The term "flight to quality" is often used to describe the shift in demand towards higher-quality office spaces. However, a closer look at the data reveals that this phrase doesn’t fully capture the complexities of the current office leasing environment.
While top-rated (five-star) buildings, which constitute about 7% of the total office inventory in the U.S., have seen some resilience in demand since early 2020, the overall picture is nuanced. These buildings have experienced a positive net absorption, indicating an increase in occupied space, unlike buildings of other ratings. Yet, the strength seen in these premium buildings is less pronounced when compared to their performance prior to 2020.
Contrary to what the "flight to quality" suggests, several indicators highlight the narrative’s shortcomings:
Diminishing Leasing Activity in Higher-Quality Spaces
The proportion of new leases in five-star buildings has actually decreased, from over 10% in 2019 to less than 8% in 2023. Similarly, the leasing volume in four-star buildings dropped, leading to a combined decrease in leasing activity in the highest quality segments. This trend suggests a shift away from the highest-quality buildings.
Reduction in Lease Sizes in Premium Properties
In 2023, the average size of new leases at five-star buildings saw a significant reduction, with leases averaging 43% smaller than those in 2019. This shrinkage in lease size was more pronounced in high-quality buildings compared to those lower down the scale, indicating a complex shift in tenant preferences and needs.
Age Over Quality for Occupancy Trends
Interestingly, newer office buildings, irrespective of their quality rating, have managed to maintain or increase occupancy levels, showing positive absorption rates between 16% and 18% of their inventory. In contrast, buildings constructed before 2020, regardless of their quality, have seen a decline in occupancy. This suggests that the age of the building may play a more crucial role than previously thought, with newer buildings attracting more demand than older ones, regardless of their perceived quality.
These insights challenge the straightforward notion of a "flight to quality" and indicate a broader preference for newer office spaces over older ones, regardless of their star rating. The office market is evidently navigating through a period of adjustment, where the allure of newness seems to outweigh traditional markers of quality. This nuanced understanding underscores the complexity of office leasing trends and the need for a more detailed analysis beyond catchy phrases.
Source: CoStar, Loan Analytics