Winning With Class A Properties

by FI Fighter on March 31, 2015

in Real Estate Thoughts

Class_A1

My thoughts on real estate investing are constantly evolving. Throughout the last 3 years, I’ve gained more experience and gotten to observe first hand all the caveats that are involved with landlording. Not only do I invest locally, but I also own a few properties out-of-state, so my datapoints are varied.

There are definitely pros and cons associated with both approaches, and yes, you can make money with either one (or both). The purpose of this post isn’t to debate in-state investing vs. out-of-state investing, but rather, I would like to share with readers my current state of mind and gameplan moving forward.

Not too long ago, I wrote an article stating that my goal was to purchase 10 rental properties by the end of 2015. Well, just like always, time moves at a blistering pace, and lo and behold it’s now already Q2 of 2015! Currently, I have an ownership stake in 8 properties, and 10 units total. So, that original goal set in 2013 is still definitely within reach…

Back then, my preference was to invest out-of-state because my primary focus was to build up cash flow. I still believe that cash flow is of paramount importance, but these days my preference has shifted to focus more on Class A properties.

And here’s why:

Class A Properties

By definition, Class A properties represent high quality. You don’t get to qualify just any property as Class A, and the ones who are lucky enough to receive such a designation (although arbitrary) usually possess some form of the following: Located within a wonderful school district, nearby a plethora of jobs, beachfront property, in the heart of downtown’s hustle and bustle, etc.

With Class A properties, you expect a good degree of appreciation. Not only that, but Class A properties are always in high demand, by both homeowners and investors. Really, when it comes down to it, there are only two drawbacks to investing in Class A properties:

  • Barrier to entry is high. These properties are expensive so you need lots of $$$.
  • Cash-on-Cash (CoC) Returns are low. If it’s cash flow you are aiming for, it will be dismal (or negative) in Year 1.

For these reasons, many real estate investors shy away from Class A properties, and instead choose to invest in properties that pack “more meat on the bones”. When I was heavily cash flow focused in 2013, that was my exact mentality and the reason I strayed away from the Bay Area.

In hindsight, I don’t have any regrets, as I feel that my out-of-state rentals do provide good diversification into my overall real estate portfolio. I went hunting for more cash flow, and indeed I did manage to locate that out-of-state! 🙂

Nonetheless, my current preference is to focus primarily back in the Bay Area again because I strongly covet adding more Class A properties to my portfolio. I do realize that this isn’t an easy task… The downpayment required to win a single Bay Area property can tie up enough funds that you could instead purchase 4 out-of-state rentals in Class B/C neighborhoods. Yes, from a cash flow point-of-view, the 4 of-of-state rentals would wipe the floor with any single Bay Area rental…

But I would still make the decision to go with the Bay Area property, today, because of the many “hidden” benefits associated with Class A properties. Recently, I finished remodeling Rental Property SH #3, and just posted a local ad to gauge market interest.

Here’s what I got on the first day of listing:

Now, I can’t say for certain how this applicant will turn out… but it’s a very promising start so early on in the tenant search. To be perfectly honest, my listing is also above market rent… so I was just taking a flyer more than anything else…

I’m sharing this datapoint with readers because this is the type of education I had to learn myself over the past 3 years as a landlord… This is an oversimplified explanation, but in a nutshell, with Class A properties it’s very much a logical give and take relationship:

Quality home = Quality tenants

With my first two rental properties, I’ve always collected rent on time each and every month, and the tenants are more than self-sufficient. Respect given is reciprocated with respect received… Just the way it should be! With my Class C properties, I’ve had situations where I rented out a fully rehabbed turnkey property to a tenant, and within the first two months, they stopped paying. In Indianapolis, for example, I had my first eviction before even the half year mark! Go figure…

Again, you won’t see these hidden benefits of owning a Class A property show up on a Pro Forma or Excel spreadsheet… But I’ve learned to stop always chasing after the projected $$$ and to instead focus on winning the highest quality tenants. If you can secure that, you can easily self-manage and set your monthly PM fee to $0. Further, vacancy can very realistically approach 0%… These non-costs do add up over time and translate into real, tangible cash flow!

