(This advanced blog summarizes real estate investing tips and insights Lofty AI has acquired from working with thousands of investors and institutional funds.)
Why different property classes?
Property classes were created to distinguish between different types of commercial properties.
The different types of commercial properties include
The class grades are somewhat subjective.
There isn't an exact science to what qualifies as a Class A property compared to a Class B property.
It's more of an unwritten rule.
When you've been investing in real estate for a while, it's a "you know it when you see it" type of situation.
Property classes were originally created to give investors a back-of-the-napkin glimpse into the quality of a property before diving into the numbers and performing due diligence.
Property classes also help distinguish a property's potential risk and return.
Properties are classified based on factors such as:
Tenant income levels
It's important to understand the different property classes. Knowing them will save you time and help you develop a scalable, repeatable investment strategy.
It's also important to understand that property classes aren't set in stone.
Just because you own a Class C property today, doesn't mean it can't become a Class B property in the future.
You just need to put in the work to get it there.
Class A properties
Class A properties are the highest quality, newest buildings in their area and are typically owned by institutional investment funds, as they're often very expensive.
Class A properties are surrounded by the best restaurants, the best schools and the wealthiest people.
These properties are typically less than 10 years old and have very modern amenities.
They also attract the highest quality tenants and command the highest rents.
Class A office buildings
An example of a Class A office building is the The Warner Building in downtown Grand Rapids (pictured below).
Class A office buildings are not for the everyday buyer, and typically cost over $100 million. If you take a look at the New York City skyline, almost all of those properties are Class A office buildings.
Class A offices are almost always owned by Real Estate Investment Trusts (REITs) or institutional investment funds such as Blackstone.
Their tenants are generally very well established companies that tend to sign long-term leases.
Class A apartments
An example of a Class A apartment is the Emerson pictured below.
The Emerson is a newly constructed 355‐unit Class A multifamily property located in Centreville, Virginia.
This property was purchased by Hines Global Income Trust for $117 million and contains plenty of high-end amenities such as a brand new gym, lobby, restaurant, and more.
Like Class A office buildings, Class A apartment properties are also owned by REITs and institutional investment funds.
These properties command the highest rents in their area.
The tenants that make up Class A apartments are of the upper-class, and typically bring in over six figures per year in income.
Class A retail properties
An example of a Class A retail property is the Westfield Mall in Seattle, Washington.
These Class A properties are generally bought by retail REITs and the individual stores are leased out to Class A tenants.
Within this particular mall, there are 225 retailers including Apple, Coach, The Disney Store, Microsoft & more.
Class A retail properties don't have to be malls with a large number of different stores located within. Most high-end restaurants and expensive shops can be classified as Class A retail properties.
Class B properties
Class B properties are slightly older than Class A properties at around 15-30 years.
They lack the shine of Class A properties and are usually situated in middle to upper-middle class neighborhoods. This means that the rental income is lower than you'd find with a Class A property.
Savvy investors see Class B properties as “value-add” investment opportunities. They'll buy the property as-is and perform renovations and improvements to common areas. Their goal is to hopefully bump this Class B property up to a Class A property and sell it for an absurd profit.
You are typically able to buy these properties at a higher cap rate than a comparable Class A property because of the higher risk involved.
Class B office buildings
An example of a Class B office building is the office space in Gaithersburg, Maryland, pictured below.
This office space was built in 1973 and is located within walking distance to a Class B retail shopping center.
Class B office buildings tend to be rented out to startups, companies that only work in an office part time, and freelancers.
They command lower rents than Class A office buildings and tend to be situated in middle class neighborhoods.
Class B apartments
An example of a Class B apartment is the The Apartments at Mark Center in Alexandria, Maryland.
Class B apartments tend to have dated amenities both on the exterior and interior of the property.
They generally have good quality construction with little deferred maintenance.
Class B apartments command lower rents than Class A apartments, typically from middle-class tenants working blue-collar jobs.
Like Class B office buildings, Class B apartments aren't typically owned by REITs or institutional investors. Instead, they're often bought by a group of investors called a syndication, or by small-to-mid size private equity funds.
The goal of these syndications or small PE funds is to add value to the Class B apartment, allowing them to bump up the rents and project a strong Pro forma.
They'll then look to sell the property to another syndication or fund for a substantial profit.
Class B retail properties
Class B retail properties are your classic strip malls in middle to middle-upper class neighborhoods.
