Commercial real estate buildings vary drastically when it comes to overall quality, age, location and other factors. That’s why commercial real estate investors classify properties into Class A, Class B and Class C based on these factors, and more broadly, the risk of investing in the property. While this classification system is nuanced, it provides investors with a simplified, universally understandable way to communicate about properties within respective markets. Each property class indicates a different level of risk, providing investors with an immediate indication of how the property could impact their portfolio and returns.
- What Is a Property Classification in Commercial Real Estate?
- Class A Vs. B Vs. C: What’s the Difference?
- Class A
- Class B
- Class C
What Is a Property Classification in Commercial Real Estate?
What is a Class A, Class B or Class C property? Property classifications help investors easily understand the value and risk level of a building before investing. Rather than hard-and-fast labels, investors loosely apply property classifications based on a number of different factors. According to the Building Owners and Managers Association, these factors normally include:
- Risk and return
- Location within a city/region
- Tenant and rental income
- Growth potential and appreciation
Investors normally consider these criteria when determining whether a building should be labeled Class A, Class B, or Class C. However, excelling in one category won’t necessarily cause the property to rank in Class A–this is determined by a combination of some or all of these factors.
Like cap rates, building classes are intended to act as relative metrics, primarily for different buildings within the same market or region. The standards for a Class A building in New York City are much higher than those in Milwaukee. As buildings improve or deteriorate over time, they can shift from one class into another.
Class A buildings aren’t necessarily a better investment than Class C buildings, either. Depending on their strategies, some investors may favor low-risk Class C buildings, while others might lean toward high-risk Class A buildings. Commercial real estate investment software can prove invaluable as you review dozens of deals, allowing you to track these differences in a data-driven, highly visible manner.
Class A Vs. B Vs. C: What’s the Difference?
Buildings in different property classes offer tenants varying levels of luxury, amenities, and accessibility within their respective city or region. Higher-quality properties that present lower risk are considered Class A properties, while lower-quality properties that present higher risk are classified as Class C. Sitting between these two property classes is Class B, providing a functional space without the frills of Class A or the downsides of Class C.
Class A Property: Premium Buildings in Central Business Districts
Class A includes the highest-quality buildings on the market, although these standards and thresholds can vary by city. These buildings are typically built within the last 15 years, as property classifications change over time. Even after the 15-year threshold., significant renovations that modernize a building could elevate it to Class A.
By definition, Class A buildings are normally located in central business districts, or densely populated urban centers within major cities. Because these buildings are accessible via public transportation and centrally located amongst similar buildings, they are more valuable in the eyes of tenants. As a result, rents tend to be above average in the respective market.
Naturally, Class A buildings command attention from high-paying tenants, which means they can yield the highest rental income and are the most profitable. These buildings are generally occupied by highly creditworthy tenants, making them the lowest-risk property class. They also offer world-class amenities, including sprawling lobbies, high ceilings, modern light fixtures and HVAC systems, as well as other desirable features.
To deliver the highest-quality experience for tenants, these buildings are often managed by professional property managers, who can work to ensure that tenants are satisfied enough with the property to renew their leases. In most cases, there are no deferred maintenance issues that go unnoticed or leave tenants with sub-par experiences.
Class B Property: Functional Buildings With Average Rents
By definition, Class B buildings are older than Class A buildings, meaning that the investment opportunity presents a higher risk for investors. While Class B buildings aren’t necessarily in disrepair or on the outskirts of a city, they are generally middling in quality.
In most cases, Class B buildings don’t offer the same luxurious amenities or centralized location as Class A buildings. They are normally older than 15 years, putting them slightly out of touch with modern building trends. However, they normally provide adequate facilities and middle-of-the-line experiences. In turn, Class B buildings tend to generate average market rents.
Because Class B buildings aren’t guaranteed to generate the highest returns, they’re viewed as riskier investment opportunities. Some investors approach Class B buildings as renovation opportunities. After investors bring new life to a building, it could command Class A rents.
Class B buildings may or may not be professionally managed by a company or individual. It’s not uncommon for buildings in this property class to have deferred maintenance issues. This can put a slight damper on tenants’ experiences, without necessarily driving them elsewhere.
Class C Property: Lower-Quality Buildings Charging Below-Average Rents
Class C buildings sit on the opposite end of the spectrum from Class A buildings. Unlike either of the other property classes, Class C office buildings are often located in less-than-desirable locations. They tend to be situated away from city centers, entertainment, financial districts and other key locations.
Most Class C buildings are at least 20 years old and in a state of relative disrepair. They may offer functional space for tenants, but most are in need of substantial renovations. In light of this, Class C buildings normally collect lower-than-average rents.
Class C buildings aren’t highly profitable directly after the purchase, relative to other property classes. For some investors, Class C buildings present an opportunity to purchase, renovate and flip. Because of the work and capital required to generate returns, investors consider Class C the riskiest property class.
Seamlessly Compare Properties In Varying Property Classes
When your firm is reviewing dozens of deals at a time, it’s not uncommon for nuanced information like property class to slip off your radar due to more pressing priorities for fast-paced deals. Tracking investment data, files and additional information from acquisition through disposition, Dealpath is the leading deal management platform that preserves crucial context like property class and more for future comparison and use during the investment cycle.
To learn how you can add visibility to your investment process, register for our on-demand webinar.