Not all commercial real estate properties are alike. Investors must evaluate if a new luxury building with cutting-edge architecture, opulent materials, and lavish facilities is a better investment than an older property that was previously similarly important and has a proven track record of success. As a result, a well-known property categorization system categorizes structures as Class A, Class B, or Class C.
This method is essential because each group has varying degrees of risk and return, and understanding the features of each category enables investors to decide if a property can achieve its investment objectives. In our expertise in completing thorough due diligence and underwriting evaluations on hundreds of properties, the class also assists us in comparing properties to the competition, i.e., other buildings that will compete with them for tenants.
Nonetheless, the definitions of each class and the distinctions between attributes in each tier are often obscure. In reality, there is no clear distinction between Class A, Class B, and Class C, and the requirements for each group vary depending on the market. Class A buildings in a Gateway City such as Boston, San Francisco, or New York will be substantially different from the rising real estate markets that we believe to be the most significant locations to invest in, such as Denver, Charlotte, or Charlotte. We have discovered that properties are classified as Class A, B, or C depending on their location, construction, age, or tenant quality. Here’s what each of these four essentials entails.
Mapping High-Demand Grassland
Location is the most prevalent criterion for classifying business rents as A, B, or C. The market snapshots of CBRE, JLL, and other brokerages distinguish downtown office buildings and infill multifamily assets from less in-demand outlying properties. Or, they will provide city areas inside and beyond the central business district and the most in-demand suburban submarkets.
Geography helps define real estate since the distance from the city center often determines property value. In our home city of Chicago, buildings in the Loop and River North have a Class A grade, followed by those in the South Loop, West Loop, and Lincoln Park neighborhoods. A building in South Loop cannot demand the same rental rates as a comparable one in River North.
Class B homes lack only the central city location, with its walkability and access to transportation, shops, restaurants, and entertainment, when seen from this perspective. Class C denotes an outer community that provides value, possibly because of its distance from the city center or accessibility to schools, retail, parks, or certain attractions.
Age and Construction: Shiny New Things
New development rents fetch a premium. The latest facilities (coffee bars, pet care rooms, indoor/outdoor recreational elements, etc.), technology, up-to-date finishes, programmable spaces, and extra green space may be tailored to the demands of individual tenants. As a result, Class A multifamily flats and office space often suggest a structure that is less than ten years old.
This status may be maintained through a property’s high-quality construction and consistent care. But if a new building, such as an apartment complex or office tower, is constructed across the street, it will likely be better and attract higher rates. In addition, newer buildings offer a trendier aesthetic, superior facilities, and an enhanced tenant experience.
Ten- to twenty-year-old Class B buildings may be updated with value-added upgrades to compete with Class A buildings or provide tenants a more affordable choice. This may be particularly beneficial in locations with a strong demand for worker housing. Over time, however, even an older structure with multifunctional floor layouts, high-quality finishes, and attractive facilities will lose its market presence.
Who’s Moving In? – Tenant Quality
Buildings may also be identified by the tenants that occupy them. Many multifamily/apartment tenants are renters by choice, not need; they have college degrees and credit scores sufficient to qualify for a mortgage and may spend over $2,000 per month. Attractive downtown office buildings attract prestigious enterprises. Both of these sorts of renters are inclined to choose Class A properties.
On the other hand, companies with poor profit margins have a lean cost structure and pay their employees less. These businesses and employees must lock in the reduced rentals of a Class C building. A Class C property’s main selling point is its affordability.
In the center are Class B business parks and professional buildings, as well as multifamily housing for families seeking strong schools and lifestyle facilities.
Class Distinctions: Which Investment Property Is the Best?
Investors may profit from all three property types. Class A properties provide the best and most consistent returns. Their tenants can afford to pay for a prestigious location and often sign long-term leases, particularly in office complexes. Short-term income is very predictable for investors, but there may be minimal space for rent hikes in locations where the new building is expanding.
According to the National Apartment Association, Class B has been more productive in recent years due to a long construction boom. Class B rentals lead the market with a 3.5% average rent rise; however, luxury rentals are narrowing the gap. Class C buildings may be profitable with a bare-bones operation that permits more vacancies. Job churn will impact renters’ capacity to pay rent and increase the likelihood of eviction.
With an injection of funds, a sturdy Class B property that can undergo a value-added restoration that puts it in competition with its Class A neighbors and permits higher rents is seen by many investors as their best alternative. Such an improvement may be effective with a realistic company strategy and superior management skills.
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