This has always been an interesting question that I have spent a lot of time thinking about. What class of properties should you buy and focus on? Is it worth it to spend your time in the war zones chasing huge cash-flow? Or work on the consistent returns and easy management of the Class A pile of rentals.
Class A properties – These are the properties that you have extreme pride of ownership over, when you are showing your friends what you do for a living these are the ones you go to. The cash-flow isn’t as good as the other classes, but they are generally newer, require less maintenance, in better areas, easier to finance and easier to rent. The theory is these properties will appreciate more (if we ever get appreciation again).
Class B properties – These are the middle of the road properties. They may be a bit older or in not quite as desirable of a neighborhood.
Class C properties – These are usually the properties you will be bragging about the cash-flow instead of showing all your friends the property. The appreciation might not be as good and they will usually be more of a challenge to find/manage good tenants and finance.
We did an interesting exercise about two months ago: I printed two copies of our rental portfolio and my partner and I ranked every property as an A, B, or C. It was a very interesting thing to discuss, we answered the same grade on everything except about 5 of them. The funny thing is, I found myself defending some of the lowest end properties saying, the tenant in that one is so good I don’t want them ever to leave.
Every investor probably has a different definition of what a Class A and Class C property is. My definition is, if you are not comfortable getting out of the car during the day, that property is probably Class D to you. The more properties you look at though, the less intimidating a group of gawking neighbors is.
I did an analysis to compare one property we own in each class. I tried to pick our average deals, as we have a couple ‘great deals’ in each category that would throw things off.
First I want to explain how I quickly compare rentals.
The Simple Formula
Rental Income per Month / Total Acquisition & Repairs
eg: $1,100 / ($65,000 purchase + $10,000 repairs)
$1,100 / $75,000 = 1.4667%
Our ideal rental should show a 1.5%/monthly return or more. This formula is similar but a bit more simple than the Gross Rent Multiplier.
Class A Property
Total Acquisition & Repairs: 124,000
Peak Value: 345,000
Total Cost versus Peak Value: 35.9% ($221,000)
Rent Ratio: 1.2%
* we have a very hard time finding Class A properties that are at 1.5%
Class B Property
Total Acquisition & Repairs: 74,000
Peak Value: 285,000
Total Cost versus Peak Value: 25.9% ($211,000)
Rent Ratio: 1.5%
Class C Property
Total Acquisition & Repairs: 58,000
Peak Value: 192,500
Total Cost versus Peak Value: 30.1% ($123,500)
Rent Ratio: 1.6%
* I am not really counting on us getting back to Peak Value, I am just using it as a comparison for appreciation across the levels.
The interesting comparison is the Total Cost compared to Peak Value is actually a lot better on the lower end properties. If you are using all cash, you can essentially buy two Class C properties or one Class A property. For the Class A you would be collecting $1,495 rent, and for two Class C’s you would be collecting $1,900 rent. But for the extra $400 you have two tenants, two roofs and two lawns. You also have to find two good Class C deals, for every good Class A deal.
Our focus has been finding the biggest discounts compared to ARV first and worrying and focusing less on the Class of the property. Right now we classify about 50% of our properties as B’s while A’s and C’s share about 25% each. The other thing I like to do is ‘go after’ properties in neighborhoods we already own properties in that we really like (no matter the class).
If you are not wanting to be involved in the management process very heavily I would focus on Class A’s. Otherwise, I think you should buy a little bit of everything.