There are 4 classifications of Real Estate in terms of property type and location: A, B, C, and D.
Class A
The highest quality real estate is Class A property. It has the best locations and is built within the last 15 years. Crime in the area is low and it is surrounded by other great real estate like nice restaurants and shops. Class A property will also attract the highest price and highest rents. However, the yield or cash flow from Class A will be lower than other classes because of its safety. Class A property is what ultimately most people want if they can afford it.
Residential
Class A residential buildings are in the nicest neighborhoods and have the best school districts. School districts play an important role in determining property values. One block or two in the wrong direction can land you in a lower ranked school district. This affects property values.
With respect to location, the top school district in the city would be considered Class A location where you would find the nicest houses. There can be some lower-class properties in the area too. Generally, you would not find too much of a lower-class property in a higher-class location, otherwise it would lower the location class.
Commercial
Think of New York City and the Empire State Building as Class A commercial real estate. The best location and the highest price. The Empire State Building was built in 1930, but it has since been renovated to the standard of Class A and achieves some of the highest rents in NYC. This is important to note that you can upgrade a building to a higher class. If no maintenance was done on the Empire State Building, then it would be a lower class building in a Class A location.
Class B
After a building becomes slightly worn and starts to show some aging it becomes a B Class property. It usually takes around 15-20 years for a property to start to trend into the Class B territory. This is also where you can get a “+” and “-” designation for a property. There are no hard-set rules or amount of years that determine when a property changes classes. If the building is 15 years old, starts to wear slightly, but still looks brand new, it could be an A- or B+ property. 20-25 years down the road with no upgrading it starts to become a B and has opportunity to add some value. Around 30 years it starts trending to B- or C+.
Residential
The neighborhoods for most B class property is still decent. The school districts will still attract quality residents and teachers. It will also start to attract blue collar workers trying to provide nice environments for their families.
Commercial
Class B commercial real estate will command average rent in the marketplace. The systems will be a little bit older and may need replacement such as HVAC and plumbing. The cap rates (link) tend to be slightly higher than Class A and the fixtures might be outdated. The yield is typically well-stabilized with slightly higher returns than Class A.
Class C
Updates are required with a Class C property. Maintenance has been deferred and it is usually visual from the street. Also, the neighborhoods will be of lower quality and there may be more crime in the area. The school districts are usually ranked low. There are most likely some construction issues that need to be taken care of. You tend to start seeing class C property from the 1970’s and earlier, although some 1980’s property could be considered Class C. The cash flow from Class C property tends to be higher than Class A or Class B.
Residential
Renters will make up a large part of the people living in Class C property. Prices will tend to not appreciate as much in a Class C neighborhood, but rents could go up. Maintenance starts to become an issue with the older houses and crime might also be an issue. Class C residential is often considered blue-collar or workforce housing.
Commercial
The building conditions of Class C properties have deteriorated even further than Class B and will need to be repaired or replaced at some point. Most likely sooner rather than later. Cash reserves are recommended for Class C properties to account for unexpected maintenance. Rents will not be as high as Class A or Class B and the tenants may be more management intensive. Expect higher vacancies and possibility of missed payments from companies going out of business or tenants being laid off. Class C can be profitable with a good value-add strategy.
Class D
Often this class is considered a war-zone. It is advised that most people steer clear of Class D properties unless they are well experienced. Class D properties are typically in disrepair, boarded up, or in high crime areas.
