As you begin investing in real estate, you’ll likely hear people talk about a property being in an A, B, C, or D location.
Just like your high school class grades, a neighborhood can receive a grade, though the classification is a bit more subjective than a simple high school test. There is no government organization, board, or company that classifies locations.
It’s honestly more of an unwritten rule accepted by most investors, and the lines are not incredibly clear. You might think a location is an A location (the best), while I might think it’s a B location (second best), but for the most part, investors will agree on the class distinctions.
Some investors grade locations on an A through C scale, whereas others grade on A through F scale. In other words, you might say a location is a C location, meaning that you think it’s the worst, because you grade on an A through C scale; at the same time, someone who grades on an A through F scale might think it’s pretty middle of the road. For the sake of our discussion in this chapter, we’ll use an A through D scale, which is probably the most common grading scale.
In addition to the location receiving a grade, the property itself can be classified as an A, B, C, or D property. So you might hear someone say, “I have an A property in a B area.” To add more specificity to the classification system, some will add a + or – to those grades, so you might hear “The property is a B- house in a B+ area.” I’ll leave out the + and – designations in this chapter, but you can always use them if you want to get fancy or more specific.
Let’s take a minute and talk about the different classes of locations and property types.
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Class A Real Estate
A Class A location is an area that has the newest buildings, hottest restaurants, best schools, wealthiest people, and highest-cost real estate. This is truly the best location you can find, and the highest-quality tenants are looking to rent here.
A Class A building follows the same concept. It is generally newer, probably less than ten years old, and therefore has fewer maintenance issues. The building has modern amenities, such as granite countertops, hardwood floors, and other in-demand features. Class A properties generally command the highest rent but may provide a lower amount of cash flow, because of the high-demand for an “easy investment.” More demand, higher purchase cost = lower cash flow.
Class B Real Estate
A Class B location might be slightly older than a Class A one, but perhaps still has decent restaurants, schools, and people. This might be your “middle class” areas, but these will attract more blue collar workers who live paycheck to paycheck.
A Class B building follows the same concept. It is probably 15–30 years old, mostly upgraded but perhaps lacking the shine of a Class A property. Rental income is probably lower than what you might find with a Class A property, and the maintenance costs will likely be higher because of the age of the home.
Class C Real Estate
A Class C location is likely a lower-income area with homes that are old—30 years or more. This area tends to attract people who are either on government subsidies or working low-wage jobs. You’ll likely find a lot of check-cashing businesses, pawn shops, and other such businesses in this area.
A Class C building follows the same concept. The property is likely older than 30 years and looks the part. Numerous repairs are likely needed, and ongoing maintenance should be expected. Systems in the property, such as plumbing and electrical, may be outdated and require ongoing attention. Properties will typically rent for a low amount in this area, but the properties will also be much more affordable than Classes A or B.
Class D Real Estate
A Class D location is a war zone where you likely would not want to travel alone. Not every city has a Class D area, but you’ll likely recognize one when you see one. Often, even cops are nervous about entering these areas, and crime and drug use/sales run rampant. There are probably numerous buildings with boarded-up windows and other indications of being vacant.
A Class D building is likely old, similar to a Class C one, but with far more neglect. Chances are, the property is currently uninhabitable, needing significant repairs before it could be lived in. Class D properties are generally exceptionally cheap, but getting good tenants can be difficult and dangerous. Unless you really know what you are doing, I don’t recommend getting involved with a Class D building or location.
As I mentioned earlier, the class distinctions are not very rigid or defined, but the classifications I just outlined here should give you a general indication of how investors view properties and neighborhoods. While doing research for this book, I stumbled upon a humorously accurate interpretation of the four classes, written by Matt R on the BiggerPockets Forums:
There is no right or wrong answer to the question, “What classification should I invest in?” You’ll likely find investors who only buy A, others who only buy B, others who only buy C, and still others who only buy D (God help them!). Each has pros and cons. Typically, the nicer properties will cost the most but may produce the least amount of headache—though this is not always true.
Because I am largely a “value add” investor (someone looking to rehab a property to bring its value up), I tend to look for Class C properties in Class B areas, but you’ll likely find a strategy that works well for you.
What do you think? What kind of location do YOU want to buy in?
Leave your comments below!