The Outperformers – April 15, 2024
Office vacancies nationwide rose to a record 19.8% in the first quarter of 2024, Moody’s Analytics said in a preliminary report earlier this month. That figure is up 20 basis points from 19.6% in Q4 2023, which itself beat two previous peaks of 19.3% that were reached in 1986 and 1991.
However, there’s a class of office product which offers a distinct advantage in the current marketplace. This group of properties represents “superior rent performance,” Ricardo Rosas at Moody’s Analytics wrote in a separate report last week.
Which class? The obvious guess would be the new-construction, Class A towers in Midtown Manhattan or Century City that have been enjoying spectacular leasing success. But that’s not the correct answer.
“The top-performing properties in the office sector share certain characteristics that contribute to their exceptional rent growth,” Rosas wrote. “Besides rent growth”—measured in terms of a z-score relative to the average for rent growth in the metro area—”their performance is also evident through their lower vacancy rates, which is further supported by their higher Spatial Demand score. The Spatial Demand score measures demand for properties based on vacancy rates in the nearby area, suggesting that these properties are located in areas with high demand for office space, which in turn drives up rents.”
Using this methodology, Moody’s Analytics analyzed more than 7,000 office properties and devised a top 10 list of outperformers. All 10 are in submarkets that Moody’s Analytics defines as suburban. One of these is located within a major city (Los Angeles) at 611 S. Catalina St., yet it’s a low-rise of less than 50,000 square feet that was built in 1957.
Staying with that LA property, which ranked ninth in the top 10, we’re looking at rent growth of better than 45% over two years between 2022 and 2023. The average for its metro area over the same time period? Just 1%.
“This finding aligns with our earlier observations about the superior performance of properties in suburban areas,” wrote Rosas. “Despite the overall performance of these selected properties, they maintain an average vacancy rate of 15.4% while the national vacancy rate as of fourth quarter of 2023 is at 19.6%.”
The others include the following: 6520 N. Irwindale Ave., Irwindale, CA; 17685 Juniper Path, Lakeville, MN; 6600 Madison Ave., Carmichael, CA; 18805 W. Catawba Ave., Cornelius, NC; 600 E. Baseline Rd., Tempe, AZ; 101 E. Park Blvd., Plano, TX; 8251 Maryland Ave., Clayton, MO; 2610 Wycliff Rd., Raleigh, NC; and 1300 Greenbrook Rd., Hanover Park, IL. Aside from the Plano property, there’s not a high-rise in the bunch.
A commonality among the locations of top-performing properties is that “they tend to be situated in areas with lower Business Vitality scores,” Rosas wrote. “This trend suggests that these properties are located in suburban regions characterized by less competition and more favorable business environments.”
Another factor underpinning the performance of properties in suburban areas is the fact that, according to Moody’s Analytics, top-performing properties typically have lower Consumer Amenity Volume Scores. In other words, they have less access to local amenities such as restaurants, retail outlets and parks.
Moreover, top-performing properties often have “lower Economic Prosperity scores, signifying their location in areas with lower household income and business payroll,” wrote Rosas. “Interestingly, this finding challenges the widely held belief that high-performing properties must be situated in the most thriving and growing parts of each metropolitan area.”
Titled Mapping Success: Identifying and Understanding the Top Office Properties of 2023, the report zeroes in on the Houston metro area as a case study. Looking at metros such as Houston, Rosas wrote, “we observed that successful office properties may cater to non-finance or non-tech firms, maintaining demand for older, more affordable office spaces. Tenants like small law offices, medical practices, back offices for manufacturing and logistics companies, trades (such as plumbing and electrical services) and other service-oriented tenants typically require a physical office presence and benefit from affordable yet quality office spaces.”
A distinct advantage enjoyed by such properties is a smaller pool of leasing options for tenants. In contrast, concluded Rosas, “office properties in urban areas that are performing averagely or underperforming may be experiencing an imbalance of supply and demand.”