What are property classes?
What do properties classified as Class A, Class B, and Class C mean, and why does it matter? This is a regular question we get from our investors. To begin, investors, lenders, and brokers established property classifications to make it easier for them to communicate quickly about a property’s quality and rating. Property class is a significant consideration for investors since each class carries a distinct level of risk and reward. Investors can use the distinctions in property class types to think about how each property fits into their overall investment strategy, such as their return objectives and the level of risk they’re willing to take to attain those returns.
What determines a property class?
Each property classification reflects a different level of risk and return, which is impacted by a a combination of geographical and physical factors. These letter grades are given to properties based on a number of characteristics including the property’s age, location, tenant income levels, possibility for appreciation, amenities, and rental income. There is no exact formula for classifying properties, however below is a breakdown of the most popular classes, A, B, and C:
What is a Class A property?
Class A properties are the highest quality of property in its respective area. Some common attributes of Class A properties include:
- Newer build, typically less than 10 years old
- High quality amenities
- Tenants with high incomes
- Professionally managed
- High rent per sqft for the area
- Little to no deferred maintenance
Chat is a Class B property?
Class B properties are one tier below Class A. Common characteristics of Class B properties include:
- Older building, commonly 10-20 years old
- Little to no amenities. If there are amenities they are typically outdated but well-maintained
- Tenants earn average incomes for the area
- Possibility that the building is mismanaged
- Average rent per sqft for the area
- Typically some deferred maintenance
What is a Class C property?
Class C properties are one step below Class B properties, and typically have some of these characteristics:
- Older building, typically more than 20 years old
- Little to no amenities. If there are amenities, they are either not usable or require significant renovation
- Tenants earn below average income
- Property has high possibility of mismanagement
- Lower than average rent per sqft for the area
- Property in need of significant renovation; strong possibility of large capital expenditures needed to bring property up-to-date
- Typically higher tenant turnover and vacancies
What is the best class of real estate to invest in?
Depending on which investor you ask, they each may tell you why one class is the best class. Some investors exclusively invest in high quality Class A properties, while other investors love the value-add opportunity of Class C properties. At Coachwood Capital, our favourite asset class is a Class B property located in a global Class A property.
“At Coachwood Capital, we prefer properties that are Class B properties in a global Class A location. We love these properties because they perform well in all market cycles, can be purchased with a value-add opportunity, and have the best cap rates.”Dan Crosby, CEO
Why does Coachwood Capital like Class B properties in Class A locations?
- Demand in all market cycles – When an economy is strong, previous class C tenants upgrade to class B properties; when an economy is poor, class A tenants downgrade to class B properties; and in any economy, class B tenants search for class B properties
- Lowest vacancy rates – Due to the demand in all market cycles and the stability of the tenant base, historical vacancy rates for class B properties are the lowest
- Stable tenant base – Class B tenants typically work jobs such as teachers, nurses, management, etc. Essentially jobs that are staple in our society.
- Possible value-add opportunity – As mentioned above, class B properties commonly are purchased with a value-add opportunity, such as being mismanaged or having deferred maintenance. If a new buyer goes in and cleans up the management and completes the deferred maintenance, the rents can be increased, thereby increasing the value of the asset.
- Better cap rates – A cap rate is calculated by taking the net operating income (NOI) and dividing it by the market value of the property. Class B properties typically have higher cap rates (therefore higher return on investment) with lower risk than class C properties.
What determines a Class A location in real estate investing?
To classify a location as being class A on a global scale, this is what we consider:
- Job growth
- High average home value
- Population growth
- Proximity to water
- Proximity to class A retail/commercial (e.g. Starbucks and Whole Foods)
- Accessibility (e.g. close to major airport)