D-Class properties are homes or apartments located in neighborhoods considered "bad" or unsafe.
These properties are usually run-down or even outright decrepit, and require a considerable amount of work to achieve livable standards. Though these properties may seem like a good investment because of their cheap prices, here are five reasons to avoid D-Class properties.
High Vacancy Rates
If renting out the property, Class D rentals tend to have higher vacancy rates than other types of properties. This is due to the fact that it is often difficult to find qualified candidates to rent the space. Applicants often have criminal records, previous evictions, or extremely low credit scores. Renting the property to a bad tenant can prove more costly than letting the property sit vacant while waiting for the right tenant, as certain tenants can cause thousands of dollars worth of damage. However, the longer the property sits, the more money the investor loses.
There's another risk to high vacancy rates: break-ins. A random passerby may notice the property sitting empty for weeks, or months at a time, and thinking the home is empty, decides to help themselves to the scrap metal within the home. Pillaged metals can lead to expensive HVAC and plumbing repair costs.
The Age of the Home
D-Class properties are often more than 30 years old, which is more of a problem than just the traditional wear and tear a home that age sees from weather and use. Buildings built prior to 1978 are at a greater risk of containing hazardous lead paint, which is costly to remove. Homes that old are also often stylistically different from modern homes, with smaller bedrooms, closets, and bathrooms. This is a major turnoff for many potential renters or buyers of the property.
Higher Maintenance and Management
Not only do older houses have more maintenance requirements than new properties, D-Class tenants tend to be higher maintenance than other types of tenants, according to Mark Ainley, founder of GC Realty and Development, at Bigger Pockets. Higher maintenance means higher costs. Ainley also says D-Class properties require more management than other types of properties. A large investor with a property manager and management team can absorb that kind of cost and work, but a smaller or first time investor may have a harder time keeping up with the kind of work necessary to manage a D-Class property.
Less Return on Investment
Low initial prices may make a D-Class property seem like a good investment. However, it takes the same amount of money to replace the floors in a B-Class property as it does in a D-Class property. An investor can get more rent from a B-Class property, though, and have less vacant time, leading to a greater return on investment.
Higher Loan Cost
The chances of getting a loan for a D-Class property at the same rate as that of B-Class property is wishful thinking. Lenders typically see D-Class properties as a greater risk, so many lenders may charge a higher interest rate and most likely require a higher down payment (typically 60%-65% LTV) for a D-Class property. If they do provide a loan, the interest rate will typically be much higher.
In the end, cheap may look good, but it doesn't mean better. Unless the investor is positive about the returns on his investment, he should consider avoiding D-Class properties. For more information, please feel free to contact us.