When purchasing an industrial building, there are three categories to choose from: Class A, Class B and Class C. While Class A industrial buildings are the nicest category, with the highest value, they are oftentimes out of reach to most investors. Class A buildings require a lot of upfront money, and they exist in a highly competitive market. For investors looking for something a little bit more affordable that could still attract tenants and maintain its value, Class B industrial buildings could be the best option.
Class B industrial buildings are typically older than Class A buildings, with a lower rental rate, and they’re often found in secondary markets, said Alex Capozzolo, co-founder at Brotherly Love Real Estate. Although Class B industrial buildings are older, Capozzolo added, they are often well-maintained and could be considered value-add assets. If demand rises, they could even be converted into Class A. There are two categories of Class B industrial properties: B1 and B2. B1 properties, Capozzolo said, are meant for businesses with light manufacturing activities, while B2 properties are meant for businesses that operate in heavy manufacturing activities, such as shipbuilding, locomotive construction, steel production and more.
Reid Hogan, a Commercial Real Estate Advisor at PropertyCashin, also noted there is some level of subjectivity in terms of what makes a property Class B. Some properties, Hogan said, may be lacking in just one area, while others may be behind in several categories. If a property is on the outskirts of town where freight vehicles need to make several turns to reach them from major highways, or if they’re far from air or rail transportation, they won’t be rated higher than B.
Other factors that lead to a Class B rating, according to Hogan, are old improvements, cheap construction, or outdated equipment and utilities. Because they don’t command top rents, lease terms for these properties will be shorter, and the tenants are often “second-tier local or rising regional companies.”
There are several advantages to buying or investing in a Class B industrial building. According to Capozzolo, Class B industrial buildings are less expensive than Class A, they can be value-add assets, and the risk-return profile is better on B buildings if investors are willing to take a bit more risk than a stabilized A building. Hogan also noted that, because the buildings are older and not as nice, Class B properties are more readily available to investors than Class A, which come with higher demand and competition. This availability is partially because institutional buyers aren’t as interested in Class B properties on average.
On the other hand, there are a few downsides to investing in or buying a Class B industrial property. According to Hogan, Class B industrial properties will have higher expenses for repairs and maintenance and may attract less-reliable tenants. Lease terms will be less advantageous for the owners, possibly with shorter terms and less than triple-net obligations for the tenant. For example, a double-net lease would require the owner to pay for all repair and maintenance expenses.
“Tenants won’t assume the responsibility for maintaining improvements that are not in top shape when they take the premises,” Hogan said. Capozzolo also made the point that Class B industrial properties will require improvements for a return on investment, and the location of these properties is just average. Class B buildings also tend to have worse features and amenities, such as lower ceiling height, less clear span, and other functional obsolescence issues.
An example of a Class B industrial building is an office linked to an industrial facility, Capozzolo explained. This value-add warehouse in Pleasanton, Texas, which is no longer available for sale, is also a great example of a Class B industrial building. The building, constructed in 2012, is slightly older than Class A, in a secondary market about 40 miles from San Antonio.
Just like with Class A industrial buildings, there are a few factors to consider before purchasing a Class B building:
Location is a big factor to consider before purchasing a Class B industrial property. If the location is desirable, then the value of the building may go up, despite the building being older and in poor shape, Capozzolo said. For instance, is the building close to a city? An airport? A train station?
One reason to purchase a Class B industrial building over Class A is because of price. A Class B building will be more affordable, and depending on your financing options and how much money you have upfront, it might be the best possible option.
The best Class B industrial buildings have value-add potential. When purchasing a Class B property, it’s important to think about how it can be improved over time, thereby adding value and allowing the property to appreciate with stronger leasing income.
As always, before purchasing any kind of commercial real estate property, it’s important to do your due diligence and research every aspect of the property. Because Class B properties are older than Class A, buyers should make sure to complete any and all inspections, including a physical needs assessment, and get the advice of a commercial real estate expert who can tell them whether or not the property has the potential for added value over time.
