Trying to get a straight answer to what’s happening with the office market isn’t hard. There are many, with lots of disagreement about who is right.
Some say this is a time for once-in-a-generation opportunities, urgent need for Class-A properties, or knowing there are gems among the mounds of dross. On the other hand, others say that the opportunity is turning office buildings into something else, waiting for the end of extend-and-pretend, and recognizing that the current office down cycle could last longer than the whole global financial crisis downturn.
To which, Moody’s Analytics CRE argues not for the overarching narrative, but looking at how to know which office properties will continue to do best. “By examining rent data, vacancy rates, and a range of location and property characteristics, we aim to uncover the patterns and trends that contribute to superior rent performance,” they wrote.
They started with properties that had at least two rent observations in both 2022 and 2023. Then they calculated the percentage change in averages of the rents in the two years to quantify rent performance — the percentage it increased between the two years.
Next came z-scores, which are a measure of how much something deviates from average performance. They subtracted each individual property rent change from the average rent change across all properties in the given metro, then divided that number by the standard deviation for all the properties. “The z-score serves as a measure of how much a given property deviated from the mean performance, enabling us to pinpoint top performers relative to their local market,” they wrote.
They also looked at physical characteristics like size, age, and location characteristics, including Commercial Location Score (CLS), “a comprehensive rating system that evaluates the relative quality of a location based on factors like accessibility, amenities, and environmental factors.” The point was to look for patterns among the best performing properties in a metro.
Moody’s defined a top performing property with a z-score of at least 0.45, which showed significant outperformance. The difference showed not just in rent growth but also lower vacancy rates. Typically, better performers were in suburban areas with “less competition and more favorable business environments.”
They looked at Houston as an example of the methodology. As was true nationally, the best performing areas were suburbs, which ironically didn’t have the highest business vitality scores. The Central Business District (CBD) and Richmond/Buffalo Speedway Submarkets has the highest average business vitality scores —1000 and 937.4, respectively. But submarkets with the highest concentration of top-performing properties were North/FM 1960 (BVS of 779.4) and Southwest (BVS of 772.3).
Even more interesting, the top performers in Housten tended to be “smaller in size and are more likely to be classified as Class B or C properties.” Nine out of the top 10 performing properties were in suburban submarkets. All were Class B or C.
Another point is that the characteristics that describe the top performing properties in one metro aren’t necessarily the same as those in another.
Additionally, a big role in performance for Houston was acquisition costs. The top performers had an average rent of $22.14 per square foot, which was less than the $25.51 average across all suburban properties. They were typically older, with average construction year of 1983 rather than 1986 for all suburban properties. Also, they were more frequently renovated, with the average renovation date of July 2004 versus October 2002 for all suburban properties.