Commercial Real Estate Building Classes Explained
Commercial and multifamily real estate is generally identified by building quality or class. Class A, B, and C are the main categories, though some properties may be referred to as “Class D.” Class A is the highest and best ranking, while Class D is the lowest. Building classes are typically relative to the quality of properties offered on the local real estate market. For instance, a Class B apartment building in Tenessee could be a class C apartment complex in Florida.
In general, class-A buildings are purchased by turnkey investors, who want a low-risk investment. As a result of their low-risk appetite, they are willing to accept a lower overall return. In contrast, class B and C buildings are generally bought by value-add investors, who plan to inject capital into the project and make moderate upgrades to the property. Lower-end C and D class buildings are purchased by distressed investors, who combine a high-risk appetite and creative financing to turn around problem properties.
As an apartment investor, understanding these building classes will help you speak precisely when talking with investors, brokers, lenders and others who need to know your business plan. In this article, we’ll review the three major classes of commercial properties and what investors can expect from each.
Class A Real Estate
Class A real estate consists of the highest-quality, highest-priced real estate in a specific market. Typically, the property will be no more than 5-10 years old. For multifamily, this could mean a brand new apartment building with top-of-the-line amenities. For an office property, it could include high-rises in the downtown of the largest city in the area. Like offices, Class A retail is generally concentrated in downtown areas near popular shops and restaurants.
Class A buildings generally have:
Modern design and high-quality construction
High-quality landscaping (if applicable)
New HVAC systems
High-grade interiors
High parking ratios (lots of parking spots)
Amenities (such as pools or high-end appliances for apartments, or cafes for offices)
In major markets, Class A multifamily units attract wealthier individuals and families, while in smaller markets, it may be focused on young professionals or graduate students (such as in college towns). Likewise, Class A office building tenants are often well-known banks, law firms, or consulting practices.
Class B Real Estate
Class B real estate is one step down from Class A. Class B buildings are often well-kempt, but may not have the sparkle of Class A properties. Class B real estate is usually between 10 and 20 years old. Other common aspects of class B buildings include:
Somewhat dated design and construction
Moderate-quality landscaping
Lower parking ratio (a fair amount of parking)
Located further from downtown than Class A
Fewer amenities than Class Ax
Unlike class-A apartment buildings, class B apartment buildings are, in smaller markets, attracting budget-conscious tenants. In larger, more expensive markets, they tend to attract middle-class professionals and families. Class B retail or office space is generally located outside (but close to) a market's downtown areas or central business district (CBD).
Class C Real Estate
Class C is the lowest classification used by most real estate investors. Class C properties are 20+ years old with significant deferred maintenance. Common components of Class C properties include:
Located far away from downtown or in lower-income neighborhoods
Lack of adequate parking
Dilapidated landscaping
Peeling paint
Roofing and HVAC problems
Little to no amenities
A Class C apartment building could be a good candidate for a value-add investor to boost it up to Class B. If the building is run-down but in a good area, they may even be able to boost it to Class A. Class C retail and office space has a similar potential for rehabilitation. Like Class C multifamily, Class C retail and office spaces are generally on the edge of a market and in need of significant capital improvements such as a new roof, installing central air, and other renovations.
Finally, there are also what some refer to as “Class D” properties. These are properties that may seem to be beyond repair and may need to be fully gutted or re-built before they can be reasonably safe and comfortable. These types of situations fall more in the category of redevelopment and are even higher-risk than C- Class properties.
Cap Rates, IRR, and Commerical Real Estate Classes
When learning about building classes, investors should consider the differences in common commercial real estate metrics between them. These include:
Cap Rate: Cap rate (net operating income/property value) goes up with risk, so Class B and C properties will naturally have a higher cap rate than Class A assets.
IRR: Like cap rate, potential deal IRR and cash-on-cash returns will go up for lower property classes (B and C) purchased by value-add and distressed investors. Chances of losing money on the property are accordingly higher when using these investment strategies.
Equity Multiple: (cash invested vs. cash extracted from a deal). This will also be (potentially) higher for lower property classes, yet also higher risk.
In addition to building class, these metrics will be directly impacted by the property type. New senior living and hospitality properties, for instance, often have higher risk profiles than value-add multifamily investments.