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Classes of Real Estate

Investors review several different criteria to determine which asset they would like to invest in. What always trends to the top of the list is looking at the class rating of that asset. These classes range from A to D, “A” being the best and “D” being the worst. Although Class A may be the “best” there are always pros and cons, and not just with Class A properties but with all the classes. Understanding the differences between each of these is imperative to making the best decision and knowing what you may be getting yourself into. Class A: These are the newest, top-tier properties with a full array of amenities and staff in the most desirable locations. Class A properties attract quality and reliable tenants which makes them a safe investment since you most likely will not have to worry about rent collections. Despite some of these pros, Class A doesn’t come without any shortcomings. Some issues with this class are the pricing and returns. Since these properties are on the newer side, usually built within the last 10 years, the risk is much lower than a property from the early 1900s which could be quite costly with capital expenditures. Since there is less risk and the locations are in prime spots you will see that pricing is usually on the higher side, yielding lower returns. Also, it is worth mentioning that although these Class A buildings hold less risk with tenants, collections, and repairs doesn’t mean that they are an ideal class to invest in. As I am writing this article, we are in the peak of COVID-19. This pandemic has caused a lot of tenants to stay away from the expensive Class A apartments. This has driven both concessions and vacancy upwards, reducing the net operating income of the property. This is a great example of why it is crucial to always looks at the pros and cons of each class before proceeding. Class B: These are a step down from Class A properties. Class B are going to be older buildings, have less amenities, and leased by lower income tenants. The location of these buildings may or may not be is less desirable areas. Sometimes there will be Class B buildings in “B” areas but there are also plenty of Class B buildings in highly desirable “A” areas. These are great because you can acquire the property at cheaper sticker price relative to the surrounding Class A properties. This is because the Class B asset is an older, higher risk property. This is a huge plus since the building is in a great area. This provides the investor the opportunity to add value to the property and raise rents, yielding higher returns. Again, it is worth noting that during COVID-19, Class B buildings are a good choice. These are much more affordable than the Class A buildings, but they still have a solid tenant base. These types are properties are a great hedge during tough economic times. Class C: Next in line are the Class C properties. As we move down the ranks you will begin to see the buildings get older, there will be little to no amenities, higher number of lower income tenants, and there will be higher risk and return compared to the A and B properties. These are overall solid properties for investors because if you know what you are doing then you can acquire these assets for a fair price, add value, stabilize the property, and realize high returns. Most of the value add with Class C assets require a lot of renovations and getting solid tenants into the units. Since rents are already much lower than Class B or A properties, exterior and interior renovations will allow rents to increase. These higher rents will hopefully attract more credible tenants. This will stabilize the property and have it cash flowing. Although the returns are advantageous, there of course is higher risk since these properties require high cost renovations and you are dealing with a more unstable tenant base. Also, COVID-19 seems to be hitting Class C properties a bit harder since these tenants are losing their jobs and not able to pay rent on time. Again, always evaluate how certain classes will perform through economic swings. Class D: Finally, we have Class D properties. These are the toughest properties out there. They are usually in very rough areas with high crime rates. Rents are incredibly low and so is the price to acquire one of these buildings. There is usually a large amount of deferred maintenance combined with tenants who are not paying their rent. With such high risk and low desirability, this explains why investors can acquire these properties for such a low price. Most investors completely stay away from these properties no matter where the market cycle is at. It is not worth all the headaches that would come along with owning a Class D building. Conclusion: Now you know the four different classes of real estate and can chose which type you are interested in. Evaluating the type of risk you want to take on will play a large role in deciding which type you choose to proceed with. As always, put in the proper time to understand what you are getting yourself into and how each type performs at each point of a market cycle. Jackson Wietecha


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