Real estate is categorized as being either class A, B, C or D. These classifications are used by investors, lenders, and brokers to communicate the quality of an investment property or location.
While not hard and fast rules, there are several things to look for when determining a property’s class. These factors include: age, tenant income, area growth, appreciation rates, rent rates, amenities, and construction quality.
Class “A” Multifamily Properties
Class A properties tend to be built within the last 10-15 years. Because of their age, they are in top condition and have no deferred maintenance. Class A tenants have higher incomes and are able to pay higher rents.
The landscaping, rental office, club building, and other amenities are nicer than all other classifications. In comparison to other properties, the cost per unit will be the highest in the area and the property will have a low Capitalization Rate (CAP Rate), around 2% to 4%.
Class A properties are often owned by Institutional investors – such as Real Estate Investment Trusts (REIT). Because of their higher rents and construction expenses, they won’t cash flow as well starting out but will appreciate faster.
Class “B” Multifamily Properties
Class B properties typically are 15-20 years old. They have rents lower than Class A properties. Because they are more affordable, they tend to be rented by a mix of white collar and skilled blue collar workers.
Often there is a little deferred maintenance and a more moderate amenity package. These both provide opportunities for improvement projects after purchase.
These properties usually cash flow better than Class A properties. Because they tend to be of higher quality, they still have appreciation potential and a higher cap rate.
Class B properties are often owned by Institutional investors, high net worth individuals, or private investment groups – like East Elm Real Estate.
Class “C” Multifamily Properties
Class C properties usually are 25+ years old. They have dated exteriors and interiors with limited-to-no amenity packages.
Rents will be lower than Class B properties. Class C properties have some deferred maintenance. Because of their quality, they usually have lower occupancy rate. Tenants may include mostly blue collar workers and could include government-subsidized tenants.
These properties are mainly owned by private investors and private investment groups. Class C have higher cash flow and CAP rates but will have lower appreciation potential.
Class “D” Multifamily Properties
Class D properties are older buildings, in mediocre locations, with potentially dangerous neighborhoods. They have a high amount of deferred maintenance with no amenity package.
The construction is of poor quality. The various system components usually are at the end of their lives. Tenants include low income earners and generally government-subsidized individuals.
Due to the tenant mix, Class D properties can have challenging tenant and management issues. The rents are on the lower end of the market and the properties have higher turnovers.
Class D properties have high CAP rates without much appreciation potential. Though they will have a high amount of cash flow, these are often wiped out by repairs and other tenant related expenses.
The assignment of property classes are arbitrary and the descriptions are used for communication more than anything else. The classifications can be quickly summarized the following way:
- A – newer, growth areas
- B – older, stable areas
- C – older, declining, or stable areas
- D – older, declining, potentially rapidly declining areas
We look for properties that are attractive to renters and have high appreciation potential. The sweet spot includes apartments fitting within the C- to A- quality range. We prefer to find a lower quality property in a higher quality area. This provides a lot of room for value growth.