How to Evaluate A-Class, B-Class, and C-Class Properties
When you speak to any investor regarding property classifications, you are going to get some different answers. Everyone tends to have a different idea as to how to classify a property into these groupings, but one thing can be said for sure—there are some clear-cut classifications when it comes to investment properties.
These classifications are strictly for rental home investments, as the need for property classifications in personal property is unnecessary. These groupings are used by investors to determine if a property meets or exceeds its value and to understand the return on investment rate they may be able to recoup after purchasing the property.
Whether purchasing a property through a traditional method or through turnkey real estate options, you want to be aware of these property classifications. There are generally three groups, although in some cases you may hear investors refer to a fourth—but if a property warrants the fourth classification you need to run away as fast as you can! The three classifications which are considered in real estate investments are A-Class, B-Class, and C-Class.
Just as the grading scale works, the A-Class properties are the highest ranking. They tend to be the more expensive properties to purchase, but collect a higher rental rate, as well. A-Class properties are generally located in areas with newer construction, great school rankings, and are in close proximity to local amenities. These areas are well-maintained and display enticing curb appeal as well as a low crime rate. Incomes in these areas are often much higher than their neighboring counterparts.
When you purchase an investment property in an A-Class neighborhood, it is most likely going to be in good condition and will need minimal repair or rehabbing work prior to renting. The majority of the homes in these neighborhoods are owner-occupied.
In these properties, you can expect to see a 4-6% net cap rate. To determine your cap rate, you need to deduct all of your costs—such as property management fees, insurance, taxes, mortgage payments, et cetera—and then compare that to your initial investment.
B-Class properties are once-A-Class properties that have aged over the years. These are still well-maintained and cared for neighborhoods and will require some rehabbing due to lengthy wear and tear, but shouldn’t be too substantial by way of repair costs. They are often easier to purchase than homes in the A-Class neighborhoods, as there are more on the market and for a lower price. They rent for a steady amount and offer approximately 8-10% cap rates.
These neighborhoods are an even mix of owner-occupied home and rental properties. These areas are in moderate school zones, with objectively low crime rates and steady income levels. While these are mostly blue-collar workers, you will see a mix of income levels across the board as some white-collar residents will have remained in their homes as the neighborhood classification changed over the years.
In general, these are the most sought-after homes for rental property investments as they tend to offer the highest cap rate with a moderate upfront output cost.
C-Class properties are the bottom tier, although, in some cases you will hear of a D-Class property. Generally, these neighborhoods are high in crime and low in school ratings. The areas are predominately rental properties, with very few owner-occupied units. These buildings are often older and require a lot of TLC and consistent maintenance due to age.
While the properties are cheaper to acquire, they are harder to rent. Tenant selection in these areas can be slim and you are unlikely to find a viable tenant for these properties. C-Class properties also see a greater vacancy rate than A or B-Class neighborhoods.
Paper figures, according to the real estate guru website BiggerPockets.com, tend to show in the 12-18% range, but these are approximated numbers and do not take into account the cost of managing a property in these neighborhoods due to vandalism, vacancy, lack of tenant care, and old age.
When it comes to making the decision between classifications, it all comes down to what your ultimate goal is. If you are looking to add a monthly cash flow to your portfolio, then a B-Class property is probably your best bet. However, if your ultimate goal is appreciation and not to add a monthly sum to your income, purchasing an A-Class property will help you to accomplish that goal better than another classification would. As a general rule, avoid purchasing in C-Class or D-Class neighborhoods—especially if you are new to real estate investing.