When I first started working with a Realtor to purchase my first rental years ago, one of the initial questions she asked me was, “What class of property are you after?”
I thought to myself “Class? Am I late for English?”
My Realtor (gently) described that the class of the asset generally indicated the “grade” it would receive based on an A through D ranking (think high school report cards). When I pressured her for more guidance, this was her only advice to me: “Stay away from D”.
So naturally, like a new investor, if D was the worst, then Class A assets must make the best investment. (Who doesn’t like straight As on their report card?!)
Today, I know that is not the case…
Let me explain.
What Does “Class” Really Mean in Real Estate?
Many investors define the asset class purely by the age of the home:
- Class A: Homes built in the last 10 years
- Class B: Homes built in the last 10-20 years
- Class C: Homes built in the last 20-30 years
- Class D: Homes built in the last 30 years
But I find this definition to be too narrow. The class of the asset is far more dynamic than just the age of a property.
It’s much like the color ranking on a ski hill: green, blue, black, and diamond. (OK, diamond is not a color… but hang with me!) This ranking is based on the degree of the slope within the resort. If you are used to skiing blue runs on your home mountain, when you visit another mountain and ski a blue run there, it might feel easier (like a green) or harder (like a black) comparatively.
Why is this? Blue is blue is blue… right?
There is more than just the degree of the slope of the mountain at play here. There is the tilt of the hill, the length of the run, obstacles such as rocks and trees, and other intra-mountain factors at play.
This holds true with defining asset classes town to town. A Class B asset (take my home, for example) in my town would be a Class C asset in a town just 10 miles south of me—and perhaps a Class A asset in a town just 20 miles west of me.
But according to the above definition of age, my home is technically a D property.
Why Does Property Evaluating Asset Classes Matter?
When you properly classify an asset, you can reasonably predict how that asset might perform and what type of tenant would want that asset. The “classier” the overall asset, one could reasonably expect a “classier” tenant.
By understanding the asset class, we can project higher rents, lower vacancy (because the tenant wants to stay and build their life), and lower maintenance costs.
How Can We Holistically Look at the Class of an Asset?
When I search a market, I break down the class of the asset I’m looking for based on four factors to gain a holistic picture of what is going on beyond just the age of the property.
These four factors are:
- The property
- The affordability
- The amenities
- The livability
Characteristics of Class A, B, C, D Real Estate
The Property: Built in the last few years, has luxury finishes, and is in a great area. Maintenance and CapEx are usually very low due to the age of the property.
The Affordability: Rents are usually very high and so are the property values. As a result, high-income earners and well-capitalized investors are usually able to afford these areas.
The Amenities: Usually located next to great amenities (think Whole Foods, Nordstrom, Starbucks, etc.), open spaces and parks, and great schools.
The Livability: Crime is low. When dealing with single family homes, there is great pride of ownership, as the area is mostly owner-occupied.
The Property: Built in the past 20 years in a good area and has builder-grade finishes. Maintenance and CapEx are higher due to the age of the property. Be sure to budget for eventual mechanical upgrades.
The Affordability: On the whole, this asset class has the lowest vacancy rate. Rents are moderately high and attract middle-income earners. The property is also more affordable for most investors. A BRRRR is possible to preserve capital, though harvesting large amounts of equity might be difficult.
The Amenities: There is still good access to amenities, schools, and jobs.
The Livability: Crime is low. When dealing with single family homes, there is still a strong sense of pride since owner-occupancy is high and the tenant mix is less than 25 to 30 percent. In a recession, someone in an Class A asset could live in a Class B asset.
The Property: The age of the property becomes a gray area. The area needs to be strongly evaluated. Generally, maintenance is higher and the property is in desperate need of updating and repair, including mechanical, roof, and other structural components.
The Affordability: Rents are low to moderate, making this asset more affordable to lower-income earners. The property is also more affordable for most investors. A BRRRR is possible to preserve capital and harvest equity due to the problems that can be solved.
The Amenities: Access to good amenities, schools and jobs are not a guarantee. You may see more budget grocery stores, pawnshops, cash checking stores and low to mid-ranked schools in the mix.
The Livability: Crime is moderate and generally non-violent. There may be some sense of ownership as the tenant mix approaches 50 percent.
The Property: This class is oftentimes called the “war zone.” The neighborhood is older or in a serious stage of neglect.
The Affordability: Properties are inexpensive but to the untrained eye seem to cash flow well. Yet repair costs and other expenses are also very high (making you wonder if the cash flow is even worth it). Rents may be largely subsidized. There may be little to no capital preservation with this class of asset.
The Amenities: There is no decent access to good amenities, schools, or jobs (if the tenant even has a job).
The Livability: Crime is high and oftentimes violent. Tenant mixture is approaching 75 to 100 percent with very low pride of ownership. Even law enforcement will hesitate to visit these areas!
Which Class of Property Do You Want in Your Portfolio?
For me, I love Class B assets, as this classification meets my investing criteria for a stable property that is affordable for both the renter and investor. These properties also offer good amenities and good livability.
Also, there are macroeconomics at play, as the Class B asset tends to be the most resilient. When the market is on the upswing, residents in Class C properties will move up to Class B to access better housing, amenities, and schools. And when the market is on the downswing, residents of Class A properties downsize, and they can still access good housing, amenities, and schools in the Class B areas.
The B class is compressed in both good times and bad, keeping your number one killer of profit—vacancies—low.
Another reason I like B-class assets is that as a value-add (or BRRRR investor), I can pull all four levers of conservative investing (capital preservation, cash flow, appreciation, and tax benefits). Additionally, I can capitalize on deferred maintenance issues and leave very little of my own money in the property.
As a result, I can supercharge my wealth through continuous recycling of my capital to create durable streams of income. And who doesn’t want that?
In the end, I couldn’t be happier with my portfolio earning “straight Bs.”
So, what’s in your portfolio?
Share in the comment section below.