An important part of investing in commercial real estate is understanding the different types of commercial real estate you can buy. Whether you're buying a storage facility, retail property, multifamily property, or office building, in general, the property will be categorized into one of the three main classes which help the investor easily distinguish the quality of the asset.
If you plan to participate in a commercial real estate investment, learning the difference between the three classes of commercial real estate and the pros and cons of investing in each type will help you be a more informed real estate investor.
The three classes of commercial real estate
Even though there are multiple types of commercial property to invest in, every commercial building will fall under one of the following asset classes:
- Class A.
- Class B.
- Class C.
The class distinction describes the desirability of the commercial property in the market based on a number of factors, which could include:
- Quality of tenants.
Class A real estate
A Class A property is deemed the highest quality asset in commercial real estate in terms of value, location, amenities, quality of tenants, and condition. It's commercial real estate property in a prime location, such as the central business district (CBD), with high traffic and visibility and generally is newly built, featuring the latest and greatest amenities and technology. Class A buildings can be luxury apartments, high-end office space, or a state-of-the-art industrial building.
These features allow for rental rates at the top of the current market, which many consider higher-quality tenants. Class A real estate is the most expensive type of commercial property to own, and it tends to be held mostly by large institutional investors like real estate investment trusts (REITs) or hedge funds. The higher value of Class A real estate typically means lower yield and net income because of the quality and convenience the investment offers the buyer.
|Attributes of Class A property||Pros of Class A property||Cons of Class A property|
|• New buildings.
• Top-of-the-line technologies or construction elements.
• Prime locations.
• Highest quality.
|• Premium rental rates.
• Highest value of the three classes.
• High demand because of the convenience of ownership and quality of tenants it brings.
|• Lower cash flow or yield for an investor.
• Can be a competitive market.
Class B real estate
Class B commercial property is the next tier down from Class A and includes slightly older buildings, around 15 to 30 years in age, that may have some general wear and tear, older construction elements, or outdated technology or maybe are newer but located in a subpar location. Class B real estate is generally in good condition as-is but may not be updated to meet current trends or market standards.
Rental rates are generally close to the median rate for this market made up of mostly working-class tenants and small businesses. While the building may offer some amenities like shopping centers or restaurants nearby, it may not include its own retail space or have amenities onsite. Class B properties have less value in the marketplace compared to a Class A property, making them a more affordable option for investors looking for stable income and slightly higher returns.
Most real estate investors who aren't doing ground-up construction are purchasing or investing in Class B commercial real estate.
|Attributes of Class B property||Pros of Class B property||Cons of Class B property|
|• Older buildings around 15 to 30 years of age.
• Some outdated technology, construction elements, or design.
•Located in slightly less desirable locations.
|• Median-range rental rates.
•Midrange value of the three classes.
•Medium to high demand because of the stable income it can provide.
|• More ongoing maintenance over time.
• Can still be expensive, especially in competitive markets.
Class C real estate
Class C real estate is considered the lowest quality of the three classes. These properties are more than 30 years old, may have significant deferred maintenance or be in need of major repairs, or may be located in less desirable locations like industrial areas, rural areas outside of town, high crime areas, or away from desirable amenities like public transportation or retail centers. The building may have substandard construction elements and offer little to no amenities onsite or nearby.
Class C property typically has lower-quality tenants, which means cash flow can be inconsistent, vacancy rates are higher, and it will often require more hands-on participation from the landlord or property manager to collect rents, manage tenants, or maintain the building. Most Class C properties are performing below market standards, meaning rents are below market value, but in many cases, it provides the opportunity to increase value by improving the property and raising it to the standards and operation of a Class B facility.
The lack of desirable features of the property means it comes with a large discount. Class C properties are valued at the lowest of the three tiers, which means the investor may achieve the highest income and yield even with its shortcomings.
|Attributes of Class C property||Pros of Class C property||Cons of Class C property|
|• 30 years or older.
• Considerable deferred maintenance, poor condition, or substandard construction elements.
|• Cheapest cost.
•Opportunity to add value and improve it to achieve a Class B value.
•Often has the opportunity for higher income or yield.
|• Will require more active management to improve and operate the facility.
•Undesirable locations and substandard quality of real estate in general.
•Significant upfront work to repair or improve the property.
•Can be difficult to obtain a loan because of condition or vacancy rates.
The bottom line
Commercial real estate investors usually determine the class of real estate to target when they start investing. Being able to articulate whether you're looking for a Class A, B, or C building to a broker or real estate agent will help eliminate properties that don't fall into the proper category for you. There is no right or wrong asset class to invest in; it's simply a matter of being able to identify which asset class is right for you.
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