Class A Office is No Longer a Safe Haven

CRE has been an industry soaked in uncertainty. Interest rate jumps, worries about a potential recession, significantly reduced transactions that makes price discovery difficult. For those in the office sector — property owners, developers, investors — it’s been worse.

Atop all the macroeconomic issues, there’s been work-from-home, hybrid business models, and tenants wondering how they will operate going forward and whether they really need all that office space they currently lease.

One of the defensive moves has been the so-called flight to quality. Yes, B and C Class properties might suffer, but surely not Class A, because those who need space would look to move up. Unfortunately, that assumption is not meshing with reality, according to a report from Moody’s Analytics.

“For the first time in over a year, Class A urban office performance has hit the skids. Occupied stock, which had been growing steadily in central business districts, sharply declined to end 2022,” the report said. Even as Class B and C properties were doing worse, A occupancies have started to do worse.

“We still tend to agree that a ‘flight to quality’ is a real phenomenon, but the net leasing activity is beginning to turn south even within those higher quality, urban assets,” Moody’s said. “This is consistent with recent news of defaults of class A properties in Los Angeles and other major cities around the US. We don’t want to sound overly alarmist, and express this feeling in the case study below, but this is another indication that the skies are turning rather cloudy and seas increasingly choppy for the sector. Our forecast is for the office vacancy rate to keep rising this year and into next, and unfortunately tempt the historic high of 19.3% last hit during the Savings and Loan Crisis.”

Not all Class A is the same. A+ — even newer with more modern facilities, amenities, and functions like HVAC —  have a greater chance of tempting workers back into the office.

Suburban office properties have fared better. “Moving forward, suburban office properties, particularly those within ‘lifestyle’ communities or in ‘urbanesque’ areas, may end up being a decent safe haven,” says Moody’s. But then, urban Class A also used to be seen as safe.

Some big names have recently defaulted on property loans, apparently deciding to hand over the properties and scuttle the debt.