Commercial Real Estate Investing: The Benefits of Class B Properties
Why should commercial real estate investors be considering Class B properties now?
There are a variety of classes of commercial property. It is important to understand the differences between these classes. Classification can make a sizable difference in obtaining financing, values and cap rates a property should be trade at. Class can be a factor in property management, how net profitable a deal will be over time, and performance during different stages of the economic and real estate cycle.
A Class Properties
These are the best. Lenders and institutional investors will often segregate assets between Class A, and everything else. Think prime properties, in fantastic condition, in the top locations. They are the most desirable properties, which attract the strongest tenants, are newer, or recently renovated. In turn, A Class properties typically provide the lowest yields. It’s a safety and prestige play.
B Class Properties
Following Class A properties, these are the next best quality assets. They are still in good locations and good condition. Class B property may be slightly older and require some updates, but are still highly desirable. This means they offer more growth potential, value-add opportunities and higher yields than Class A apartment buildings, offices, retail and mixed use.
C Class Properties
Expect to find these properties outside of main thoroughfares, and in working-class neighborhoods. Expect them to be over 15 years old, in need of repairs and updates. Tenant credit quality may be lower, and management more intensive. Class C properties can offer some sizable promises of growth, cash flow, and returns.
D Class Properties
Class D properties are in the worst condition. Expect them to be dated, requiring extensive repairs or renovation and to be found in the least desirable areas. Crime, credit quality and property management can be far more challenging. There may be potential, but these are also the riskiest properties to invest in.
How Different Property Classes Perform Over Time
Class A properties are considered the safest. They are great strongholds in tough economic times. The yields will probably be lower in exchange, but if you are looking for low risk with the best wealth preservation potential and consistent returns, this can be the way to go. However, they may be considered underperformers in bull markets when many investors are chasing double-digit returns.
Class B properties offer similar benefits, but generally better value. They will be priced lower, but can attract good tenants who are willing to pay premium rents. They typically still qualify for the best financing and rates. They are expected to deliver the optimal blend of risk and reward.
As markets rebound these properties can be as desirable as A-Class ones. When markets are contracting these assets can keep performing well, even though Class C and D properties may run into trouble.
When markets are strong investors start chasing yield potential and are willing to take more risks in speculative retrofitting, Class C and D properties become more attractive. However, they will be the first to struggle and get hit with vacancies and a depleting resale market.
What to Invest in Now
A good destination needs all of these types of properties to remain sustainable over the long run. This means having affordable options to attract and retain key workers, new talent, and new business startup activity. As well as providing prime luxury space which residents and businesses can grow into.
You may not want to hold all of these asset classes all of the time, but each has its pros and cons in different phases of the market, and for different roles in your investment portfolio.
At this point in the current commercial property market and economy investors may want to be preparing for some volatility and correction in prices and demand. A- to B class properties may currently offer the best combination of wealth protection with reliable yields looking forward. If growth continues these properties will only grow in value and benefit from higher rents. If softness occurs, they’ll hold their values and see more demand than Class C or lower properties.
ABOUT THE AUTHOR
Bill Zahller is the Managing Partner of Park Capital Partners, LLC and resides in Asheville, NC. As a Multifamily Real Estate Investor and Syndicator, he founded Park Capital Partners, LLC in 2016 after 14 years involvement in real estate investment. He works with accredited investors and professionals who are interested in real estate investment, diversification, and financial freedom.
Bill has been flying since high school. His father was a Naval Aviator and Captain for TWA. Bill has been flying professionally for over 25 years, 23 of those at his current company. He has accumulated over 12,000 hours and 7 Jet type ratings. He has also held Instructor, IOE Instructor and NRFO pilot positions with a large fractional flight company. He is currently flying the Global 6000 in a long range mission capacity. This keeps it interesting – one week its Beijing or Sydney; the next Rio or Rome.
Bill is also the founder of the Asheville Multifamily Investor Club. Visit www.ParkCapitalPartnersLLC.com for more information.