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The ABC’s of Real Estate Asset Classes

by Engelo Rumora on June 28, 2014 · 20 comments

  
The ABC's of Real Estate Asset Classes

Real estate experts and investors share different perceptions when it comes to ranking property and area classes.

Most will rank them on a general scale from Class A to Class C with others going as far as from Class A to Class F. Including lower subcategories of each class such as A-, B-, and C-, etc… Different states and cities can also offer variations on how the “classes” are ranked.

I prefer to stick with the KISS (Keep It Simple Stupid) approach and will only rank a particular area/property as either “A, B, or C”.

Please see below how I distinguish the different area and property classes in Toledo, Ohio- a market we are heavily active in.

The Class “A”

These properties are top of the line.

They are newer built homes with the majority of them situated on large river front lots. The properties are very well-maintained and posses a “WOW” factor, when driving past you can’t stop the thought of wishing you lived in one of them.

Related: What A “Working Class Neighborhood” Is … and Isn’t

Class A properties in Toledo are located in sought after school districts, are within a short commute of medical/shopping facilities and have ease of access to all major highways.

Owner-occupiers mostly reside in these properties with only a minority being tenanted. The cashflow tends to be low with a high potential for growth due to a high demand from home owners who’s decisions tend to be emotion based.

The Class “B”

I believe that Class B properties should be the bread and butter for every hands-off investor.

They can range to be anywhere from 30 – 60 years old and are mostly occupied by blue-collar working class people. While driving around you might find the odd vacant home with an overgrown yard but in general the area is very well kept.

The school zones tend be slightly less prestigious but the close proximity to all amenities makes the area very similar to Class A. The residents equal out to 50% owner occupied with the other 50% investor owned and tenanted.

Due to the cashflow, growth potential and exit strategy offered, Class B properties should be the foundation for every investor looking at building a substantial property portfolio.

The Class “C”

These properties fall into the highest risk category but can also be very lucrative investments with a right strategy and system is in place.

WARNING: Unless you have an armored vehicle I don’t suggest you drive in this area after 5pm.

All joking aside, most of the Class C homes are much older than the higher ranked areas with some dating back as far as the 1880s. Some of them show visible deterioration and a higher portion of them are bordered up.

Related: How to Find Great Working Class Neighborhoods to Invest In Using The “Leveraged Analysis Technique”

These properties are predominantly investor owned and are occupied by lower income tenants. They offer by far the highest cashflow out of all the classes, but require full time monitoring and management.

The property manager needs to specialize in this particular area in order for the numbers to work. In my opinion this Class should only be considered once a solid portfolio has already been built with Class B properties that are performing and generating a decent monthly cashflow.

Conclusion

A great portfolio needs to be built on strong foundations by acquiring B Class properties with the lowest amount of debt possible.

Once a strong foundation has been established and a decent amount of cashflow is generated each month, you can then consider to take on more risk. By using leverage and diversifying into the Class C area you will further increase monthly cashflow which will enable you to grow your portfolio at a quicker rate.

One of the most vital components, no matter what class you decide to invest in, is to have the right property management in place looking after your best interests.

Smart investors base their decisions on the numbers in the deal and focus on building a team that can make those numbers work. Capital growth is a prediction and if it occurs should only be considered as a bonus.

As far as Class A properties go- they should just stay as the “WOW” factor and instead of telling yourself “I wish I lived there” —once you have built a grand portfolio, you can!

What class do you primarily invest in?

Be sure to leave your comments below!

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{ 20 comments… read them below or add one }

Alex Craig June 28, 2014 at 11:22 am

Out of state buyers need to beware when sellers classify property by class. I find in my market that most sellers boost their classification by 1 grade. Meaning they will call a C class property a B property. Funny enough I see many sellers calling C class properties when they should be D or F.

BTW, I recommend not buying C class property as a out of state buyers. Most managers do not know how to manage these properties. C class Management is much different then A and B class property.

Reply

Engelo Rumora June 28, 2014 at 11:27 am

Hi Alex,

Thanks for reading and commenting.

Yes and Yes, it sure does take a very unique manager to make the numbers work in C class.

A very aggressive and no BS attitude is needed.

What market do you work in?

Thanks and have a great day.

Reply

Alex Craig June 28, 2014 at 12:22 pm

I work in Memphis and Little Rock.

Reply

Dominique June 28, 2014 at 11:41 am

Great blog, Engelo! Thanks for sharing!!!

Reply

Engelo Rumora June 28, 2014 at 12:32 pm

Awesome,

I have seen quite a few turnkey outfits working the Memphis market. Looks like you guys have some great numbers there.

