Property Class and Cash Flow

51 Replies

What properties have best cash flow? A,B,C, or D?

C & D typically

Lower priced/lower quality properties tend to cash flow better because the rents are not reflective of the market value. For example, a $250,000 3BR/2BA home may rent for only $1,800 per month where as a $50,000 home could rent for nearly $600. You could buy 5 $50k homes for the price of the one mid-class one. Do that and your gross rent would be $3,000 per month.

So why doesn't everybody go after c and d property?

C&D property are typically harder to get good tenants and to keep good tenants that don't tear everything up and that are paying. If it was easy to manage everyone would do it.  

I kike B  property that is in a good area that i can find good people and get a steady return. Turnover and mismanagement will kill you rate of return. 

For several reasons. 

C & D properties are associated with being "slum lords" and many people just don't want that title associated with their business.

These properties, though very profitable, are extremely time intensive. You will have to constantly chase down rent, evict deadbeats, deal with police/drugs/dogs/complaints and pay out money for repairs. Tenant turn over can be much higher as well. Not every investor wants that hassle or to pay a PM to deal with it (which cuts down on the profitability). 

Lots of reasons:

1) They don't appreciate as well as A and B class

2) The tenants in C and D properties have less stable incomes, and generally don't take good care of the properties.  You also are potentially dealing with tenants who have criminal past, or associate with those who have criminal records.

It's all about risk.  Higher risk = the potential for higher profits, but also equals the potential for serious headaches and loss of revenue.

I generally stick to class B, decent cash flow, relatively good appreciation, and decent working class tenants usually.  

everyone has their own speciality and therefore they are go after what they feel they can make their "specialty". I am an A and B girl. Although my margin are slender my expenses are almost nothing. This allows me to keep my entire margin. I also have appreciation and principle . So when you look at my cash on cash earning. I do fairly well ;)

Hello Everyone,

I am new to the site.  Can you give me the breakdown for the property types mentioned in this discussion Etc, A, B C?

Originally posted by @Reggie Maggard :

So why doesn't everybody go after c and d property?

Same reason not everyone goes into a profession where you can make a lot of money but need to work long hours (doctor, lawyer, etc)...

C & D properties may generate the highest cash flow, but they will always (generally speaking) create the most work and headaches...

@J Scott - E Class property has the best cash flow!  learn already:)

Understand - we cannot underline the concept of cash flow separately from underscoring "stable".  When most people here speak of cash flow, what they mean is a paper analysis which spits out a dollar amount.

In real life, however, over a period of time, these numbers are highly impacted by the stability which underpins their occurrence.  For many reasons, D and C are inherently unstable, and therefore paper (we call it Pro Forma) cash flow is about as meaningful as ... well, I duno...it's not meaningful.  Does this help? 

Yep... D always looks good on paper.  By the time you factor in all the income losses and the real expenses that are occurring, the cashflow does not look the same.

I like C properties in A or B locations.

Originally posted by @Ben Leybovich:
In real life, however, over a period of time, these numbers are highly impacted by the stability which underpins their occurrence.  For many reasons, D and C are inherently unstable, and therefore paper (we call it Pro Forma) cash flow is about as meaningful as ... well, I duno...it's not meaningful.  Does this help? 

 Agreed...to a point...

This is why I discussed the hard work and headaches.  If you're willing to bust your butt, you can get close enough to the pro-forma estimates that you'll likely outperform better properties.

For example, pro-forma on an A-property in a location may generate a pro-forma 6% ROI. A D-property in a nearby area may generate a pro-forma 12% ROI. The A-property will actually generate 6%, and the D-property may actually generate somewhere between 4-8%, depending on how hard the owner wants to work.

Anybody here own retail strip centers or industrial / office space divided into 5 units as investment properties in A / B locations? What does your cash flow and tenant managment look like compared to single family home investments?

James Park im seeing people get between 7-12% typically if it's a stable or slightly value add play. If opportunistic with redevelopment or significant new leasing can be more.

To the original question, returns in the c and d areas can certainly be worth it even when accounting for all the headaches. Take a vacancy /collection loss estimate right off the top line when doing your proforma. On multi families this might be 3-5% on larger deals in gold areas to 20% for mid sized c or d. More headache for sure but it was budgeted for.

I'm not sure what the appropriate number is in your market, but bump it up a bit, bump up capital reserves and you might be surprised that even with this accounted for you're still making more than on an a property.

@Reggie Maggard  

  as others have answered .. One is proforma  ( best case scenario ) and the other is actual  based on 2 years tax returns and full disclosure of the books.

when you look at the different class's one will note that the C an D do not or will not perform to the expectations or Proforma estimates.. and many times not even come close.

Were as A and B might actually hit proforma's.

Just talk to any astute multi family investor and ask them if they get to value based on performa or ACUTALS.. and you will have you answer.

What happens in the SFR rental game is there are NO Acutals your usually buying a home that has just been renovated ( because last tenant beat the crap out of it) and you have a brand new tenant so you really don't know how you will do until year 3 or longer.

Some do well others fail miserably.. As @J Scott 

mentions those that work it for a living make it work.. I submit those that try to buy C and D as passive and let someone else try to make it work  IE ( property manager) have a rocky road

Originally posted by @Robbie Perksin :

I am new to the site.  Can you give me the breakdown for the property types mentioned in this discussion Etc, A, B C?

