant experience. Understanding property class types can allow people to make better investment decisions. They can also help active investors align the properties they choose with the amount of risk and work they want to take on.
We’ll cover property classes, including common characteristics shared by class and how investors can choose between them for their projects.
Real Estate Property Classes: A, B, C (and sometimes AA and D)
When it comes to comparing classes of property in real estate, think about each class as a grade. Most real estate falls under Class A, Class B, and Class C.
Class A
Class A properties tend to combine several appealing characteristics – high-profile neighborhoods, areas of strong demand, and high-quality amenities and finishes, to name a few. These properties tend to be newly constructed or newly renovated, but are generally built within the last 15 years. Tenants in these buildings normally have high incomes, garnering high rents, and vacancy rates in Class A properties are low.
While Class A properties can offer steady income, they normally generate lower cashflows because there is less to do from a value-add standpoint. They offer a turnkey type of investment for private equity or investors who want to park their money long-term.
Initial investments and rents are likely to be highest for Class A properties, but investors and residents won’t have to worry as much about deferred maintenance. The buildings tend to be professionally managed and well cared for. However, in times of market fluctuations, Class A properties can be more vulnerable.
Class B
Class B properties are a tier below Class A. These buildings are normally older with lower rents than Class A buildings. However, they’re still well-maintained.
One of the most attractive factors of Class B properties is that they garner a solid demand and tend to have a better cash flow, due in part to moderate value-add opportunities. These properties also serve as the perfect middle-ground for investors based on renter behavior. When the economy is good, people in Class C properties move to B. When things are bad, Class A tenants move to Class B.
There may or may not be professional management for this class of property, and there may be a few deferred maintenance issues here and there. This class of properties is generally seen as a value-add because there are clear opportunities for improvement at the outset. Improvements to amenities or renovations made to units, for example, could bring the properties up to B+ or even A. Because there is more work to do, Class B properties are considered riskier and less turnkey compared to Class A.
Class C
Class C properties may have shortcomings where Class A properties have strengths, but they shouldn’t be ignored by investors. These buildings are usually 20+ years old, with rental rates and subsequent income of renters that tend to be below Class A or Class B. However, there is a lot of blue-collar demand for this class of properties.
Due to the legwork that may need to be done on Class C properties, they tend to be higher-risk projects. However, this also means that they can yield the highest returns. On one hand, investors may have to contend with the risk of collection issues. On the other hand, there are more opportunities for deep value-add projects that yield strong cash flow.
Some properties are also classified as Class AA when they’re very high-end, or Class D when they’re extremely distressed; however, these classifications aren’t as common.
We tend to try to shift properties from C- to C+ or C+ to B- in the blue-collar profile. We also love B+ to A- value-adds.
Do Classes of Property in Real Estate Always Coincide With the Surrounding Area?
It’s also important to look at the area the property is in and how it can either coincide with or differ from the immediate market. Properties can have a mismatch from the area where they’re located. For example, you may see a Class B property in a Class A area. When it comes to value-add, we like to find properties that have a lower class compared to the surrounding area.
Improvements Made to Real Estate Properties and Class Changes
When investors are looking to make improvements at Class B and Class C properties, there are a few features they might want to explore first. These include:
- Upgrading appliances
- Modernizing kitchens and bathrooms
- Replacing filtration and HVAC systems
- Adding amenities, such as dog parks, Amazon mailboxes, and improved common areas
- Updating windows or insulation
- New finishes to interior common areas
- Beautifying the outside through landscaping and other outdoor features
While improvements do require more management on the part of the investor, and may be more risky, they can also yield higher returns.
Repositioning vs. Value-Add
Deciding which improvements to make, and when, can roll up into an investor’s overall strategy. Value-add improvements may keep the property in its current class but give a facelift to individual units, common areas, or exteriors. Repositioning involves making more dramatic improvements to the property in an effort to move it up a class, from Class B/C to Class A for example. When repositioning, operators may engage in rebranding and marketing campaigns to debut the new classification within the local market.
How to Decide Between Classes of Property in Real Estate When Investing
Making solid investment decisions starts with figuring out which class of real estate property to invest in, and what strategies to use once you acquire the property. Risks and rewards vary based on class and the amount of work and creativity you put into the project. What will be right for you will depend on your group’s budget, goals, hold duration, and the state of the current market, among other things.
At Investream, our multifamily investing criteria spans across Class A, B, and C properties. We look for buildings that were built between the 1980s and 2000s in Texas submarkets with strong growth periods. Our transaction sizes average between $10 – 70 million and we look to make light to modest capital improvements. Most multifamily properties we seek out have a minimum occupancy of 90%, stabilized at acquisition. Instead of looking at just one set of criteria, we weigh these factors together before making offers on properties.
Want to learn more about our investment criteria, or the property classes we’ve seen? Any other questions? Contact us today!
