The class of building is extremely important in commercial real estate. Industry professionals including brokers, landlords, investors, lenders, research analysts and industry data vendors rely on this data. A building’s class affects its valuation and how tenants are attracted to it.
If you’re looking for office space, it’s helpful to understand how different building classes may affect your business and overhead expenses.
Why have an office building classification system?
Classification systems have evolved because commercial real estate professionals needed a way to identify which buildings comprise a competitive building set, which means the buildings that technically compete for the same tenants and investors. For industry analysts, grouping like buildings together is necessary for assessing market fundamentals, in other words, whether occupancy and investment is changing for a group of like buildings.
The system evolved as commercial real estate became an asset class. While investors have always been attracted to the revenue streams office buildings produce, the ways of investing in them have changed over the years. The universe of commercial real estate is enormous and now attracts investors of all types, from small local owners to large funds. One characteristic they all have in common is that they are keenly aware of how a building is classified and what will attract a business like yours.
Why is a building’s classification important to you?
A building’s class can directly affect your business. If you will be receiving clients in your office, the building’s appearance and facilities will affect their impressions of your business. In a way, the building’s image is intertwined with your brand.
How did it come about?
To understand a market, you have to have the right sampling of buildings. Identifying a set of physical characteristics that allow one to categorize buildings has been the goal of CRE researchers for years. Several standards have been created, and they have evolved as commercial buildings have changed over the years. What was considered a market-leading building 25 years ago would not be the same today as landlords have changed their offerings as tenant expectations have changed. For example, the amenities in today’s office buildings are far different than what they were years ago.
A reliable classification system was developed by NAIOP, a commercial real estate organization for industry professionals. The organization assembled a task force in 2004 that standardized definitions, which have been updated as buildings have evolved.
Here are the office building class definitions:
Commercial Real Estate Building Classifications
Class A Building
A classification used to describe an office building with rents in the top 30 to 40 percent of the marketplace. Class A buildings are well-located in major employment centers and typically have good transit, vehicular and pedestrian access. Additionally, they are located adjacent to or in proximity to a high number of retail establishments and business-oriented or fast-casual restaurants. Building services are characterized by above-average upkeep and management. For example, a law firm might consider a Class A space a necessity as it projects the appearance of a thriving practice to its clients.
Class B Building
A classification used to describe an office building with rents that are based between those of Class A and Class C buildings. Class B buildings are in good to fair locations in major employment centers and have good to fair transit, vehicular and pedestrian access. They are located adjacent to or in proximity to a moderate number of retail establishments and business-oriented or fast-casual restaurants. Building services are characterized by average upkeep and management. For example, a back-office for a firm would be a good candidate for a Class B building.
Class C Building
A classification used to describe an office building with rents in the bottom 10 to 20 percent of the marketplace. Class C buildings can be older buildings in good locations or moderate-level buildings in poor locations, so transit, vehicular and pedestrian access may vary. Typically, fewer amenities and restaurants are found in or near these buildings, and they are usually of moderate to low quality. Building services are characterized by below-average upkeep and management. Class C buildings are ideal for startups and small businesses with low space requirements.
What additional factors affect class?
The definitions above are an attempt to describe buildings objectively. There are, however, several additional factors that influence a building’s classification according to NAIOP. A building that might be considered a Class B building in a downtown area could be considered a Class A building in a suburban area. Also, some buildings are simply not classified properly, which could be due to industry professionals subjectively considering additional factors such as age, amenities, parking, construction materials and architecture.
You should assess what other building characteristics are important for your business:
- Amenities – Are there additional common areas such as a fitness room that would bring additional benefits and value to your occupancy?
- Accessibility – How easy is it for your team and clients to get into your office space?
- Security – What level of security does your business need?
- Elevators – Wait times for elevator cars can impact your team’s productivity.
- Lobby – What sort of first impression do you want people to have when they enter your building?
- Views – Having a nice vista is more than a nicety: it can affect your team’s comfort level.
How do market fundamentals affect rents and how do they relate to building class?
Put simply, the better the building, the higher the rents, so Class A buildings command the highest rents. Some Class A buildings are labeled “trophy”, which are the top buildings in a market. These are the architecturally significant, newer inventory with the highest Class A rents. They have an interesting characteristic: their rents lead the market up and down, first to rise and fall.
Class B rents are lower than Class A rents, and Class C rents are less than Class B. Again, location is important: a Class B building downtown might command higher rents than a Class A building in a suburb.
Generally, rents are a reflection of basic supply and demand: when a market tightens, landlords grow rents and when demand weakens, they reduce their asking rents. When rents do weaken, companies have more options, sometimes in buildings, they once could not afford. This is called a “flight to quality”, and it happens during a down real estate cycle.
What building class questions should I ask of my broker?
If you are searching for new office space, you should ask your tenant rep broker some basic questions:
- Is a building’s class correct?
- How much does its location affect its classification?
- How does it compare with buildings with the same class designation?
- Are the market conditions such that I can afford a high-quality building?
As stated, a building’s classification is important to your business. Understanding why a building is classified as Class A, B, or C will help you decide where to rent. It will also affect how your business operates and could determine its success.
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