04.11.14 ABC's of Classifying Neighborhoods

Recently someone asked me what neighborhood class my properties are. I’m never sure if they are class C or class D. I decided to do some research on neighborhoods which brought me back to forum posts on Bigger Pockets.

I learned that the letter grades vary by area, can sometimes be more of an art than a science, and are easier to nail down for multifamilies.

But here’s some characteristics:

“A” Class properties are in newer growth areas, are in nice neighborhoods, are newer properties built within the last 15 years with the most amenities. They command the highest income earning tenants, lowest vacancies, and highest rents with no deferred maintenance. They generally have the most appreciation potential, but lowest cash flow starting out.

“B” Class properties consist of properties in older stable areas, are in a slightly less desirable neighborhood, are built in the last 15-30 years, still nice, with some amenities. Rents will be a bit lower than the A Class properties with low deferred maintenance. Some feel this is a blue collar neighborhood, some call it a mix of white collar workers and more skilled blue collar workers. Class B properties are typically owned by Institutional investors and private investment groups, or very high net worth individuals. They make great rentals because they usually have appreciation potential with decent cash flow on acquisition.

“C” Class properties are in older, declining, or stable neighborhoods, are not the most desirable areas, are typically older properties, built 30+ years ago with much fewer amenities, if any. Rents are lower than B Class buildings and usually have more deferred maintenance and a lower occupancy rate. The neighborhood has some boarded up properties, low rate of home ownership, and a vibrant neighborhood (think lots of people out on their porches during the day). The tenant base is blue collar service employees and government-subsidized tenants. These are considered the bread and butter for rentals, with higher cash flow and CAP rates, but normally much lower appreciation. Landlords disagree on whether these are desirable properties to own.

“D” Class properties are older, declining, potentially rapidly declining areas, characterized as bad/challenging neighborhoods, are older run down properties and potentially dangerous areas (war zones). Properties are older, with no amenities, have high deferred maintenance, functional obsolescence (small, one bathroom), and the tenant base can be very challenging and very management intensive. These properties will usually have double digit CAP rates, but will not have appreciation potential. D Class properties are the most challenging, and definitely are not recommended for most investors, especially new investors.

While some of the D class characteristics resonate, I think my investment neighborhood would be considered a C by most investors.