The Pros and Cons of Investing in Class B Properties

Real estate investing is big business. It goes way beyond renovating houses, and it includes investing in rental properties and even in the companies that manage them.

Institutional investors have taken big positions in the rental property market. After an estimated 10 million people lost their homes in the 2008 financial crisis and its aftermath, institutional investors—including big banks, private equity firms, and hedge funds—dove in to take advantage of government incentives for big investors to buy foreclosures. They did, by the thousands. However, instead of simply reselling the homes, these investors transformed many of them into rentals.

The supply of single-family homes for sale is now very tight, and home prices are rising. Fewer people can afford a down payment, and more are looking to rent. Predictably, rents rise as supply tightens, creating an affordability problem in many cities. Newer homes in great neighborhoods—known in the industry as Class A properties—are financially out of reach for many prospective renters. Investors hold on to these properties even though their higher initial cost may make the effective yield on them lower, because well-maintained Class A properties tend to retain their value and their valuable tenants.

If you’re a real estate investor competing in this crowded and rising market, consider the pros and cons of investing in Class B properties. These will likely be older homes in need of a little TLC, but if you decide to flip them, they’ll still attract a large market of reliable tenants: middle-class people who need decent places to live, good schools for their kids, and basic neighborhood resources such as restaurants, grocery stores, and reliable city services.

Pros of Investing in Class B Properties

Class B properties can be better values than Class A properties. They can bring higher yields because of their lower initial costs, even with upgrades. Plus, those upgrades can eventually move the property up in the real estate food chain to Class A. Financing may be more affordable, and the properties will still attract reliable tenants willing to pay healthy rents.

Housing shortages are pushing rents up even in B class properties, but overall, Class B rental homes offer a good balance of risk and return for investors. If the market loosens up or the economy sours, Class B properties will provide reliable performance and hold their value better than higher-rent, more luxurious Class A properties that may see vacancy rates rise in economic downturns.

Cons of Class B

Class B properties are older, and they usually require more maintenance. The purchase price may be lower, but investors will need cash for upgrades for plumbing and electrical systems, dated-looking interiors and exteriors, and old appliances. Tenants who can’t afford to buy a home or rent a higher-end property still want a home that functions well with a contemporary lifestyle. Even though yields will be higher, rents will be lower, and the overall property value will be lower than Class A homes.

Investors should examine their tolerance for risk, ability to weather changing market conditions, and overall financial goals when deciding what kind of rental property to acquire. Entering the single-family home investment business can be financially rewarding, and it can provide the satisfaction of making decent homes available to hard-working families that need them.

Whether you choose to invest in rental property for income or appreciation, remember to carefully weigh the pros and cons of investing in Class B properties.

image credit: Pixabay