The ABCs of Classifying Single-Family Rentals
By Kerry Curry, B2R Contributing Writer
Rental property investors often use real estate property classifications in their investment strategy.
In this blog post, we’ll talk about what it means if a single-family rental is considered a Class A, B or C property and what these classifications mean to investors in terms of risk and return.
First, let’s go over the basic definitions of real estate classifications:
Class A: These are properties in the best condition — either new or recently renovated with premium finishes. They tend to be located in the most desirable neighborhoods and draw the highest rents.
Class B: This class contains older properties in good, but not the best, neighborhoods. They are in good condition, but may not have the latest amenities and could require some maintenance or updating. Rent will be less than a Class A property, but typically “average” for the area.
Class C: This classification contains everything that doesn’t qualify for an A or B classification. Class C properties might be old and located in less desirable areas. These properties often have significant maintenance issues due to age or deferred maintenance. Renters typically are residents paying below average rent for the metro area. Turnover may be higher than that of other classes.
Just like grades in school, each broad classification mentioned above can be broken down further, so Class A includes properties that are A+, A or A- and so forth for the other classes.
Using Classifications as a Real Estate Strategy
Investors often become an expert in one classification. Tolerance for risk weighs heavily in the decision of which class an investor chooses for their real estate investment portfolio.
“Most investors tend to lean toward one class,” said Ken Charnock, valuation manager for B2R Finance. “You don’t see too many investors investing in all three classes,” he said.
“Your Class A properties are going to be nicer and newer, but they are going to be less risky so the returns likely will be lower,” Charnock said.
“You’ll have the potential for higher returns with a Class C property, but there is more risk involved,” Charnock said. The opportunity for a higher return on these investments, however, is what entices investors to choose Class B or C investments over Class A, he said.
Tenants in Class C properties may be less credit-worthy. An investor seeking Class C properties should be well-versed in property management and collecting rental payments.
Property Classification Caveats and Lending Restrictions
It should be noted that no formal standard exists for classifying a property. What one person describes as a Class A+ property, someone else might peg as an A-.
In addition, appraisers don’t use an A, B, or C classification. They use a special set of conditions from the Uniform Appraisal Dataset to rate the condition of a property on a scale of 1 to 6.
A property rated a C6 (the “C” stands for condition) is a property in which deficiencies and defects are so severe that they affect the safety, soundness and structural integrity of the property while a C1 is a brand-new, essentially pristine property.
B2R Finance will lend on properties that have an appraisal rating of C1 to C5 but will not lend on a property that receives a C6 rating. A property with a C5 will also require more underwriting for it to be considered by B2R. Most loans at B2R Finance are made on properties that receive a C4 or better rating, Charnock said.
While B2R Finance doesn’t assign an investment class of A, B, or C to properties financed, these commonly used real estate classifications are useful to investors in determining their investment strategy.
Are you interested in the safest and newest properties that will command high rent and have low risk, but might not have as much upside, or are you drawn to greater risks and the potential for greater rewards? Neither strategy is better than the other, it’s really all about your preference as an investor.
B2R Finance offers rental investors innovative lending products to help unlock equity from existing portfolios and provide the cash needed to build rental portfolios nationwide. For more information about how B2R can help you obtain rental property financing, just call 800-227-8107 or visit http://www.b2rfinance.com/apply-now and follow us on Twitter @B2RFinance.
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