One of the most difficult things for first-time investors to understand is that the lowest-priced duplex for sale in Minneapolis is not necessarily the best investment.
The best explanation I’ve found to explain why is most commonly found in commercial real estate, where locations and properties are often labeled as Class A, Class B, Class C and Class D.
And while not hard and fast, there is a general consensus in commercial real estate as to what qualifies for each classification.
Class A – A Class A often is usually located in a Class A neighborhood. People who live there are generally affluent, the schools are sought-after, and there are popular restaurants and new construction. Because so many people want to live in these areas, real estate is generally more expensive.
A Class A property is generally located in a Class A or Class B location. It is often newer or extremely well-maintained and upgraded. Inside, you’ll often find granite countertops, upgraded appliances and hardwood floors.
Because these properties are highly sought-after by both tenants and investors alike, there is more demand. This results in higher rent and higher average sale prices. These properties are considered by many to be safe investments, and the demand for them causes prices to go up, which results in lower cash flow.
Class B – These properties tend to be a bit older, but updated. They may require more maintenance or cosmetic improvements due to their age. They may be less-appealing to tenants, and those who do live there may have lower incomes and credit scores. Rents are generally less than those generated by Class A properties.
A Class B location may still have the amenities of the Class A neighborhood, but things like the schools, restaurants and neighborhood amenities may not be as popular or sought-after.
Class C – These areas tend to have lower-income residents, and properties tend to be more than 30 years old.
Class C properties tend to attract people either working low income jobs or receiving government assistance. Properties may have high vacancy rates, higher eviction rates and deferred maintenance. Plumbing, electrical and heating systems may not have been updated. Investors should enter into these types of investments with healthy reserves on hand for capital improvements and ongoing maintenance. These units will generally rent for less, but also have lower purchase prices since demand for them isn’t as high as elsewhere.
Class D – Not for the faint of heart, Class D neighborhoods are obvious even to those who don’t live in the area. Think boarded-up windows and high crime levels.
Class D buildings are usually extremely old with a ton of deferred maintenance. Managing tenants isn’t for the faint of heart, and may require extreme attention to detail so as to be able to win eviction battles in court.
Overall – It’s important to know your own personal tolerances, strengths and weaknesses before you begin your investment career. We’ve all heard stories of investors who tried only to discover they hated it. I think it’s because they weren’t objective about the demands of the property, tenants and own limitations.
In my opinion, that self-knowledge is just as important as reviewing the numbers to make sure a property makes financial sense.