- A property class is based on characteristics like the condition, location and age of a property.
- Investors should familiarize themselves with the classes of property real estate.
- There is not a one-size-fits-all formula when it comes to the best property class for your first investment deal.
Do you remember being in school and getting letter grades based on your work? There may not be letter grades within real estate investing, but there is a system of classification used to determine the quality of a given property. Real estate investors often use a property class to analyze the potential of a given deal. However, unlike in school, the highest property class does not always indicate the best deal. Keep reading to learn how to use a property class to determine the best property type for your first investment.
Real Estate Property Classes
When it comes to the classes of property real estate, the guidelines are relatively easy to understand. Real estate investors will look at a number of characteristics such as location, age of the property and its overall condition to assign a class. Investors can then use that information when searching for properties or when considering whether or not to move forward with a particular deal.
It is important to note that assigning a property class is a subjective process, and it may vary between two investors. Be aware of those who may try and sell properties based on a high (or low) property class rating, as you may have a different understanding of that category. That being said, for the most part there are characteristics that fit cleanly into different property classes; as an investor, it is important to understand what those are. The different types of property class are as follows:
- Class A
- Class B
- Class C
- Class D
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A Class A property can often be classified as a newer build in good condition. Class A properties are often built within the last ten years, or are fully renovated historical homes. These properties are often in highly desirable areas, such as popular neighborhoods or up-and-coming locations. Class A properties will usually possess top of the line features such as stainless steel appliances or hardwood floors. Because of their high quality condition, investors and property owners will find that vacancies are often low with Class A properties.
Given that Class A properties are high quality, one can also assume that they come at a higher purchase price when compared to a lower quality property. This can be a downside for first time investors working with more limited funds, especially because a higher purchase price can equate to lower cash flow. On the other hand, Class A properties can make ideal buy and hold investments due to their low-maintenance nature.
There are specific features you can look out for when it comes to a Class B property, namely that they will often be similar to a Class A property but will be slightly lower in quality. For example, a Class B property is typically older than a Class A property and are often around 10 to 30 years old. They will feature some amenities similar to Class A properties, but they aren’t required to. Additionally a Class B property will often still be located in a popular location featuring good schools and the potential for market appreciation.
A Class B property may have similar features to a Class A property; however, because they often require more maintenance the acquisition costs are often much less in comparison. This makes Class B properties attractive to a variety of investors, particularly those looking to put in a few improvements and upgrade to a Class A property. As a whole, Class B properties can be thought of as having lower upfront costs but with the potential for steady cash flow and appreciation over time.
A Class C property is often an older build with the need for quite a bit of maintenance. These properties will usually have outdated plumbing or electrical systems and contain the original appliances. A Class C neighborhood is often in a lower-income area when compared to a Class A or Class B property; consequently, the rent in these areas will be lower when compared to other options.
You may be wondering why investors would consider a Class C property as an investment, and the short answer is lower acquisition costs. Due to the condition of Class C properties, they will often be easier to acquire upfront, though investors may find fewer financing options when pursuing a deal. All things considered, Class C properties can offer high cash flow and unique opportunities for investors.
Finally, there are Class D properties to consider. These are often older buildings, sometimes the same age or older than a Class C property, but with more neglected features. A Class D property often needs a significant amount of repairs, and may be uninhabitable until such repairs are completed. Class D properties can often be found in less than desirable locations and because of this investors may have a hard time attracting reliable tenants even after a considerable amount of maintenance.
Class D properties can provide opportunities for seasoned fix and flip investors with a strong understanding of the market area. Investors often think of Class D neighborhoods as unsafe areas, and will commonly run into tenants with lower incomes and credit. Investors who are seeking to fill the role of property manager may find Class D properties especially difficult to work with. That being said, they are the cheapest to acquire when compared to other property classes and can yield the highest rent-to-price ratios.
What Makes A Great Real Estate Investment?
There are a number of factors to consider when looking for a great real estate investment. Though there is not one formula for finding the best investment, you can count on one piece of advice: landing the perfect deal will depend entirely on your situation and goals in real estate. That being said, the purpose of understanding property class distinctions as an investor is to help familiarize yourself with the potential of a given property or deal in real estate.
When looking at the above property classes, you should be careful to consider your financing options and initial investment. This could make the difference between moving forward with a given property or walking away. Additionally, it is important to recognize that when it comes to financing properties you may find less options available as you go through lower property classes.
On the other hand, investors may find a higher rent-to-price ratio when it comes to a lower property class. This is a result of the low acquisition costs and high rent potential. Some investors will even suggest that a Class C property might make the best property type for a first time investment. Although, there is something to be said for higher quality properties, even if they come with higher acquisition costs. First-time investors looking to invest in passive income properties may find more luck with a Class A property.
All in all, first-time investors should seek to gain a solid understanding of the different property classes. They can help prepare you to analyze deals, classify neighborhoods, and determine whether or not a property matches your investing goals. Investors who familiarize themselves with property class distinctions may also find themselves less likely to get roped into a deal based on an incorrect property class designation. With anything, mind due diligence and pay attention to situational factors when considering an investment. A property class can provide a great guideline for investors of all experience levels.
Which property class sounds like the most appealing investment to you? Leave a comment below with your reasoning.