The commercial real estate industry uses a lot of lingo. This can seem daunting for first-time investors looking to make sense of different property types. One of the ways to distinguish amongst property types, for instance, is by a property’s “class” rating. Generally speaking, properties are classified as either Class A, Class B, or Class C properties. This is true across all asset classes, regardless of whether you’re referring to office buildings, retail centers, apartment buildings, or industrial and warehouse facilities.
In this article, we look at the distinguishing characteristics of Class A vs. Class B vs. Class C real estate. Any prospective investor should understand the differences between product types prior to investing in a deal. We’ll then look at specific keys to success for investing in any one of these property classes.
Features of Class A Real Estate Properties
Although there is no universally-accepted definition of a Class A (or Class B or Class C) property, most in the industry consider Class A buildings to be newer with higher-quality finishes, amenities and accessibility. Class A properties tend to be located in the urban core, and oftentimes have their own brand or lifestyle associated with them.
Class A properties tend to be extremely desirable, investment-grade properties with the highest quality construction and workmanship, materials and systems. They often contain unique architectural features, robust services and other amenities, and utilize first-rate maintenance and management.
Class A properties are also distinguishable for the tenants they attract. Most Class A properties will be occupied by prestigious, highly credit-worthy tenants that are willing to pay above-average rental rates. Class A properties are frequently bought and sold by national and international investors, including institutional investors such as life insurance companies and pension funds, who are willing to pay a premium for quality assets.
The desirability of Class A buildings means that they provide more liquidity than Class B or Class C properties. In other words, there is enough consistent interest in Class A properties that an investor can expect to have an easier time selling the property than if they were trying to sell a Class B or Class C property in the same market.
For all these reasons, Class A properties are considered to be one of the “safest” additions to an investor’s portfolio (but conversely, offer some of the lowest returns in exchange for this lower risk profile).
Features of Class B Real Estate Properties
A Class B real estate tends to offer more utilitarian space with fewer amenities than one would find in a Class A building. It will typically have ordinary architecture design and structural features, with average interior finishes, systems, and floor plans. The systems will be in adequate condition and the property will be structurally sound, but not overwhelmingly impressive.
The maintenance, management, and tenants in a Class B property are considered good (but not necessarily great). Class B properties may also be less appealing to tenants, in general, as the buildings may be deficient in a number of respects, such as floor plan configuration and building or facility condition. Tenants may be less established, have lower credit, or may be unable to sign longer-term leases. Therefore, while Class B buildings tend to attract broad interest among a wide range of users, the rents these tenants are willing to pay tends to be less than what Class A properties can command.
Class B properties are often considered more of a speculative investment than their Class A counterparts. Class B properties will occasionally attract attention among national investors, but most investors tend to be local to the marketplace.
While Class B properties tend to be considered a “riskier” investment than Class A properties, there are still several benefits to adding a Class B building to your portfolio. Namely, well-located Class B properties can generally be purchased at a lower price (and therefore, have a lower barrier to entry), and can be renovated to Class A condition over time. As building improvements are made and leases turn over, the new owner can increase rents and improve the tenant mix. With thoughtful value-add strategies, an investor can realize greater returns through Class B properties than they might be able to achieve by investing in Class A buildings in the same market.
Features of Class C Real Estate Properties
Class C buildings can be highly lucrative for those with a solid investment strategy, but these properties are certainly not without their risk. In fact, Class C properties are considered the riskiest of the three property classes featured here today.
One of the reasons for the additional risk is that these buildings are generally older (20+ years) and in need of significant renovation. Many will show visible signs of deterioration, such as overgrown landscaping or crumbling building facades. These properties, because they are older, will usually include few, if any, on-site amenities.
Compounding the risk is the fact that Class C multifamily buildings tend to be located in less desirable locations. They may be farther from major employment centers and/or in areas with high crime and few neighborhood amenities (e.g., grocery stores, pharmacies, restaurants, parks and playgrounds). Often, those who live in Class C buildings do so only because they are more affordable than the alternatives.
Class C properties, however, offer the potential for the highest cash flow out of these three property classes. This cash flow is hard-earned, as these buildings are often management intensive.
Five Primary Indicators of Real Estate Property Class
There are several factors that affect a property’s classification, including location, the age of a building, property condition, amenities and occupancy. These factors should be considered generalizations, as there are almost always exceptions to each of the “rules” below.
1. Location
A property’s location is one of the biggest driving factors of its classification. As noted above, Class A properties tend to be the most well-located. These properties will have easy access to major employers, hospitals, universities, and arts and cultural amenities including retail and restaurants. They will usually (but not always) be located in areas with good school districts and low crime. The reason for this caveat is that some Class A properties are located in highly desirable urban locations where the school districts might otherwise be inferior to some of their suburban counterparts. That said, many of those who live in Class A multifamily buildings will sacrifice school district for location, opting to send their children to private or charter schools instead.
Class B and Class C properties are generally in less desirable neighborhoods. Again, this is not always the case. A Class B or Class C property – whose classification is instead driven by its age, condition or lack of amenities – may have an excellent location but the building itself otherwise leaves much to be desired.
2. Age of Building
The age of a multifamily property will also influence its classification. Class A buildings tend to be newer (often, new construction), whereas Class B and Class C properties are usually older. Class C properties will usually be 20-30+ years old.
However, another exception to this “rule.” An older building, such as a historic property, can still earn Class A status if it meets the other criteria listed here. Older buildings are often gut renovated to include high-end finishes and other amenities akin to their newly-constructed peers.
3. Property Condition
A property’s condition is one of the leading factors of its class. A property that has been fully renovated and upgraded with high-end finishes is more likely to achieve Class A status than a multifamily property that is old, weathered and in need of both cosmetic and structural repairs. As a result of property conditions, Class A and B properties tend to need less maintenance than Class C buildings.
4. Amenities
Class A properties will usually offer robust amenities. In the multifamily realm, this could mean an on-site fitness center, media room, concierge, underground or otherwise covered parking, outdoor pool, doggy daycare and more. The larger the apartment community, the more robust the amenities will tend to be. Class B and Class C properties usually have fewer, if any, amenities to offer residents.
5. Occupancy
Occupancy is a key factor in determining a property’s class. Class A properties tend to attract the most qualified tenants: high-income earning professionals. Class A buildings appeal to the masses, and therefore, will usually have very low vacancy. Class B and C properties usually have less desirable tenants (typically, people who earn less) and may have more variable occupancy levels. Of course, there are exceptions to this rule as well. Class B and Class C properties may also attract high-income earning professionals who are more cost-conscious than their peers.
Conclusion
Once again, it is important to remember that there’s no right or wrong investment strategy. It can be equally as lucrative to invest in a Class A property as it is a Class B property; there are just different considerations to keep in mind, such as risk tolerance, investment horizon, portfolio diversity and access to capital.
