Investing in real estate can have many benefits. The asset class is known for being a hedge against inflation, uncorrelated with stock markets, and solid performance. However, not all real estate is equal. To put it another way – not all real estate shares the same risk and return characteristics.
If you want to minimize the risks, then you must know what you’re getting into. Start by educating yourself on the different classes of investment property.
What Exactly Is “Class” in Real Estate Language?
In real estate terms, class refers to the category of a property. Although there is no hard and fast rule, it’s usually determined by a property’s features, condition, and location. To guide you better, you can ask questions such as:
- Where is it located?
- How old is it?
- How well-maintained is it?
- What are the amenities?
- What type of community lives in the area?
Property classifications were developed by real estate professionals for the sake of convenience in order to communicate the conditions of properties more easily. In addition, it helps investors determine the possible risks and rewards of each property.
Defining Class A, B, and C
There are many sub-classes of properties, but in this article, we will cover the three main (and most common) classes of investment real estate: Class A, B, and C.
Think prime, pristine, and exclusive. Class A properties are your most expensive option of rental property investment. They offer the most stable (likely) returns, too, among all types of properties.
Location. They are found in prime locations such as Tier 1 cities centers and affluent suburban enclaves. They are close to the best school districts and high-class commercial establishments.
Age. They are generally newly constructed or were built within the last 10 years.
Condition. Since they’re still new, they’re in tip-top shape. Deferred maintenance should be minimal to zero.
Amenities. The amenities consist of ultra-modern features with the bells & whistles, triple glazed windows, IoT-enabled security and more luxurious or high-end finishes.
Community. People who live near or work in class A properties belong to higher income earning cohorts.
Class B properties, as you can imagine, are a step down in quality and character. These properties do not have the bells and whistles that you would find in class A properties. They’re also older, which means more deferred maintenance issues arise.
Location. Class B properties are not in prime areas, but they’re still found in decent locations. In fact, a lot of them are located right by class A properties.
Age. They were built in the last 10 to 20 years.
Condition. They have deferred maintenance issues, but not as much as you’d find in lower-class properties.
Amenities. Unlike the luxurious amenities in class A properties, the amenities here are more geared toward functionality. Or you may see amenities that were “state of the art” for their time. That time recently coming to pass.
Community. People and businesses who live, work or occupy class B properties will vary across the economic spectrum.
Class C properties are the riskiest type of investments, unlike class A and class B properties. They’re old, not in the best shape, and are located in less desirable places.
Location. Class C properties are not in prime areas. You will find them in places that are visibly less appealing.
Age. They were built in the last 20 to 30 years.
Condition. They have a lot of deferred maintenance issues.
Amenities. You’d be lucky to find decent amenities around the area. But they’re mostly establishments such as budget stores and budget restaurants.
Community. People who live in class C properties can be a mix of those who belong to the lower middle class and working class. Your tenants here will vary as well.
Which Offers the Best Investment?
There actually isn’t one “best investment” for everybody. It all boils down to the investor’s budget and expected returns.
Class A Property Investment
If you have the budget and want an investment that won’t need renovations, then go for class A properties. However, you must be financially ready once repairs are needed. Class A properties are built with first-class features, which require a handsome amount of money to maintain. Due to their stable nature and low risk, they often demand the lowest returns and highest cap rates.
Class B Property Investment
Class B properties can be riskier than class A properties. They cost less in terms of selling price, but you might end up spending more due to repairs since these are relatively older.
However, class B properties are also the most flexible type of properties. They cater to a wide range of social classes, so the vacancies tend to be lower and they are open to various management strategies. Class B properties have higher cap rates and generally slightly higher returns to justify the risk.
Class C Property Investment
Class C properties are the riskiest type of investment. They are not as well-maintained as class A and class B properties, and may require heavy rehabilitation. But once you put them back in great shape, they’re a great source of passive income.
Now that you’re much aware of the different classes of properties, you can figure out which type of investment suits you best. Again, there is no hard and fast rule in defining property classes. But these should help you gauge the risks and returns of any rental property investment you are eyeing. Don’t forget to create a cash flow model of your investment. Tools like Money Weighted can help you forecast your profits accurately.