Thanks

Reply

Eric June 28, 2014 at 1:59 pm

I have seen far too many RE investors go after a Class C (or D), thinking they have great returns, and suffer so much maintenance expenses that they go broke.

If you rent to the subpar caliber renters, you better know how to get them in, how to get them out, and how to maximize revenue.

Reply

Engelo Rumora June 28, 2014 at 5:35 pm

Thanks Eric,

I couldn’t agree more.

It is a completely different world once you go down the ranks of property/area classes.

Very rarely will a check for the rent arrive in the mail. Most of the time its the door banging rent collection sessions lol

Thanks and have a great day.

Reply

Vania June 28, 2014 at 5:56 pm

Engelo,

Thank you for your very concise explanation regarding the different types of properties.

Very useful information!

Reply

Engelo Rumora June 28, 2014 at 6:00 pm

My pleasure Vania,

This is blog is based on my opinion and how I differentiate the properties/areas in the Toledo, Ohio market and also other markets that I have been involved in.

Thanks for your comment and have a great day.

Reply

joseph ball June 29, 2014 at 6:44 am

I agree with the author comments.
And I believe one should have one or two “Class A” properties (negative cash flow, but strong appreciation potential), most “Class B” properties (moderate cash flow), and several “Class C” properties for strong cash flow, no appreciation.

Reply

Engelo Rumora June 29, 2014 at 4:38 pm

Thanks Joseph,

Your comment is much appreciated.

Thank and have a great day.

Reply

Mehran Kamari June 29, 2014 at 4:19 pm

Love this article, thanks Engelo!

“One of the most vital components, no matter what class you decide to invest in, is to have the right property management in place looking after your best interests.”

I couldn’t agree more on this!

Reply

Engelo Rumora June 29, 2014 at 4:42 pm
ggg June 29, 2014 at 6:35 pm

good comment Joseph. We have a mix of A,B, and C properties and that balance works well for us. C properties are a challenge but we use an experienced PM. One day down the road we’ll probably offload them but right now they ensure our cashflow is more than sufficient to build liquid savings to purchase more and cover losses that the A’s and B’s might have on rough months.

Reply

Engelo Rumora June 30, 2014 at 5:57 am

Thanks ggg,

It seems like you have a very sound strategy.

Thanks for sharing and have a great day.

Reply

Kay Khan June 30, 2014 at 1:16 pm

Thanks Engelo for this educational article. I invest in Detroit (I know, class C) and having problem with management. Since you are in Toledo can you suggest some strategy or a crash course in class C property management. Thanks in advance.

Reply

Engelo June 30, 2014 at 2:25 pm

Hi Kay,

Thanks for your comment.

When dealing in lower income areas it is crucial for the property manager is flexible and needs to be very active. When the tenants call to offer rent collection he must not postpone and needs to go to the property immediately. “You snooze, you loose” as the saying goes.

I have witnessed on many occasions PM lack of response to the call and when they are ready to collect the tenants had another expense pop up and they shorted the rent or don’t pay at all. As you can imagine this will cause dramas for all involved.

Before a tenant moves in make sure to eliminate any upfront issues that you predict might occur during the tenants stay. This will won’t give them excuses to short or not pay.

Spend the time to network and establish a relationship with a PM that has been working in this type of market for a while and maybe even owns properties in the area.

You will find that they need to posses a fearless and alpha male type character.

Most tend to be a bit wacky to be honest with you. Suit and tie won’t cut it in these areas.

Don’t expect to have fancy online management systems and statements might might be a problem for these guys.

This has been my experience with PMs in the lower class that actually perform and make the numbers work.

I hope I helped a bit.

Thanks and have a great day.

Reply

joseph ball June 30, 2014 at 8:11 pm

Kay Khan,
I think the best answer to investing Class C properties in Detroit is a ten year-old boy with a box of Red Diamond kitchen matches.
Good luck!

Reply

Bob P October 8, 2014 at 9:07 pm

In my neighborhood, (Calabasas, CA) the ‘working class’ B homes (the one’s I’m working on buying) have a median resale price of $1.15m, with the A’s going upwards of $15m. And that $1.15m only buys you 3800sqft on a 7000ft lot. The very few C’s are around $600k+, and you’d call them a “C” only based on size and age… there’s really no such thing as a bad neighborhood here.

Reply

Engelo Rumora October 9, 2014 at 5:56 am

Hi Bob,

Thanks for your comment.

Those are some big figures.

$15million would buy three 30 story building in downtown Toledo, Ohio haha

Thanks and have a great day.

Reply

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