Lender Ratings of Residential Investment Properties
Lenders have developed general classifications of apartment
buildings so that they can communicate amongst themselves and other
members of the industry with some level of uniformity. The
classifications are Class A, Class B, Class C, and Class D.
Grade 1. Class A.....Newer, Institutional Grade 2. Class
B.....Older, Institutional Grade 3. Class C..... Older,
Declining Area Grade 4. Class D......Older, Declining Area, Poor
Condition
Class A Apartments - Institutional buyers like new, larger
apartments in prime locations because of low deferred maintenance.
These properties are typically occupied by white collar workers and
have amenities such as garages, in-unit washer/dryers, pools, spas,
exercise gyms, the latest technology, etc. They are typically
between 1-10 years old. Typically they are in the path of progress
and as of this writing (July 2008) can be bought at cap rates of 7%.
They will likely have less cash flow than properties with higher cap
rates but will have greater appreciation potential.
Class B Apartments - Class B buildings are in good areas with
many of the same amenities as Class A properties, but Class B
buildings are 10-20 years old and occupied by both white and blue
collar workers. Class B properties are often owned by investment
groups, such as limited partnerships and limited liability
companies. As of this writing (July 2008) they can typically be
bought at cap rates of 8% - 9%. These properties will have decent
cash flow and decent appreciation potential. Class C Apartments -
These apartments are older properties built within the last 21-30
years in working class areas typically occupied by blue collar
workers and even some Section 8 tenants(please see my article on
Section 8). The properties may be in declining areas but not
necessarily dangerous areas. The units in Class C buildings are
smaller than those in Class A and B buildings and the projects have
fewer amenities. The occupancy rates are typically higher than Class
A 0r B because they are more affordable. Individuals usually own
Class C properties, which as of this writing (July 2008) can be
bought at cap rates of 10%. These properties will have decent cash
flow but little opportunity for appreciation.
Class D Apartments - These buildings are older, in declining and
even dangerous areas and as a result may have high vacancy rates,
deferred maintenance, functional obsolescence and demand a high
level of hands-on management from their individual owners. As of
this writing, they can typically be purchased for cap rates of 12%
but may generate less income than other properties despite their
higher cap rates because of higher maintenance and management
demands.
Rules of Thumb:
1. Class A & Class B properties are purchased for
appreciation potential. 2. Class B & Class C properties are
purchased for cash flow 3. Unless you are an experienced investor,
don't buy Class D properties.
The goal is to buy a particular class of property in the same
area class. In other words, buy a Class B property in a class B
area. Alternatively, buy a lower class property in a higher class
area. In other words, buy a Class C property in a class A area or
one in the path of progress. The reasoning is so that you can
possibly change the Class B property bought at higher cap rates
(lower in price) into a Class A property which can be sold for lower
cap rates (higher prices). This "infill opportunity" is typically
only possible if the area is better than the property. For a better
understanding of cap rates, please read my numerous other articles
which give detailed information on the subject.
Kerri Hamilton is a commercial broker, CCIM
Candidate, instructor and Founder of the Commercial Investment
Education Institute, LLC which teaches commercial real estate
investment to both novice and seasoned investors in a friendly
and easy to understand manner. As an investor like you, she
understands your concerns and your needs.
Invest bigger! Invest better! Take a FREE
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