They'll usually have an anchor tenant such as a grocery store, which serves as the main foot-traffic source for the strip mall.
Other tenants in Class B retail properties include, for example, Subway, Panda Express, Little Caesars, Nail salons, and the like.
An example of a Class B retail property is this small strip mall below in Wynantskill, New York.
Class C properties
Class C properties tend to be over 30 years old and are usually located in lower-income, less desirable areas.
These areas tend to attract those on government subsidies or working low-wage jobs.
Class C properties are typically in need of significant renovations before they're able to generate a steady cash flow for investors.
These renovations include:
Updating the building infrastructure
A Class C building can sometimes be renovated to become a Class B building. It is very unlikely for a Class C building to ever become Class A property due to its smaller size and less desirable location.
For a Class C building to become a Class A building, you would need to add significant value and renovations while the surround neighborhood gentrifies simultaneously.
When you buy a Class C property, you’ll likely find a lot of check-cashing businesses, pawn shops, bail bond stores, and 99-cent stores nearby.
Class C office buildings
An example of a Class C office building is the Plaza Office Center in Arlington Heights, Illinois, which was built in 1980.
Class C office buildings have the lowest rental rates, take the longest time to lease, and are often targeted as re-development opportunities.
Some Class C properties remain occupied by tenants. But, they command lower rental rates and attract tenants with smaller operations that cannot afford nicer spaces.
They also attract tenants that don't need their businesses to be located in centralized hubs.
Other Class C buildings are sold as rehabilitation opportunities.
Class C apartments
Like Class C office buildings, Class C apartments are located in less than desirable areas. They require extensive renovations before they're able to generate cash flow for investors.
An example of a Class C multifamily property is the Woodridge, a 30 Unit Class C Apartment Building in Mesa, Arizona.
Class C apartments are typically rented by blue-collar and low-income residents, and the rents are below market.
You’ll find many residents that are renters “for life” living in these apartment complexes. You'll also find tenants that are just starting out, who will eventually work their way up the rental scale.
Class C Retail property
Class C retail properties tend to be located in low-income neighborhoods
The rents are typically below market and you'll often see bars covering the windows because of constant crime in the area.
When a neighborhood is starting to gentrify, you'll often see new retail shops opening as the first sign.
If you happen to come across a micro-neighborhood that has, for example, a new coffee shop located next to Class C retail properties, that's usually a good sign of future revitalization.
Examples of Class C retail properties are:
Check cashing stores (pictured below)
Bail bonds stores
Class D properties
Class D properties are located in crime-ridden neighborhoods that you would not want to travel to alone.
There is typically rampant drug use, crime, and vacant properties in these neighborhoods.
A Class D building is old, just like a Class C property, but is worse in every way with far more neglect.
Class D properties can sometimes be located within pockets of Class C neighborhoods.
But in most cases, they're located within an entire Class D neighborhood. Typically, the tenants are low-income earners and/or live in subsidized housing.
We're not going to show pictures, because you can probably imagine a run-down property with broken windows and graffiti on the sides of the building.
Generally, Class D properties require significant repairs before they're considered live-able.
You might be thinking that Class D properties have a lot of upside potential after renovating. This is true, but you have to keep in mind that even if you renovate a Class D property, that property will still be located in a Class D neighborhood with rampant crime and drug use.
The only time you should think about purchasing a Class D property is if you're able to see early signs of gentrification in the surrounding area.
If you're able to purchase a Class D property in a neighborhood like Williamsburg or The Arts District in Los Angeles before the gentrification occurs, you can double or triple your investment in just a few short years.
This has worked for plenty of investors in the past, but it's one of the hardest things in real estate investing to pull off.
Which property classes should you invest in?
Unless you're a REIT, Blackstone, or involved in a massive syndication, you're not going to be able to afford Class A properties.
That leaves you with Class B and Class C properties.
Your goal: find a Class C property in a Class B neighborhood that you can add value to that will also benefit from rapid neighborhood appreciation.
You also want to find a property that is being mismanaged and neglected by an out-of-state owner. Often when this is the case, the rents are below market for no reason, and you can come in and bump them up immediately.
If you're lucky enough to find a mismanaged Class C property in an up-and-coming neighborhood that you can add value to, you're going to make more money than you know what to do with.
It's not impossible, but it's extremely difficult. You're definitely not going to find one of these diamonds in the rough by surfing listing sites and driving around searching for them.