Strong Anchor

As investors, we are all searching for peace of mind. Who doesn’t want to own assets that allow them the ability to sleep comfortably at night, sound like a baby with no care in the world? Class A assets will give you as much peace of mind as any investment possibly could.

Within my own portfolio, my Bay Area properties are the ones that I least worry about. This goes for Rental Property #1, Rental Property #2, and so far both SH #1 and SH #2… Over time, I would love to add SH #3 to that list as well. For the most part, that entire portfolio runs on auto-pilot, and I simply kick back and collect the rent checks. I know I’m making it sound almost entirely too effortless, but I would be lying if I said otherwise…

And all these datapoints are the ones nudging me to keep on investing in the Bay Area. With these properties, I get a good blend of the following: appreciation, cash flow, quality tenants, easy exit strategy, and the ability to self-manage to reduce expenses. If it ain’t broke, why try and fix it?

When it comes down to it, I’m not saying you have to ONLY invest in Class A assets. I don’t believe in binary numbers (or thinking), and I can never for the life of me figure out why some people feel like they can only play for ONE team. You can also own Class B and Class C properties… Why not? I’ll agree with you 100% that Class B and Class C rentals cash flow better than Class A… Actually, I wouldn’t mind owning some more Midwest cash cows, even as we speak, and I may very well pick up some more in the future…

So sure, I’ll definitely dabble in other spaces and allocate a portion of my portfolio to different types of assets, but at the end of the day, I know that the bulk of my portfolio needs to be concentrated on Class A properties. The anchor to my investment portfolio needs to be strong (for future sake), so if I’m going all in, it’s got to be with Class A rental properties.

Over the past 3 years I’ve learned a few things… Previously, I was hell bent on chasing after cash flow. Now, I’ve realized that I need a supremely sound anchor in place FIRST.

Cash flow can come later… Even with less of it, I have a feeling things will work out A-OK as long as I keep on stockpiling some high quality Class A rentals!

{ 13 comments… read them below or add one }

1 Income Surfer March 31, 2015 at 4:33 am

Thanks for sharing Fighter. From developing real estate I agree there is no substitute for a great location. Still, I need my investments to cash flow. Glad you’re feeling better!
-Bryan

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2 FI Fighter April 1, 2015 at 8:59 am

Bryan,

Absolutely agree, location is key to succeeding in real estate. Picking up cash flow in the process is the way to go, kind of like collecting the dividend while you wait for the astronomical growth to continue.

All the best!

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3 Tyler Tran March 31, 2015 at 6:52 am

Thank you for sharing your experiences with us FIF. I would like to own some rental properties down the future and it’s greatly appreciated learning from a mentor. Thank you and keep it up. I hope you are feeling better these days. Take care my friend.

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4 FI Fighter April 1, 2015 at 9:00 am

Tyler,

Glad you are finding the posts useful. Appreciate the kind words and support.

Real estate is an extremely lucrative game to be playing in… I’m glad I got started when I did and right now I can’t imagine ever walking away from it. REI is in my blood, I love the stuff!

Take care!

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5 mark March 31, 2015 at 7:31 am

Awesome post! I am glad to hear you found a system that works for you.

Would you believe me that it is possible to have both cash flow AND appreciation AND less head ache? Our strategy is to buy B class properties in neighborhoods that are not great but good. We employ a forced appreciation mentality. We strip the old carpet and change to lament. We give our homes fresh paint, fixtures ect.
What happens is when you have such a nice upgraded property, you can be selective in terms of your tenant (as you eluded to in your post: “Quality home = Quality tenants”). We have the best head ache free tenants because we can find that tenant who makes good money, but like us, does not want to spend that money. In other words we offer great value. We can cherry pick who we want and we only want the tenants who have great qualifications. In terms of cash return our gross rent is $1200. Our net profit is $940/month with no mortgage, all other expenses included. Not to mention because we bought a B class, we had tremendous upside since purchase 2 years ago. 20% to be exact.

