When you are preparing to invest in a new venture, commercial real estate building classes can be helpful in providing information about the property. This grading system is both simple and straightforward, giving investors details about the location, quality, and other key characteristics of the building.
Three Categories: Commercial Real Estate Building Classes
The building classes are broken into three categories: A, B, and C. These three classes apply to all types of commercial buildings, such as retail, multifamily, office, and industrial. The “grade” is a snapshot to help investors see how competitive this asset is compared to other commercial properties in the local market.
As a general rule of thumb, the higher the building’s class, the higher the proportionate overall value and rent. Of course, it isn’t a perfect system since a variety of factors can influence the success of a commercial real estate investment. Opinions will vary, and it is always smart for investors to research their options before committing money to any investment.
Here is a breakdown of the three categories used for commercial real estate building classes:
- Class A: This class encompasses premium assets in the marketplace. Class A often includes top-of-the-line mechanical systems, high-end construction finishes, and modern architectural design. Examples of Class A buildings include skyscrapers in the financial district of a big city. They are designed with visual appeal in mind. These class A buildings always include high-end amenities such as an excellent parking ratio, construction finishes, security systems, and more. As a result, they are usually preferred by the most affluent or successful businesses or tenants in the area. Class A covers the top price range in the area and attracts clients such as well-known banks and law firms. As a result, the rents fall above the market average.
- Class B: The simplest way to explain this category is that it covers the average, mid-grade properties. Consider the attributes listed above for the Class A properties, then step it down a notch and you will have a Class B building. In most situations, Class B buildings were formerly Class A, but are now dated, and as a result, bumped down to Class B status. These buildings are usually between 10 and 20 years old, so they still have decent visual appeal. In most cases, Class B buildings are four stories or less and are a good size for mid-market clients, such as local, mid-size businesses.
- Class C: The lowest of the three categories is Class C, which encompasses the least desirable of all assets. These properties have dated finishes and are older buildings, and they are usually more than 20+ years old. Substantial improvements and renovation will be required, including the addition of elevators, central HVAC systems, and more. They tend to have lower rents since they are less desirable compared to newer construction and designs. In most cases, Class C buildings are occupied by small, family-run companies because of the below-market rent.
Keep in mind that these classifications are subjective, especially since real estate quality varies from one location to the next. For example, a building might be rated as a Class A property in a suburban or mid-size population area. But another building with a similar style and quality might fall in the Class B category when located in a larger, urban real estate market.
Why Value Classification Matters for Commercial Real Estate Investment
Every investment property has a unique risk and return. Even if you are careful with your investment, you can’t eliminate the risk. But smart investors understand the industry to maximize the potential for a strong Return on Investment (ROI).
As you learn more about the value classification, you’ll see that a precise formula isn’t used to place properties in classes. Personal opinion can influence the rating, and it is necessary to consider a combination of factors that might impact the value of the property:
- When the property was constructed
- Location and access
- Income levels of the tenants
- Growth possibilities
- Rental income
- And more
Comparing the differences in property classes can help you determine how each property fits in your investment strategy. It is essential that you evaluate the amount of risk you are willing to take, as well as return objectives for the investment.
While Class A properties typically provide more security to investors, these investments can be sensitive if a recession happens. It is common for high-income earners to be most affected in a recession, which means they won’t have the cash flow to pay the expensive rent prices. On the other hand, Class B and C properties can be purchased at higher CAP rates, but the investors are also taking the risk of investing in an older property.
Our Proven Strategy for Real Estate Investment
We are value-add investors, which means that we aren’t just investing in Class A buildings only because they are the “best.” Sometimes the most profitable investment strategy is to choose a dated B or C property and work on renovations. A focused cosmetic repositioning can be used to step up with a Class C building to a Class B or even Class A.
Buildings are always getting older, which means that there is no shortage of Class C properties that are available. We work hard to find great investment opportunities by selecting buildings that are well located but significantly dated. These properties are great candidates for “class repositioning” to boost potential ROI.
Of course, commercial real estate investing isn’t an exact science. Many factors go into the selection of an investment property, such as the amenities of the building and the current real estate trends in the local market. But it is still smart to be familiar with commercial real estate building classes to ensure that a profit is possible from the investment.
Are you looking for opportunities to invest in commercial real estate? It is essential that you not only choose an investment team you can trust, but that you also find a firm with a proven reputation. At First National Realty Partners, we are here to help! We are working hard to offer great solutions for investors. Contact us any time to learn about the factors you should be considering for your commercial real estate investment. We are here to assist!