Robbie, Here is my broad view of property class, I hope it helps.

Class A: Newer property in a highly desired, stable location with good schools.  These attract high income earning, stable, and responsible tenants leading to low vacancy rates.  Purchase prices and the investment amount required are driven up by owner occupied buyers which provides appreciation but lower cash flow.

Class B: Property in a mostly stable location with average schools. The vacancy rates are mid level and normal wear and tear is expected from tenants.  The added managed risk provides opportunity of higher cash flow than A class with lower purchase prices.

Class C: Older properties in a less stable location with typically less than average schools but must not be in a "war zone".  These may experience higher than average vacancy and higher than normal wear and tear with a mix of government subsidized tenants.  The additional managed risk allows for potentially high returns but can be difficult to manage and may require longer time to liquidate.

Class D: Old properties in challenging and potentially dangerous neighborhoods with little to no amenities. These are characterized by high maintenance, high vacancy rates, and the tenants are the most challenging.  The cash flow will appear to be the highest on paper of all classes but will be greatly effected by the cost of repairs and eviction fees from the lack of payments from the tenants.

I prefer Bs, but not killer bees.

An investor I know has a D, that he's owned for about 10 years, he's had about 13 tenants, nobody ever stayed a year and he has had long periods of vacancy.

otoh, I have two 30 year tenants where I haven't had even one day of vacancy.

The pro-forma rent doesn't account for vacancy or lack thereof.

Greetings, I'm a new member and first post, here are my thoughts on one of the most important topics of real estate investing...        While the grading is a bit subjective,  I tend to focus on the C's and mix in a few D+'s because I find that the returns are far superior to the A/B's.  As everyone has pointed out, there is more work involved.  They require excellent screening, excellent management, and more repairs than the A/B properties.  The way I look at it though, is that my rental portfolio is a business, not a passive investment, so I expect that part of my % return on investment is the work and the management.

I have several of my C's on lease with option to buy contracts.  Believe it or not, there are a lot of potential C tenants that are not criminals.  Most do not execute on the purchase and that is ok and generally preferred.  If you are patient and screen well, then you can get stable tenants.  My D's do require a LOT of work, but the cash flow is very strong.  My definition of D requires that while the area might be a little rough, it is not in a war zone.  It is true that you must have the stomach, time, and energy for D properties.  The fact that my strategy differs than many others is what makes this business so great and make room for all.

@Reggie Maggard

Great question. And this thread could go on forever with everyone and different opinions. And that is one of the things that make this a great site and business. 

I think that @Jay Hinrichs   @jscott say it the best, you can make money in C and D houses. But NEVER buy into the proformas, secondly I would HIGHLY HIGHLY recommend that you manage these houses yourself. Very rarely have I ever seen a PM and a C-D landlord get a long and be on the same page. ( I actually can't think of a time)

I once worked for a man, who owned a 1960ish trailer park in Gary IN. He had about 150 trailers on the lot and a little brick office as well as a work pole barn. He went in everyday there with two assistants and brought in around 75k a month gross. A 60 year old trailer park in Gary IN that may actually be "F" class.... BUT he worked it and brought the cashflow in on a monthly basis laughing all the way to the bank. 

Again, I would just remind you that he worked there every day himself and as far as a retirement strategy for him it would be sale the park, not try to hire a PM.

Lastly, it seems to me that the people that I have worked with and watch become successful throughout the years in C-D landlording mainly used it as a med term strategy to get quick cashflow then as they built there business model they would sale off those C-D rentals an upgrade to A-B rentals.

Best of luck to you. 

Andrew

Originally posted by @Reggie Maggard :

What properties have best cash flow? A,B,C, or D?

Hi Reggie,

You got some awesome answers from quite a few reputable investors. I am happy to chip in with further molding your perception.

Please see a link to a blog I wrote for Bigger Pockets a while back about the differences in asset classes -

http://www.biggerpockets.com/renewsblog/2014/06/28/abcs-real-estate-asset-classes/

I hope you find it useful.

Thanks and have a great day.

Well I break it up into two parts.  There are a-d locations and improvements. 

The improvements have to do with amenities.  The weight rooms, nice pool areas with bbq's, washer/dryer hookups, contemporary layouts are A.  The older buildings with painted countertops crappy floors, outdated floor plans, no real amenities other than a living space are D.

Locations are the same thing.  A is great, D is very rough.

You have to look at it this way to make any sense out of the rating process.  I have seen A buildings in D locations and vice-versa.  The old properties in A locations are the best ones to find if the price is right.

I know, I said this already.... the concept does not seem to take though.

It is tough to buy a value add property in a run down area and make it worth more money.  This process works well for the poor condition units in good areas.

I am trying to optimize my available cash and borrowing power. This helped tremendously, thanks guys.

@Steve Olafson  

I've never seen an A building in a D neighborhood unless it was built by the government or with government money.  By definition an A building is a NEW building, who would build a NEW building in a D neighborhood?

And the reverse a D building in an A neighborhood, means a run down, deferred maintenance, dilapidated building in a neighborhood with all NEW building.  That can exist, but not for long, many investors will line up to buy a D building on the cheap, that is surrounded by all new construction. 

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