Any number of real estate research reports for 2023 will verify that the United States office sector is struggling, except for the Class A segment. And that is true. Sort of. It’s actually the “trophy” class that is experiencing substantial demand. Trophy is the term used to describe the small group of cream-of-the-crop buildings that comprise the best of the Class A segment. This exemplifies one of the major problems with the way we classify office buildings in the U.S. The Class A-B-C rating system is actually created based on local indicators. A Class A designation constitutes the very top properties in a particular market. So, a Class A office tower in, say, Minneapolis, Minnesota, will be quite a different property than a Class A office tower in Manhattan. This means that when investors are trying to compare properties in different markets, the class system doesn’t allow them to compare apples to apples rather than apples to lemons.
One has to examine the ins and outs of the class rating system to understand why the star rating option is a long-overdue necessity. The class system compares such factors as age, location, amenities, and finishes of a building to those of other properties of the same asset type in a particular market, rendering the system all relative. “What that means is the market is what’s really determining what is Class A or B or C, not the properties,” said Phil Mobley, national director for office analytics at CoStar. When looking at the office sector, Class A constitutes the very top of a specific market, buildings with the newest and best amenities of the stock and are sited in premier locations. Most office buildings in the U.S. fall into the Class B range, and while they are well-maintained and offer certain amenities, they’re older than Class A properties and aren’t as well-located. Class C office properties are typically much older buildings that have not been upgraded to market standards and don’t offer the best location.
This is a problem that CoStar is hoping to tackle with its CoStar Building Rating System. CoStar has created a system that breaks down the quality of commercial properties much like the global hotel industry does, classifying buildings with a 5-star system. The star system takes away the subjectivity that is inherent in the class system. It culls a plethora of property details and compares that information to a collection of defined criteria for each star rating. For the office sector, the star rating system evaluates five categories, among them a property’s architectural design, including elements ranging from exterior materials to building access to lobby features such as double-height ceilings, premier finishes, an alluring waiting area, and prominent artwork. As Mobley noted, “You know when you walk into the lobby of a 5-star building that you’re in a 5-star building.” The remaining categories taken into consideration in the Star rating system are the quality of the structure and systems, amenities and management, site/landscaping/exterior spaces, and the existence of certifications.
Five-star properties are mostly state-of-the-art buildings, and the 5-star designation places the Class system’s trophy label, which is lumped in with Class A, into a separate category. Four-star properties are just a step below 5-star buildings, as they aren’t at the cutting-edge level but still offer a very high-quality structure with above-average maintenance, long-term desirability among tenants and investors, and some 5-star characteristics, like a prime management team. “Property management and the quality of that is an important feature up and down the scale,” Mobley said. “If you’ve got an onsite management team, that’s a lot different for the tenants than if you’ve got a single property manager that’s managing seven different buildings and going between them.” The 3-star rating is fundamentally an indication of an average property. These older buildings are likely to feature some basic amenities and limited upgrades, a modest lobby, simple landscaping, if any, and floor plates with less flexibility than those in newer properties.
The Star system’s criteria for office assets change at the 2-Star and 1-Star levels as the number of categories judged is smaller. At the 2-star level, only architectural design, structure and systems, and amenities and management are taken into consideration. Two Star properties are basically functional at best, with bare minimum structure and systems, small windows, and likely no amenities or management in place. Properties that earn a 1-star rating generally require major renovations and are essentially functionally obsolete. “The idea behind the star rating system is that there’s consistency across markets. If you’ve got a 5-star building in one place, it will be comparable to a 5-star building in another,” Mobley said. And the same applies to all the other ratings as well. The only real variable with the star system is pricing. Rental rates for 5-star office space in Chicago will be far less expensive than those found at 5 5-star-rated properties in New York, for example.
While much more detailed in its classification of buildings than the Class A system, the CoStar Building Rating System is not a rigid platform. For example, while 5-star buildings are generally newly built, age does not necessarily exclude a building from achieving the highest designation. “An old historic building that just has some cachet, like the Empire State Building or Willis Tower in Chicago, those types of buildings that have also been upgraded are 5-Star not only but in part because they have that architectural significance and historic value,” Mobley explained. “There’s a little bit of art and science to it.”
Usually, a trophy-type asset or a property that would rank five stars evokes images of glass-clad high-rises, but a building needn’t touch the sky in order to earn 5-stars. Apple’s Cupertino, California, headquarters campus, Apple Park, is a low-rise, high-tech building shaped like a gigantic ring, so while it doesn’t meet the 5-star criterion of destination dispatch elevators, its distinctive architecture ticks a key box of the 5-Star category. Transit orientation is on the 5-Star checklist and is vital in places like New York City, but in markets like Dallas, which is not a leader in transit, a building won’t necessarily be excluded from the top category for not having the transit-oriented element.
The Star system also serves as a reality check of sorts. With the class system, classification is market-based and is essentially the equivalent of grading on a curve. Alternatively, the star system allows for consistent assessment of a particular property type at the national level. As such, some markets will have a low inventory of 5-star properties or no 5-star properties at all, and others, like Los Angeles, Manhattan, and San Francisco, will have a wealth of 5-star options.
CoStar’s proprietary property classification system acts as a uniform measuring stick for commercial properties, and the company is aiming for the Star system to be the industry standard. However, CoStar isn’t advocating the elimination of class ratings, as it still sees value in the traditional property classification. “It depends on what your goal is. If you’re an investor or an owner who wants to have a very consistent brand of building, I think something like a star rating system makes sense,” according to Mobley. “If you’re a broker competing in a single market, then I think using class is perfectly appropriate to what you’re doing. We try to enable both.”
The CoStar Five Star Building Rating System is an evolving rating method, as it is constantly modified to accommodate such factors as technological advancements and emerging sustainability practices. Commercial buildings have become very complex, and the broad and rather generalized class system does not give investors, brokers, and tenants a consistent national benchmark for understanding their quality. The class system has its benefits for understanding where a building stands in comparison to its local competition, but CoStar’s star system offers an even playing field across markets. By building out this star system, CoStar has created yet another reason for brokers and investors to pay for their service. CoStar is already the leader in commercial real estate research; now, they have more proprietary data in the form of their star system.