Posted 11 months ago

A, B, C, D: Which property class should new investors go for in Metro

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With 5 million locals, growing demand for rental properties, and an affordable housing market, Metro Detroit’s 185 cities attract rental investors to this area from all over the country and the world.

The area as a whole is on the rise, and more landlords want to get into this market. Housed within the Metro Detroit area are 17 Fortune 500 companies, who have been providing jobs and contributing to its steady economic growth since 2010.

However, the metropolitan area of Detroit is huge, varied, and can be daunting for new investors to wrap their heads around. If you’re not knowledgeable of the area, you might run into unexpected issues, problematic tenants, and costly maintenance surprises. Nobody wants that.

So, we’re going to try to take out some of the guesswork by going through the risks and rewards of each type of property, neighborhood, and tenant class in Metro Detroit. Being able to identify which category your rental property falls into will help you budget and plan accordingly, and set you on the path to long-term rental business success.

Pros & Cons of Each Property Class

Property classes are subjectively defined, but generally range from Class A to D. The criteria that determine these letter scores are the age, quality, and location of a house.

Property Class: A

Class A properties are usually newly built or recently renovated (less than 10 years ago), very well maintained, and set in a very desirable neighborhood. The houses are rarely in need of any serious renovations, and are often located in pleasant areas (e.g., has high-ranking schools, plenty of shops and parks, and a low crime rate).

Most of these properties are in areas where the majority of the properties are owner-occupied. Generally, they make for low-risk buy-and-hold investments.

Pros:

  • ● Typically the appreciation rate of these properties is at the high end of the area.
  • ● Class A properties attract high-quality tenants that will pay rent responsibly, assuring you of a stable revenue stream every month.
  • ● Said tenants will also be well-behaved and treat your property as their own. This protects your property against costly maintenance expenses.

Cons:

  • ● Purchase prices tend to be at the high end of the area, leading to low rent-to-price ratios.
  • ● With higher-class tenants come higher expectations. It might be harder to keep them satisfied with your management and maintenance services.
  • ● City inspection requirements may be higher (if they have them).

Some areas in Metro Detroit where you can find these properties include many areas in Downtown/Midtown Detroit, and in the suburbs, Birmingham, Bloomfield, Canton, Grosse Pointe, Royal Oak, Sterling Hts, South Lyon, and Troy. Ferndale is also fast becoming Class A.

Property Class: B

Class B properties are considered the “perfect blend of risk and return” property class. They are similar to Class A properties, except they’re slightly older and of lower quality.

This class is considered by many to be the most resilient property class, as it captures both the lower end of the Class A tenant pool and the higher end of the Class C demographic, giving it a broad appeal.

For beginners looking for a safe yet affordable investment, this is a good class to start in.

Pros

  • ● Compared to Class A properties, Class Bs have lower acquisition costs with near-similar qualities. A few tweaks can often upgrade them to Class A easily unless it’s the location that’s holding the property back.
  • ● Rent will be attractive and affordable for the general public of middle-income earners, potentially giving you steady cash flow and high rental demand.
  • ● Given that the rental market for Class B properties is wider, these properties often have a lower vacancy rate vs. the other three classes.
  • ● Though not luxurious, Class B properties are still of good quality and have the potential for appreciation, without extremely high maintenance costs.

Cons

  • ● Since the houses are around 20-30 years old, expect to have some added maintenance costs, compared to Class As (like updating electrical and/or plumbing systems).
  • ● A decent amount of Class B tenants live paycheck-to-paycheck, so are more likely to be late on rent payments if they get sick and miss work, lose a job, etc.
  • ● A higher percentage of tenants may not take good care of the rental property.

For the most part, all of the Ring Cities touching the City of Detroit are Class B. Also some in the next outer ring, like Madison Heights, most of St Clair Shores (with some class As by the water), Harper Woods, Lincoln Park, etc.

Property Class: C

Class C properties are endearingly named “cash cows” by investors who are willing to risk more, to gain even more in return. They are mostly investor-owned and attract those who seek strong cash flow.

