Episode 74 – Building Classification
In commercial real estate, a property’s “building classification” is meant to be a short description to provide an investor with information about the building (age, location, amenities, condition, rental rates, sales price, etc.).
In Episode 74 of Investing with GoodLife, Rohan and David discuss building classifications, explain the difference between Class A, B, and C buildings, and discuss how building classifications are used in the real estate industry.
What are the Building Classification Classes?
In commercial real estate, all buildings are classified into three classes: A, B, or C buildings. Since every type of building is classified, investors in the real estate industry are always discussing building classifications.
To start at the top, (A) buildings are your top-of-the-line buildings. (A) buildings are often the newest in age and tend to have luxury finishes, such as granite, high end cabinets, and stainless steel appliances. They usually generate the highest rents in the market and also have the highest sales prices. For the building location, they are usually located in what people refer to as class (A) locations. For example, in New York, a class (A) office building could be located in Downtown Manhattan or on Wall Street. It could also be a brand new building. Today these buildings usually include special upgrades, for example, due to COVID, most class (A) buildings now have new HVAC systems, air filters, and touchless elevators.
The next building class is (B) buildings. (B) buildings are not as fancy as class (A) buildings. Class (B) buildings are usually older buildings but they’re still of good quality. In the residential space, class (B) buildings usually attract a solid base of average working-class tenants.. These types of tenants are usually attracted to class (B) buildings since they might be priced out of the class (A) assets.
“It used to be that class (B) buildings would be around 10-20 years older than A buildings. I think now class (B) buildings have really evolved into 30-40 year old assets. I believe the lifespan of a class (B) building has been and can be extended with the proper capex improvements and preventative maintenance. After the 70s the quality of buildings really started to evolve. Windows were designed better. They tend to be double-pane or insulated windows. Siding evolved as well with technology on the residential side. But even for offices, the quality of building really started to ratch it up as we got into the 80s. Since the late 70s and 80s, it started to become a lot better.”
– Rohan Gupta
Lastly, you’ve got the class (C) buildings, which are the lowest classification. These buildings are the older buildings that need a lot of updating and potentially have a lot of deferred maintenance (older electrical systems or chillers) and numerous items that need to be repaired (which can cost a lot of money). Older buildings also have a tenant base, especially in residential, that might be less wealthy. Due to this type of tenancy, you can face some issues and challenges with rent collections (especially in states like California, where there are a lot of tenant protections and eviction moratoriums). Due to these reasons, class (C) building deals can be quite challenging if you don’t have enough adequate capital to improve and maintain the asset.
“You have to roll up your sleeves as you move down the scale from A’s to B’s to C’s.”
– David Fong
Why Does GoodLife Primarily Purchase Class B Buildings?
Since class (B) buildings are not as updated as class (A) buildings, they are more affordable. Due to the more appealing price tag, for investors, it presents opportunities to buy class (B) buildings or class (B-) buildings where there are opportunities to renovate the building and upgrade it into a higher class (B) building or even a class (A-) building. Since you’re able to buy class (B) buildings at a better value than the price of a class (A) building, there tends to be more upside if done correctly.
Rohan and David often try to find bridge lenders who are willing to lend based on the future renovations and higher rent GoodLife HP proposes to gain. At GoodLife Housing Partners, the ultimate goal is for Rohan and David to find class (B) buildings in class (A) locations where there’s a story.
“There are always all sorts of reasons why class (B) buildings or class (B-) buildings may not have reached their potential. For example, neglect in management or an absentee owner from out of state, and so that’s the opportunity for investor groups like ourselves to look at.”
– David Fong
Each class of property represents a different level of risk and reward. As an investor, it’s important to understand the differences between each building class to know what type of property you are investing in and the various conditions of the property. GoodLife Housing Partners often focuses on Capital appreciation, a rise in an investment’s market price, which is why Rohan and David primarily invest in Class (B) buildings.