CBRE Econometric Advisors’ Effective Rents Show the Office Sector’s Full Picture

CBRE Econometric Advisors (CBRE EA) now offers to clients a proprietary effective rent series for the office sector, covering 61 U.S. markets including 834 submarkets on a quarterly basis with data going back to Q4 2010.

The EA Effective Rent series is based on a net present value (NPV) analysis incorporating base rent, term, escalations, free rent, tenant improvement allowances (TIs), and a discount rate equal to the long-run returns of the NCREIF office index.

TIs are the most opaque deal terms that impact effective rent calculations, and thus the most complicated to model. A key finding is real Treasury bond yields and forward inflation expectations are good predictors of TIs.

A Recap of the EA Taking Rent Methodology

Leveraging CBRE proprietary voucher data, CBRE EA uses a model to predict the gap between asking rent and taking rent. EA’s ability to match individual transactions to suite-level asking rents allowed us to map an ask-to-take discount percentage for nearly every transaction in our database. We then modeled how key factors influence this discount, landing at a model for the ask-to-take discount that utilizes deal factors (lease size, lease term, and lease’s matched asking rent) as well as market factors such as the vacancy rate and asking rent. This modeled discount is then applied to the EA Asking Rent series to form the EA Taking Rent series (Figure 1).

Figure 1: EA Asking Rent Vs. EA Taking Rent

What is EA Effective Rent?

The EA Taking Rent series was a pivotal step toward an EA Effective Rent series. In addition to accounting for lease term, rent escalations, free rent concessions, and tenant improvement allowances, a key component of an effective rent series is the ability to account for the time value of money. To do this we construct a discount rate which reflects the opportunity cost of capital or the return that an investor would expect to achieve in investments of similar risk. Aggregating each of these components allows us to compare different transactions with different cash flow schedules to accurately assess the relative value of each transaction (and most importantly, how that ‘true value’ is changing over time and across markets).

Figure 2: Sum of Markets: Modeled TI (2010=100)

With our custom equation, we can estimate the TI values needed to construct an effective rent series dating back to 2010 across all 61 of EA’s Tier 1 markets.

To gain more granularity, we share the market level EA Effective Rent for individual submarkets using the market level relationship between vacancy and effective rent/taking rent discount as a guide. To reduce the impact of vacancy volatility, we put guardrails on the movement of the effective rent discount based on how correlated a submarket is with the broader market. Submarkets with more volatile vacancy movements will have discounts that more closely match the broader market, and vice versa.

Figure 3: EA Asking Rent vs. EA Taking Rent Vs. EA Effective Rent

What does the EA Effective Rent series tell us?

• Changes over time: While asking rents across EA’s Sum of Markets have increased 1% from their Q1 2020 level, EA Effective Rents are 11% below their early 2020 level. Further, the national EA Effective Rent figure now represents a 40% discount to EA Asking Rents, and a 33% discount to EA Taking Rents. This compares to Q1 2020 when the ask-to-effective discount was tighter at 33%.
• Spread of different markets: The variation among markets is also better defined in EA Effective Rents. This is important because different markets are showing different capacity to absorb market weakness. The value in an Effective Rent series is the ability to normalize and compare each of those mechanisms in a single, holistic equation. For example, in Atlanta asking rents have increased 5.6% since Q1 2020, but the combination of concessions and post-negotiation discounts have caused effective rents to fall 6.6%. Similarly, in Manhattan asking rents have fallen 3.3% - notably more than the national figure, which has been flat. But the decline in effective rents is 17.3% for Manhattan compared with 11% nationally. We also see this in markets like San Francisco, which was hit extraordinarily hard by hybrid work’s impact on the tech sector. Not only are asking rents down 18.5% since the start of the pandemic but effective rents are down 32.2%. EA Effective Rents are picking up the nuances across markets, normalizing various methods for capturing fundamentals, and allowing for the first time an apples-to-apples comparison of true rental income across both space and time.

Figure 4: EA Effective Rent Decline Since Q1 2020