If You Want Office Workers Back, Don’t Turn Them Away at the Door | PROPMODO WEBINAR→
Commercial property - Real Estate

Flight To Quality Creates the Need for a Better Office Classification System

Big tech firms like Google and Apple changed office leasing forever by bringing hospitality to the workplace. Attracting and retaining the top talent in Silicon Valley and other tech hubs became an all-out war. First, it was ping pong tables and arcade cabinets, then came the full-service dining halls, the gourmet chefs, on-site baristas, golf simulators, athletic clubs, nap rooms, all with the finest glossy finishes backed by hyper-efficient building infrastructure. The buildings have only gotten taller and the finishes even finer. 

This same mentality has infected other industries as well. While COVID might decrease the overall demand for workspace, it will also push companies towards better offices, ones that people will want to go to when they can just as easily stay home. An office amenity arms race to sign lucrative tenants seeking the finest office spaces in the country is creating a new class of office space at the very top end of classifications. The problem is that years of improving the quality of office spaces has not been reflected in office search requirements, creating a huge range of value within Class A offices. Informally referred to by brokers as Class AA, Class A+, or Trophy Class, ultra-luxe high rise offices are being used more than ever to attract top talent, fueling demand for space in opulent offices amid a historic downturn. 

“Building class historically includes a certain level of subjectivity, though the rise of CoStar as the pre-eminent database has led to using their classifications more often than not,” NAI Partners Vice President of Office Tenant Representation Joe Bright said. “CoStar uses a rating system and local research professionals to grade buildings using the following criteria: architectural design, structure/systems, amenities/management, site/landscaping/exterior spaces, and certifications.”

Bright explained for most tenants, you know when you’re in a high-end Class A Building. They’re regularly or recently renovated with high-end finishes, with amenities like fitness centers, conference spaces, and on-site food and retail. Dedicated property management and security are huge factors as well. But none of that captures the intangibles today’s top tenants are looking for. High-end Class A offices won’t just have a fitness center and a deli, they’ll have fitness complexes, numerous dining options serving up chef-inspired food, and finishes in interior and exterior commons areas that are noticeably distinguishable from lower-end or older Class A buildings. Rating databases like CoStar don’t have a way to account for food halls in the basement, rooftop gardens, and/or the world’s fastest elevators. 

“Though not officially, there is absolutely a range in quality of Class A buildings,” Bright said. 

This range is reflected by rents at the top end of Class A offices which can be nearly 15 percent higher than on the lower end. Elevated offerings that attract blue chip corporate tenants have a trickle down effect, creating demand for a ‘trophy’ building that leads to accelerated leasing and higher rents on subsequent deals. Outside of the world of tech, law firms, financial managers, and companies ranked in the Fortune 500 have an immense appetite for the most luxurious office space in their market and are willing to pay premium rent. For some, grand offices can impress clients and establish a brand. 

This range of rent in ‘Class A’ offices might widen even further. While the pandemic has the rest of the office market hurtling down a mountain on a double black diamond, Class AA office is cruising down on the bunny slopes. Commodity office products are reporting occupancy decreasing 1.5 times faster than in trophy class buildings, according to JLL’s latest data. Generous concession packages and lavish tenant improvement allowances have tenants considering leases in Class A+ offices they never thought possible. In Manhattan, the average tenant allowance was up nearly 20 percent to $101.58 a square foot in 2020, adding on an additional average of nearly 12 months of free rent on new leases, according to Colliers data. 

Higher-end Class A offices are eating the lion’s share. Many businesses are taking the opportunity to ‘right-size’ (read, downsize) their office space and upgrade their building, penciling out the increased real estate costs. Trophy spaces in Manhattan accounted for 69 percent of all new leasing in the final quarter of 2020, according to VTS. That flight to quality is being seen all across the nation. 

“The flight to quality has certainly been a significant factor in our market in Houston,” Bright said.   “With our market being overbuilt even prior to the pandemic, the move of large tenants into new Class A buildings (usually decreasing their footprint) and out of older buildings has left a number of significant holes in the market and further increased vacancy rates.”

The Class A+ office market is not immune. In 2019, the property class set a record in Manhattan, inking 145 deals with rents over $100, totaling roughly 8.8 million square feet. In 2020, leasing at Manhattan’s priciest offices fell by 75 percent, signing only 60 deals with rents over $100 a square foot, totaling 2.1 million square feet, according to JLL’s annual report that tracks high-end offices. Notably, the majority (57 percent) of the 60 new high-end deals were for new leases, while the majority of other Class A leasing was renewals. New construction landed 44 percent of Class AA deals, a positive sign for underwriting. 

“The health of the top end of the market is often a bellwether for how people are feeling,” JLL vice chairman Cynthia Wasserberger, who compiled the report, said. “Even though 2020 was challenging, it wasn’t dormant at the top end.”

What’s clear is that Class AA, Class A+, Trophy Class, or whatever particular term for ultra high-end offices you use, the top end of office space is establishing itself as its own class. Office brokers have known for years there’s a wide range in Class A space, but this variance might be a lot harder for occupiers to understand. Until research databases like CoStar agree, every broker will have to rely on their own classification. What makes a building Class AA? For now, the office sector will continue to abide by the infamous test the US Supreme Court uses for ambiguous terms: you know when you see it.

Image - Design