It's not uncommon for a real estate investor to categorize their investment properties by whether they're residential or commercial real estate. However, there's also another method for property classification: ranking them by asset class. To that end, we've laid out the different property classes for you below. Read on to learn more about what each property class entails, why property classes matter to investors, and how you can determine which asset class is the best fit for your investment strategy.
What are the different property classes in real estate?
The easiest way to think about real estate asset classes is as a grading scale, except, rather than going from A to F, this scale goes from A to D, with Class A properties boasting the highest property values.
This scale is largely subjective. A Class B building in the eyes of one investor could be a Class C building in the eyes of another. Luckily, a fair amount of characteristics are typically used to separate one property class from another. Take a look so you understand how each property class is broadly defined.
As mentioned, Class A properties typically hold the highest property value, so they also often garner the highest rents. They are generally the newest buildings available, usually less than 10 years old. They also tend to offer the greatest selection of amenities and are located in a desirable location.
Keep in mind the definition of "desirable location" varies depending on whether you're talking about a residential property or commercial real estate. In the residential market, it means the location has a low crime rate, good schools, and lots of green space. With an office building or retail space, it would mean the property is located in the area's central business district (CBD), is closely located to other amenities like restaurants and banks, and provides easy access to transportation routes.
Class B property is often considered to be just a step below Class A. Typically, these properties are still in a good location and offer decent value. However, they're also usually 15 to 30 years old, which precludes them from achieving Class A status. They also may not be able to offer the same high-end amenities you might find in a Class A property.
It's possible to upgrade a Class B property to a Class A status. Usually, it involves a lot of maintenance and renovation, but it can be a good option for investors with sufficient cash flow who are looking to achieve higher rental values.
While Class A and Class B properties are fairly similar, except for Class A properties being newer and more polished, Class C property is where investors will really start to see a difference.
These properties are usually more than 30 years old and may include subpar construction and/or have an outdated infrastructure. As far as location, these properties may be in an area where crime rates are higher and the school district quality is lower. They also may be further from amenities like restaurants or public transportation.
Lastly, Class D property may be the same age range as Class C property. However, these properties often are neglected. They often require significant renovation to be considered inhabitable. These properties are often in areas with higher crime rates, lower-rated school districts, and with fewer amenities.
Why do property classes matter to investors?
Since property classes are subjective, you may wonder why they would matter to you as a real estate investor. Property classification is a way for you to gauge the overall potential of an asset as an investment property. After all, each property class has its own unique potential for risk and reward, and while every investor must make their own determination of whether that risk is worth it, knowing a property's asset class can make the decision-making process easier.
For example, if you're an investor who wants to be mainly hands-off, you may want to focus your search on Class A properties. Anything lower will have an older infrastructure and need a lot more routine maintenance.
That's not to say ranking a property by real estate asset class should be your only weighted factor in determining whether to pursue an investment opportunity, nor should it replace calculations like net operating income (NOI) and cap rate. However, property classifications are a good way to help you narrow down your search and give your real estate agent an idea of the type of properties you're in the market for this time around.
How to determine which property class is the best fit for your investment strategy
The next step is to help determine which property class is the best fit for your investment strategy. We've summarized each property class from an investor's perspective. Read them over so you can determine which one is the best fit for your return objectives.
Class A properties tend to have the highest property values, which means they garner the highest amount of rental income. However, they come with the highest upfront and recurring costs, which means your returns might be lower than you might expect.
In addition, there's a good chance there will be fewer renters in the market for this type of property. Generally, those who can afford a Class A property have higher incomes, which means these properties are more likely to be owner-occupied than by tenants.
Overall, Class A properties are usually the best bet for investors whose main objective is to create a stable passive income, rather than focusing on achieving the highest returns.
In general, Class B properties tend to be the most popular among real estate investors. Since this property type is older than Class A, it often comes at a lower cost overall. However, because it can potentially be upgraded, there's also the potential for generating more rental income in the future.
Additionally, these properties are more likely to be filled with tenants as opposed to owner-occupants. But renters of Class B properties tend to have decent jobs and relatively stable incomes. This potential also means that there will be more competition for these properties.
Meanwhile, since Class C property is older than either Class A or Class B, it usually requires the most maintenance, which means owners need to be prepared to be more hands-on to keep things up and running. Also, since these properties tend to be in lower-income areas, they tend to experience higher turnover and vacancy rates than either of the two higher property classes.
Overall, Class D property is usually not a good fit for the buy-and-hold investor. Typically, these properties need too much work to become habitable again. Instead, they might be a good fit for an investor using a fix-and-flip strategy.
Since property values are so low in these areas, you can usually get Class D properties for a discounted price. However, before you buy one of these homes or commercial buildings, do your due diligence to make sure the area is actively in transition.
The Millionacres bottom line
Ranking property by its real estate asset class is more of an art than a science. Still, property classification can be a useful tool for investors when searching for new properties to add to their portfolios.
With that in mind, use this as your guide to real estate property classification. Armed with this knowledge, you should have a better idea of what class of property will be the best fit for you.