The purpose of the asset classification system is to provide short-form means of communicating certain information about a property. Although there are four categories, three of which are eligible for investment, the fourth is more speculative. Details of these are provided below.
Category A buildings are the latest and of the highest standard.
They are generally under ten years old and are generally located in or near central business districts and the most desirable locations of large cities (Like New York City or Los Angeles). Their location is highly visible, and the number of vehicular and pedestrian traffic is high. Class A properties have the finest finishes, the latest technology, and the strongest pleasure sets. For example, a Class A office building can have marble floors, a high-speed Internet connection, and outdoor terraces offering fantastic views. Moreover, it can be very energy efficient, as shown by the LEED certification. Class A properties are generally new or new and do not require significant renovations. As a result, they order the highest rental rates and are generally only affordable for the most profitable businesses or the highest revenues (for multifamily apartments). On a unit or per square foot basis, they also order the highest selling prices with cap rates generally ranging from 4% to 5%. Category A properties are considered the lowest risk due to the quality of their tenants, their physical condition, and the stability of their cash flow by their high-earning tenant base. But they also have limited bullish potential and tend to call on "cash flow" investors who favor stable income over price appreciation.
Class B buildings are well maintained but may be somewhat outdated and require minor renovations. They are generally between 10 and 20 years old and generally situated in good, but not large markets. Category B properties have medium finishes that be highlighted. For example, a Class B multifamily property may have tiled floors, laminated countertops, and a fitness center that's a little out of date. Class B properties tend to be in good condition with fully functional mechanical and HVAC systems but may need minor repairs or retrofits. Class B rents are lower than class A rents and are generally available to small and medium-sized enterprises and middle-income earners (for multi-family households). On a unit or per square foot basis, selling prices are lower than Category A properties and yields consist of a combination of price appreciation and revenue.
Category C vessels are old, in demand, and require moderate to major repairs. They are between 20 and 30 years old and are usually located in less desirable areas away from major motorways, shopping districts, employment centers, and public transport. Class C properties have dated finishes that probably need to be replaced because they are outdated or not functional. They are in relatively good condition and will likely require repairs or improvements to mechanical systems such as roofs, parking lots, heating, ventilation, and air conditioning or plumbing. Class C rents are lower than class B rents and are generally affordable for small businesses and hourly workers. On a per square foot or per unit basis, Class C properties are less expensive than Class B, but they have a high level of risk because of the capital investment required and the vulnerable nature of the tenants' sources of income. However, they often present an attractive opportunity for investors with a high-risk tolerance and operational expertise to deliver a retrofit program.
Category D properties are highly speculative and do not qualify as investment-grade properties. Usually, they are very old and need major repairs or complete reconstruction. They are over 30 years old and have poor sites in areas with no access to transportation networks, restaurants, grocery stores, or other amenities. Furthermore, the location may be in a region where crime is a problem. Class D properties have very outdated finishes that require replacement. This could entail a full renovation or demolition of the building. Class D rents are affordable, but properties often face high vacancy rates because of their condition. Per square foot, Class D properties are the most affordable because they present the greatest risk. It is expected that Class D investors will be prepared for a typical expansion-downturn scenario. These are properties that may be purchased at an attractive price, but the capital investment required to bring them up to market standards can be considerable and can take months or years until the investor receives a return in the form of income or appreciation. At any one time, there are dozens or hundreds of commercial properties for sale in a particular market. Because investors tend to specialize in certain kinds of properties and asset classes, they need the means to restrict choices.
Why the Property Type and Building Classification Matters
For example, popular Internet search aggregators offer options for filtering the choices by type of ownership and market. This would allow hundreds of choices to become just a handful, which contributes to the due diligence process. This is the number of transactions made, the type of ownership, and category criteria that can be shared with a broker, who can filter opportunities on behalf of an investor and present only those that meet their criteria.
For example, an investor might say to the broker, "I just want to see class B office buildings in the United States with cutting-edge technology systems or Class C industrial properties with lots of functional space and a high degree of accessibility for both employees and customers."
This highlights the importance of having several good relationships with brokers as it increases the number of opportunities that can be brought forward.