Flight to Quality Narrative Not Entirely True

CoStar is here to rebut the common narrative that luxury office leasing – the so-called “flight to quality” – is not entirely accurate.

And those tenants signing on for it are opting for smaller square footage.

The share of leasing volume at higher-quality buildings has shrunk, CoStar revealed in a recent report.

In 2019, over 10% of new office leasing volume took place at five-star buildings, while 39% occurred at four-star buildings, accounting for nearly half of the activity occurring in buildings within one of the top two quality segments, according to Phil Mobley, CoStar Analytics.

In 2023, however, less than 8% of new office leasing was in five-star buildings, with 36% at four-star buildings for the combined share to fall to 43.5%.

“Leasing has declined generally across all quality ratings,” Mobley said. “It has decreased relatively more at the top of the market because the tenants who tend to lease space in those kinds of buildings are larger, more nationally and globally oriented organizations.

“Those are precisely the types of firms that have pulled back their hiring and adjusted their leasing behavior to account more for current employees and less for future growth.”

Lease sizes shrank fastest at five-star buildings, CoStar reported. Total office leasing volume was well below its pre-pandemic average in 2023, driven primarily by lease sizes that were, on average, about 20% smaller than in the second half of the 2010s, according to the report.

It’s the highest-quality buildings that have shrunk most, with tenants occupying an average of 43% less space in 2023 than in 2019.

By contrast, Mobley said, lower-rated buildings tend to house more locally-focused occupiers less sensitive to the broader secular and economic factors. One (but not the only) piece of this is the healthcare sector. Medical office buildings have been quite resilient, and they have a lower average quality rating, he said.

“Leasing volume is likely to be depressed until hiring accelerates again, which it may have started doing in January, and until attendance rebounds more fully,” according to Mobley. “We are not expecting either of those things to happen to a large degree during 2024.”

“There are always individual buildings that outperform based on a variety of nuanced factors, including location and amenities. Newer buildings are still attracting demand, but at a slower rate than they have historically.

“Generally speaking, they are stealing occupancy from older buildings, which are struggling to backfill the space.”