4 Expert Strategies to Invest in Every CRE Rating

Almost everything is graded in today's world. We assess a child's math skills, the strength of concrete, and even the quality of eggs with letter grades. The financial markets use a similar system to rate stocks, bonds, and credit quality.

Commercial real estate is no different; it gets letter grades too, reflecting the asset's physical quality and location.

In real estate, investors use grades to gauge a property's potential to generate income, which indicates its return potential. Although there are no official rules for property grades or how to invest based on these ratings, investors depend on them to quickly understand the asset type and devise the right investment strategy.

Here's an overview of the 3 major ratings in commercial real estate and the best investment strategies for each type from Terra Alma’s expert CRE advisory in Atlanta.

What Are Commercial Real Estate Property Ratings?

Commercial real estate properties, aka assets, are rated using a standard letter grading scale, usually ranging from A to C. This system assesses the property's physical quality, including construction quality, architecture, design, age, fixtures, finishes, and location.

Although there are widely accepted industry standards, there is no "official" grading designation, making asset grading subjective.

1. Class-A Assets

A-assets are the highest quality tier. This rating is typically reserved for new constructions or luxury properties built within the last 10 to 15 years. Because of their superior quality, class-A properties attract above-market rents and high-quality tenants and trade at the lowest capitalization rates.

2. Class-B Assets

Class-B assets are mid-tier, older buildings that offer average or slightly below-average market rents. These properties may need some maintenance or upgrades due to their age. But they remain highly functional and maintain stable demand.

Class-B properties can provide favorable cash flow, though they come with a higher capitalization rate due to an elevated risk profile. However, they also offer upside potential if the owner invests in capital improvements.

3. Class-C Assets

Class-C assets refer to older buildings, often situated in less desirable locations or secondary and tertiary markets. These properties typically attract below-market rents and face weak demand.

They may have significant deferred maintenance issues or be prime candidates for redevelopment. However, class-C property can be upgraded to class-B status with renovations.

4 Strategies to Invest in Every Rating

Rating and classifying assets are effective ways to describe a property's quality and attract the right type of investor without needing a physical tour. Investment strategies align with these asset class quality grades.

There are four main investment strategies: core, core-plus, value-add, and opportunistic. Each strategy has a different risk profile, depending on the asset's quality at the beginning of the investment.

1. Core Investing Strategy

A core real estate investment is a low-risk strategy. Investors following this approach target high-quality class-A properties in desirable neighborhoods. This strategy may also include newly renovated class-B properties with strong occupancy and stable income.

Core investments feature high-demand properties, above-average rents, and no existing maintenance or upgrade needs. These are fully operational, cash-flowing, and stable assets already providing healthy returns to the current owner.

Core investors aim to acquire well-managed assets, benefiting from low risk and ease of management. Consequently, core assets have the lowest cap rate among commercial real estate strategies, meaning investors should expect to pay more for these properties and accept lower returns in exchange for reduced risk.

2. Core-Plus Investing Strategy

A core-plus strategy offers a slightly higher risk profile than a core investment in exchange for better returns. Investors following this approach make improvements to the property to increase net operating income (NOI) and achieve a higher return.

These improvements might include minor upgrades like painting, landscaping, or rebranding. Core-plus properties often have above-average vacancy rates or other operational challenges.

New ownership can add value by implementing management improvements such as lease-up strategies, raising rents to market levels, or reassessing operating budgets to reduce costs.

For example, a newly constructed development, still in the early stages of leasing, is a prime core-plus property. Although class-A in quality, the new owner will drive occupancy, set rents, and develop operating plans to maximize NOI.

Other core-plus investments might include a class-B property in excellent condition but needing rebranding and new management to improve NOI, or properties requiring minor improvements to boost income.

3. Value-Added Investing Strategy

A value-added strategy involves higher risk, targeting class-B and class-C assets that require significant capital improvements. These properties are often older than 25 years and may have deferred maintenance issues affecting their functionality.

These properties typically need extensive renovations to meet modern quality and style standards.

Investors can usually acquire class-B or class-C properties below replacement cost and at a higher cap rate, which compensates for the additional investment and risk. This strategy appeals to investors comfortable with higher risk, including those with construction and project management expertise, such as developers.

4. Opportunistic Investing Strategy

Opportunistic investments represent the highest risk category. Investors in this segment often acquire lower-quality assets under distress, such as properties in default, vacant or shuttered, or the ones requiring extensive redevelopment beyond mere upgrades.

These investors accept substantial risk for the chance to purchase at a deeply discounted price and realize significant upside potential.

Typically, opportunistic properties are class-C or below-grade assets with major issues. However, after comprehensive redevelopment, these properties can be upgraded to higher-quality status.

Along with being the riskiest, opportunistic investments also involve the longest time horizon, often taking three years or more for the owner to achieve a return.

In Conclusion

Investing in commercial real estate involves understanding different property grades: Class-A, Class-B, and Class-C. Each grade represents the property's quality and location.

Terra Alma’s expert CRE advisors recommend using core, core-plus, value-added, and opportunistic strategies to make the most of these properties.