Lastly, if you want to take your landlord experience to the next level. Which I know you do. Not only go to HOA meetings but run for the board. That is exactly what my business partner and I did. You will be surrounded by like minded individuals who want to work towards making your property more desirable in the community. Someone like you would get a lot from it and it would be a great way for you to network and learn the in’s and out’s of your biggest investment.

until next time…

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6 FI Fighter April 1, 2015 at 9:04 am

Mark,

Sounds like you are doing extremely well for yourself, kudos on getting both cash flow and appreciation… that’s something that many are dreaming about today since the market’s have rebounded so much.

Agreed, Class A and Class B is the space you need to invest in to minimize the number of headaches. Great tenants will make that possible because you will be able to use logic with them! 🙂

“I give you a quality house in spectacular condition at a fair price, and you pay your rent on time and keep the place nice and clean.”

Makes sense to me!

Thanks for the tip on HOA meetings. That, along with REI meet ups are a great way to learn more and to network with other liked-minded individuals.

All the best!

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7 FIHopeful March 31, 2015 at 7:38 am

I couldn’t agree more. About 12 years ago, I made the mistake of selling what would turn out to be a fairly profitable condo in a desirable Sunnyvale neighborhood because I wasn’t interested in owning rental property. It turns out, the proceeds from that sale have done well, but not nearly as well as if I had rented it out (this is 2003-2015 timeframe).

At the time, I had purchased the property for $310K and sold it for $350K just happy to get my investment back. Had I hung onto it and rented it, the rents would have gone from about $2K-$3K/month and it’s listed on zillow today for about 2x what I paid for it. So, in hindsight, I could have paid off the mortgage by now with rental income and also be sitting on about $2.5K/month rent income after expenses with about zero chance of vacancy or “bad” tenants.

But, you’re right, each investment is an education, and today I’m hoping to be on the cusp of declaring FI soon due to returns on the lessons I’ve learned. Looking back, I probably could have gotten here a lot earlier if I knew then what I know now, but unfortunately hindsight is 20/20. It’s great that you’ve already figured out these things out.

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8 FI Fighter April 1, 2015 at 9:08 am

FIHopeful,

Thanks very much for sharing your story with us. Sunnyvale is booming, and prices have shot up to an absurd level… relatively speaking.

I’m sure we all wish we had a crystal ball because it’s so tough to know which way the market will go and I don’t think anyone could have predicted this type of growth just a few short years ago.

So, I’m just going to try and do the best I can and make an “educated” guess. I am very bullish on the Bay Area, which is why I’ve decided to continue to invest here.

Earthquake and water shortages are really the only thing that scare me about this area… Yes, houses are expensive, but there are creative ways to get into the game, even today.

Congrats on being on the cusp of early FI. That’s an amazing accomplishment!!

All the best!

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9 Adam @ AdamChudy.com March 31, 2015 at 8:45 am

We’re searching for that first rental, so I’m soaking in all the knowledge I can. Thanks for posting your thoughts on quality.

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10 FI Fighter April 1, 2015 at 9:11 am

Adam,

You’re welcome! Yeah, take the time to soak in all the information, there’s a lot to learn.

For the most part, I think most will agree that real estate is a fantastic tool to help an investor build wealth. I’m not big on statistics (didn’t like it in college), but I’m going to guess that a great majority of wealthy folks got there by playing real life Monopoly.

Take care!

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11 Mike March 31, 2015 at 9:52 am

Being flexible in your approach and tactics is paramount to success in such a dynamic environment as RE.

Thanks for the updates!

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12 FI Fighter April 1, 2015 at 9:11 am

Mike,

Absolutely, and it’s kind of fun to dabble in many different pots! 🙂

Cheers!

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13 No Nonsense Landlord April 2, 2015 at 10:48 am

Class A tenants are more important than class A properties. It is difficult to get them in anything less though.

Make sure that you screen hard, and get high credit scoring people, with plenty of income. Do not fall for a con artist, professional tenant, that says “I want to move in right away and make this place my home for several years”. Moving in right away is a huge red flag.

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