Despite the prevailing economic uncertainty, corporate tenants have demonstrated an increasing willingness to pay higher prices for premium accommodations in the office market.
This phenomenon known as the “flight-to-quality” is taking the commercial real estate industry by storm. And the growing preference among tenants and investors for high-quality, modern, and well-equipped office spaces has rapidly devalued older or less desirable alternatives.
Because top talent will not put up with out-of-date offices especially after being given the freedom of workplace flexibility. And because of this, vacancy rates for premium class buildings are overwhelmingly lower than their less impressive counterparts. Let’s discuss.
“Flight-To-Quality” in a Post-Pandemic Office Market
As companies reevaluate their pre-pandemic working environments, there is a new emphasis placed on bringing employees back to the office with premium features and upgraded spaces.
Because with the omnipresent option of working from home, companies that do insist on the value of physical workspaces need to reorient the use of these spaces to become more appealing. Because in a talent war, companies with stronger commercial real estate properties stand out.
| Everywhere, the push for better buildings has further devalued Class B properties, as a result there is a bigger delineation in the asset classes. |
Class A, Class B, and Trophy Class Offices
The differences between Class A and B properties are significant; Class A offices are modern with premium amenities, on-site parking, more centrally located, etc. While Class B buildings are often older structures with limited features or amenities. Typically, Class B buildings are often yesterday's Class A buildings.
Building class is only one consideration when it comes to finding the perfect office space. Learn the other factors that will find you the best office for the best price and terms in the free course.
Businesses looking for better accommodations have been willing to pay higher leasing rates for the better facilities found in Class A offices. Because overwhelmingly businesses are opting for smaller footprints, and extra funds saved in square footage cuts can be devoted elsewhere.
But even beyond Class A, the circumstances have also allowed for the rise of certain trophy class buildings. Like 1 Vanderbilt in Manhattan, where rents are rumored to start at $300 psf, these buildings are typically characterized by their prime locations in prominent business districts, iconic architectural design, state-of-the-art facilities, advanced technology integration, and top-notch amenities.
1 Vanderbilt, Read: The Manhattan Rent Crisis.
Trophy class buildings are often occupied by renowned corporations and serve as symbols of excellence and success in the commercial real estate industry. And interest in trophy class buildings is trumping other buildings across the country.
The Flight-To-Quality in Manhattan
The robust interest in premium properties is reflected in steadily climbing rates for asking rents. And of course, this is observable in the country’s most expensive office market, Manhattan.
| “Net effective rent for trophy space in Manhattan averaged approximately $100 per square foot in the first quarter of 2022 and jumped to $112 per square foot in the first quarter of 2023.” -Propmodo |
In fact, any recovery the post-pandemic office market in Manhattan has shown seems to be primarily driven by an ongoing shift towards high-quality properties.
The price for premium properties is steadily growing while outdated properties are rapidly losing interest and largely sitting vacant. In fact, an overwhelming majority of prospective tenants are not even considering signing a lease for on older/ Class B office and this reflected by touring statistics.
An overwhelming 81.6 percent of tours in New York City involved Trophy and Class A office space in February 2023. This number reveals how quickly and persistently interest is climbing year-over year. In February of 2022, 76 percent of tours were for premium properties.
The Flight-To-Quality in San Francisco
It’s no secret that a great majority of the San Francisco leasing market is dismal. But despite this, interest in (overly) premium properties continues.
With tech titans closing offices, subleasing, and relocating from the previous empire, the vacancy rate in the city climbed 10% throughout 2022. Now, empty offices haunt the city, encompassing 27 million square feet. This figure represents eight times what it was in 2019 when the vacancy rate lingered around 5%.
The tech industry was synonymous with Class A, impressive offices. But with so many of them working from home, a tidal wave of modern offices hit the market. What does this mean now? Well, they’re a dime a dozen.
The wildly oversaturated market is driving down premium property valuations to a fraction of what they were prices at in the Silicon Valley Gold Rush. Now, in order to really get attention from prospective tenants in San Francisco, lately, the buildings have had to be trophy Class.
| “The San Francisco office market is experiencing record-high vacancies, a soaring 29.4 percent in the first quarter of 2023, but the vacancy rate among trophy assets is roughly 10 percent lower than the overall average.” -Propmodo |
This dramatic shift is reflected in an even more rapid price growth of trophy properties as other classes stall. “The average asking rent for trophy and Class A office space in the first quarter of 2023 was $122 and $75 respectively,” according to Propmodo.
Despite facing one of the highest vacancy rates in the nation, the market continues to show strong demand for prestigious office properties.
What Should Tenants Know About The Flight-To-Quality
Tenants should be aware that the flight-to-quality in office buildings presents unique opportunities.
By opting for high-quality spaces, tenants can benefit from enhanced amenities, improved infrastructure, better services, and a more prestigious business address.
Additionally, these buildings often attract a professional and established tenant community, fostering collaboration and networking possibilities. However, it's essential for tenants to carefully assess their needs, budget, and long-term goals to ensure that the advantages offered align with their specific requirements.
Because at the same time, tenants should be aware of how the flight-to-quality implicates rent prices and demand in their area (and beyond).
With such a national emphasis on premium properties, alternative properties have been severely devalued. For tenants who are willing to consider these as prospective options, this dramatically increases their leverage in negotiation. It increases the likelihood that they can take advantage of dropping demand (even in Class A properties) and negotiate a more favorable deal.
This may include securing a generous tenant improvement package to update the building according to their needs. Because landlords, recognizing the value of such investments, may be open to working with tenants to enhance the property, as it can lead to stronger returns in the future.
Take Advantage of the Flight-To-Quality
The flight-to-quality represents a new era where companies are funneling their corporate funds into quality over quantity when it comes to office space. Rather than focusing on large amounts of space, businesses are now seeking high-quality office environments that offer premium amenities, modern infrastructure, and desirable locations. This shift reflects a recognition that the quality of the workspace has a significant impact on productivity, employee satisfaction, and overall business success.
Right now, there’s incredible leverage for tenants wanting to expand their footprints. Since so many companies are slashing their space, this introduces a window of opportunity for those looking to retain their offices but still cut costs.
Commercial tenants should view the current downturn in property valuations and the upturn in vacant space as a valuable opportunity to secure real estate at significantly lower prices. In markets like
San Francisco, where a downturn is being experienced, tenants have the potential to acquire Class A properties for a fraction of their previous cost. Moreover, this presents an opportunity for future appreciation as the market eventually rebounds.
Taking advantage of the current situation, tenants can negotiate harder deals and secure more favorable lease terms, benefiting from concessions offered by landlords. Alternatively, they can explore the increasingly flexible leasing sector, allowing them to find a space that perfectly aligns with their square footage requirements. But only if you know what you're looking for. Learn how to find the best office space for the best price and terms on the market in the free course below.
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