Since we all have our own definition, I think it would be helpful to describe mine and see what insight you guys have and what your definitions may be. Please let me know in the comments below if this is helpful, or if you have more criteria to add in this discussion.

Percentage of homeowners vs. renters:

When ranking a community, I start with homeownership. What percentage of the neighborhood is homeowner vs. renter? In an A-class community, I’d like to see 90% or better homeowners vs. renters. B neighborhoods would be 50% homeowner and 50% renter which is typical in Memphis, TN my hometown. The C neighborhood would be mostly renters.

Land value:

The next factor in ranking a property’s neighborhood would be the value of the land the property is on. Imagine with me if you will that your rental property burned to the ground. Everyone is safe, and no damage was done that money can’t fix. What would you do with that piece of land after receiving a lump sum check from your hazard insurance provider for the replacement value of the property?

In an A-class community, the highest and best use of this parcel would most likely be that you would rebuild bigger, better, and with higher amenities than the previous property and sell the house to a homeowner, for a profit. Afterward, taking these funds and reinvest in more rental properties.

When a property in the B class area of town meets the same fiery fate, you would rebuild exactly what was lost because this is the highest and best use of the land and the replacement cost check from your insurance company covers the rebuild of that 3bed 2bath home that no longer remains.

However, in a class C community, things may look a little different. If you own a 3bed 2bath 1524sqft home built in 1964 and it burns to the ground in a community with mostly renters and the average sales price is lower than the median sales price for the greater area the highest and best use may be to donate the land to a local charity and reinvest your insurance claim funds in another property because the cost to build new construction does not make sense in these areas based on comparable sales.

Crime:

I use Trulia.com’s crime map to gauge the level of criminal activity around each subject property considered. Simply put, C class areas are going to have more crime, while A class areas should have lower stats. I’ve noticed a peak in the number of incidents near multi-family and commercial properties. Trulia.com uses a scale from light blue to dark blue with dark blue indicating the highest levels of crime. It also gives a detailed list of criminal activities in the area. If you wanted to dig in further, you can find the local precinct and call to enquire about the neighborhood.

Shopping, Parks, and Amenities:

Where is the nearest Chick fila? Or you could ask where is the nearest super Walmart, wholefoods, dollar general? Use the big box stores and their million-dollar studies to help with your demographic study. An A-class community will have multiple shopping options and usually a Chick Fila and Wholefoods, while the B neighborhood almost always has a local super Walmart and a Dollar Store. C class areas are often overlooked by the big corporations and this is where you will most likely see less fresh food options and local mom-and-pop type convenient stores/check-cashing operations, and maybe a dollar store.

I’m not saying that any of this is fair. Life is not fair. If you were a multi-million dollar company where would you invest to build new buildings, stock the shelves with goods, and hire hundreds of employees? Therefore, we can simply follow the money.

Parks, biking trails, restraints, movie theatres, music venues, and others simply put: A class areas have greater options than B and the B areas have more than the C.

Schools:

Sadly, more educational options will be available in nicer communities. Memphis is a city known for private school education. However, in Memphis and many other cities charter schools offer a private school education at no or little charge. Greatschools.org is a good tool and Zillow.com offers a list of nearby schools. An A-class neighborhood does not necessarily have to have great public-school options. For example, the neighborhood I live in has horrible public schools and we pay a hidden tax called private school tuition.

Should I invest in an A, B, or C neighborhood?

The answer to this question is always: It depends. Depending on your investment strategy you may be drawn towards a specific class of neighborhood. The question to ask your self is: Are you more attracted to a lower return / lower risk or a higher return / higher risk type of investment?

If you plan on owning only a few rentals you may be inclined to stick with B+ & A properties. If you plan to grow a large portfolio you may be a C class neighborhood investor. Overwhelming there is less risk involved in owning class A properties, and the ROI is most likely lower than what you should expect (on paper) when compared to a C class home. The tenants should in most cases have higher credit scores and more to lose if they were to not fulfill their obligations outlined in the lease.

C class properties are the most popular investment because of the low entry points. A $65,000 home can be purchase with only 20% down and closing cost. With roughly $17,500 cash out of hand invested this opens the door to many investors with limited capital or for many investors allows them to purchase 2 C class properties vs. one A class.

What I have seen is that many investors end up with a blended portfolio. Maybe 2-3 A class homes, 5-6 B class, and 5-6 C class properties. This helps to know that they have some steady producers in the mix and a few higher reward / higher risk properties in their portfolio that help to maximize the ROI.

How to define an A, B, or C renovation:

Now that we have covered the location you need to know what condition the subject property is being delivered to you in. The big-ticket items on any home are your roof, HVAC, trees and landscaping, flooring, and mechanicals. A typical new roof that I install ranges from $3500 - $6000. This includes the removal of the existing roof, repair of any damaged roof decking, installation of new tarpaper, and a new 30-year architectural shingle, all boots are replaced, and vent pipes painted. A new HVAC can ben $3500 - $5000. This is assuming you will be able to keep the existing ductwork. The vendor I use gives me a 1-year part and labor warranty. We also cage all our AC units. Not because the neighborhood is rampant with theft but because a fully renovated and vacant home is a target. Most of the AC thieves I have been able to catch are in the industry. They sell our stolen units to homeowners, homebuilders, and sadly investment companies as “refurbished” units. Hard surface flooring in high traffic areas and wet areas helps to keep turn costs down. A turn is industry jargon for the actions taken between the time a tenant moves out & another tenant is placed. Water heaters are $800 and last about 8-10 years. Trees are beautiful but mature oaks and pine trees near a home and/or with limbs overhanging your roof can equate to big expenses over the years. I’ve paid as much as $10,000 to remove large trees.

Properties that are in A-class condition would include new construction, and Turnkey renovations. I own several homes that have B class renovations. Often, I buy houses that are tenanted. The residents have no plans to move, and you can not complete a full turnkey renovation with a tenant living in the home.

What is my definition of a turnkey renovation? The work turnkey has been used and abused but simply stated all major components have been replaced, the home has been renovated to 2020 standards esthetically and to code, and will attract a highly qualified tenant. This is an ideal property if you are using leverage. With a 30-year fixed interest rate mortgage and only 20% down payment, your tenants will pay for these big-ticket items over the years vs. writing a check for them in the coming years.

The C class renovation is simply lipstick on a pig and most of the rental properties I tour fall into this category. The overwhelming majority of rental properties in Memphis have never seen a proper renovation. These properties seem to trade more frequently, and each owner inherits the last owners’ issues. Duct tape, spray foam, and endless tubes of caulk make up the material list used by repairmen and property managers from years past. I receive phone calls weekly from out of state owners who have a property in Memphis and they do not understand why their property manager is spending $500 nearly every month on maintenance or why they can not keep a tenant. My first question is: “Where is the property located” and my second question is “What condition is the property in?”

Overwhelmingly their home is in an area that would not attract a long-term resident and the home falls into the C class renovation category.

“You can pay for it now or pay for it later.” Would you rather purchase a rental property that has been fully renovated or one that needs some work and pay for these repairs, out of pocket, as they are needed? My answer is: it depends. Each property and situation is unique and the best investors will know what best fits their strategy, and execute.

It’s important to note that you can have properties in B class neighborhoods with an A-class renovation.

GET A HOME INSPECTION – a non-bias 3rd party can be worth its weight in gold. If you are buying properties out-of-state, make sure you know the condition of the property.

@Stephanie Jones