The office market’s bifurcation between prime and non-prime is driving demand for prime Class A properties with top amenities while other assets struggle to remain relevant.
There is a paradigm shift in the office market that’s changing where employers want to operate. This bifurcation in the market is allowing Class A properties with the right amenities in well-located areas to thrive. Meanwhile, other Class B and C buildings struggle to remain relevant. This dynamic is a good thing for institutional office investors given their tendency to own some of the best and highest quality real estate out there.
A Class A Split
The first quarter of 2024 brought a split in office property performance nationwide. Overall office asking rents remained stable or increased thanks to continued interest in Class A properties. Though demand for Class A office is strong overall, it’s important to acknowledge an emerging bifurcation within this asset class, which is being referred to as prime Class A versus non-prime Class A.
Prime Class A office assets have the high-quality design, wellness standards and amenities that Class A product is known for. They’re also typically situated within premier walkable neighborhoods near retail and transit options. A great location has always been a sought-after characteristic for tenants, arguably more so post-pandemic. Net absorption across the U.S. for prime Class A property was a positive 48 million square feet from first quarter 2020 until first-quarter 2024, according to CBRE research.
Meanwhile, non-prime Class A properties have experienced more than 170 million square feet of negative absorption. Prime Class A properties comprise just a small subsection of the total market – only 8 percent by square footage and 2 percent by number of properties. The small footprint of existing prime Class A properties means that the next tier of office properties — Class A buildings that may not be in such premier locations — will continue to benefit from the bifurcation if those properties meet the expectations of modern tenants. These expectations include health and wellness amenities, access to retail or dining, EV charging stations, functional outdoor and greenspace and tech-enabled building controls, among many other features.
The potential for new developments to put pressure on U.S. office markets is quickly fading. The lack of new office properties across the country will force tenants to focus their search for space in existing top-tier buildings. CBRE expects that prime Class A vacancies will return to pre-COVID levels, hovering around 8.2 percent by 2027, if not sooner, with the next tier down likely to benefit from the overflow of tenant demand that trickles downward.
Quality Over Quantity
These trends mean that the future of office investment should focus less on total square footage owned and more on the quality of space and amenities. The pandemic’s required shift to work from home demonstrated that, for some, business offices were not necessary for success — at least in the short-term. However, for many, this success came at the expense of company culture, camaraderie and, ultimately, productivity and employee retention in the longer-term.
Today, those looking to gain an edge in corporate culture seek out high-quality offices to attract and retain the best employees, minimize turnover and ultimately perform at a higher level. Investors in top-tier buildings will benefit from the ongoing separation of office property tiers. There are many regional investment hotspots nationally that are thriving as a result of these characteristics. These include Orange County, Calif.; Century City in Los Angeles; and Cherry Creek in Denver, to name a handful.
KBS sees this prime vs. non-prime trend in many areas of California, including at Sorrento Towers, a life sciences and technology center in San Diego. The prime Class A asset is situated off the 805 freeway within minutes of La Jolla and Torrey Pines and UC San Diego. Sorrento Towers is an example of a Class A building that attracts top employees in today’s job market.
Conversely, the municipal challenges within the cities of San Francisco and Oakland, Calif., are driving office tenants to seek spaces that better meet employees’ expectations for safe, accessible and healthy working environments. One such area that’s benefitting from tenant migration out of those areas is Emeryville, Calif. Situated across the San Francisco Bay, the Towers Emeryville is a three building, Class A office park that takes advantage of its waterfront location with panoramic views, a comfortable tenant lounge, café and fitness center. Freeway access, in addition to subway and BART availability, further make this an ideal destination for employers looking to attract and retain tenants.
Story first published in Western Real Estate Business