Yesterday I completed the requirements to earn a certificate in property management by the California Association of Realtors®. I decided to add this designation to gain a better understanding of the challenges facing real estate investments. I can’t add the designation after my name until the application has been processed, however I can put the education to work immediately.
The coursework gave me the excuse to put together some information about investment property that I thought would be helpful for the first time investor.
Property Classifications
The industry has defined three property classifications as A, B, C, based on the quality of the building and location of the property. If you are considering real estate investments you should start by deciding which class is right for you. The advantages and disadvantages are considerably different for each class.
- Class A: Well located premium quality newer (generally) buildings that offer premium amenities to their cash rich tenants.
- Class B: Well maintained mature properties in less than stellar locations with some deferred maintenance issues that investors purchase for “value-add” opportunities. Investors seek a higher CAP rate to compensate them for the additional risk.
- Class C: Less than desirable locations that are in need of renovation. These properties produce the lowest rental rates and often require significant cash infusions.
Which is the best to purchase?
The answer is that each investor has their own timelines, tolerance for risk, cash flow requirements, and other considerations that would result in an answer that was different than the next person. The question that should be answered is, which is right for me now and in the distant future.
Real Estate Investments Timelines
One advantage that securities investments have over real estate investments is liquidity. Even a hot property in a hot market with an all cash deal is going to take some time whereas the stock market is click-click quick and only takes three days to clear. That will not change in the short-term and should not. Mechanic liens, easements, and other encumbrances need to be identified by the title company and may need to be removed before closing.
Investors who want to make real estate investments and who seek to minimize the liquidity constraint should add some Class B properties that are small in size. The reason I suggest small properties because a small Class B in a good neighborhood will be desirable and priced lower than other properties in the area.
I once owned a tiny house. It was 560 square feet in the lovely town of Chico. When it was listed, it was the lowest priced property on the market. It was in a charming neighborhood and would easily meet FHA requirements. I had multiple offers in less than three days.
Flipping
My grandfather was a builder and an investor. In addition to building homes for others, he would build a house that he lived in for a couple of years and then sold. During those years he landscaped and added more value to the property and enjoyed it. He would then list the house and build another to repeat the cycle. While this is not an example of Flipping, it is an example of how real estate has one very large advantage over securities. You can physically make improvements to increase the value of property.