To minimize risk as much as possible, investing in Class C rentals requires thorough screening and rigorous management of tenants, neighborhoods, and properties.

If you don’t know an area well, this is best done with a local property management company that’s familiar with the area and its tenants. They’ll help protect your investment in this riskier market, because they know which problems to expect (and how to avoid or plan for them).

As long as you plan ahead like this, investing in Class C properties can still be the Metro Detroit landlord’s bread and butter.

Pros[

  • ● Though rent is lower than Class A or B, these properties produce large amounts of cash in relation to their acquisition cost (i.e., great for cash flow).
  • ● Because they’re more affordable, Class C properties are typically in strong demand amongst applicants (especially if you have a well-presented 2-3 bedroom SFH).
  • ● Low purchase prices mean a low barrier to entry for new investors.

Cons

  • ● Because of the location and age of Class C properties, they may not be ideal for appreciation or value-added investments.
  • ● Properties are usually older houses (30+ years old) with deferred maintenance that could require large-scale renovations (like installing new plumbing, HVAC and/or electrical, new windows, roof). However, some are also newly renovated, so you just have to do your homework.
  • ● Class C properties tend to attract lower-demographic tenants, so you’ll have more instances of missed rent or evictions than with the higher classes.
  • ● Class C tenants are highly likely to “live hard” in a property, leading to a higher cost of turnover repairs.

Some areas in Metro Detroit where you can find these properties include 25-35% of Detroit, south Warren, Inkster, Ecorse, River Rouge, and some of Harper Woods (the rest is Class B).

Property Class: D

Yes, there are technically four property classes. But Class D properties rarely make smart investment choices. They are trickier and aren’t suited for new investors with little to no experience.

Labeled as the “war zones” in the real estate business, this property class includes run-down buildings and severely neglected houses in less-desirable neighborhoods.

To invest in Class D properties in Metro Detroit requires a high tolerance to risk. For example, plan on dealing with the theft of mechanicals and even the kitchen sink, and squatters.

Pros

  • ● These properties are the cheapest to acquire, so could potentially have the highest rent-to-price ratios on the market. They’re what most people consider a high-risk/high-reward type of property investment.
  • ● Because of the cheap prices, those with a vision and the commitment to see it through may be able to buy numerous rentals in a specific neighborhood and raise them to Class C status.

Cons

  • ● Extensive repairs and overhauls are needed (like major structural or electrical work).
  • ● They are located in the least desirable areas, attracting tenants who have low income, a questionable rental history, or who may not maintain your property well.
  • ● Property management for this class is very challenging. You’ll need to deal with late rents, disappearing tenants, and ruined properties - all of which can be quite costly and stressful, especially when it elevates to court.

Some areas in the City of Detroit where you can find these properties are almost 50% of the City of Detroit and a decent part of Pontiac.

The Choice is Yours

In theory, all of these classes have the potential for great returns on investment, if all the risks are assessed beforehand.

Class A and B properties demand a higher purchase cost, but they’re great for appreciation in the future. With a lower rent-to-price ratio, they are slow but steady investments. Most of their risk only comes from possible downturns in the economy, which can impact the value of higher-class properties the most. But in general, they are low risk, low return rentals.

On the other hand, Class C and D properties are high-risk, high-return properties. They have higher rent-to-price ratios, making them ideal for cashflow-prioritizing strategies. If managed correctly, these can potentially yield a much greater ROI than the higher classes.

So, when you’re scanning your options in Metro Detroit, decide on the level of risk and return you’re willing to assume.

How prepared are you to tackle and solve tenant issues on a regular basis? Are you willing to hire a property management company to help you with labor-intensive property classes? Most importantly - what is your long-term goal in real estate investing?

Knowing the answers to these questions will help you determine which class is the best fit for you.

Which property class is your portfolio focused on? Which property class are you planning to include next?


Image courtesy of Tiago Rodrigues



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