More Evidence 'Flight to Quality' a Myth Amid Dismal Office Report

Yet another report on the office market offers no good news for investors. Instead, it highlights a slide in asset values, with the average office property price down at least 25% across the nation. The trend is predicted to continue in 2024.

More than 20% of the 1,700 office properties sold since January 2023 changed hands at a loss, according to a February 2024 report from CommercialEdge. Despite the frequent talk about a “flight to quality” in office leasing, losses were concentrated in higher quality Class A or A+ buildings, where 43% sold for less than their purchase price. This was the case for only 19% of B-rated and 13% of C-rated properties. However, lower-end buildings not in prime locations are taking a hit, a trend which is expected to accelerate, said CommercialEdge director Peter Kolaczynski.

Just $1.5 billion in office properties were sold through the end of January, at an average price of $195 per SF. California’s Bay Area had the highest sales volume with $259 million changing hands at an average $244 per SF.

By location, offices in the nation’s central business districts were worst affected, with more than one in three properties disposed of at a loss. In some cases, these were extreme – 70% in the case of 1101 14th Street NW in Washington, DC and 62.5% for Wells Fargo’s 550 California in San Francisco’s financial district. Offices in the suburbs fared better with only 21% selling for less than their purchase price while rents rose 0.3% year over year.

As interest rates stay high and occupier demand shrinks, the bid-ask gap between buyer and seller is narrowing, the report said, noting an increase in loan defaults. “More borrowers are walking away from underwater loans, and lenders are increasingly reluctant to extend loans indefinitely.”

On a nationwide basis, rents have fallen 1.8% year-over-year to $37.35 per SF, down 29 cents from the previous month. Average rates for Class A and A+ office space fell 2% from the previous year to $45.78 per SF, while Class B rents rose 0.4% and Class C moved up 5.7%. Rates for offices in urban areas dipped 0.5% to $43.53 per SF and CBDs experienced 7.3% average drops to $47.70 per SF.

At the same time, the national vacancy rate climbed 130 basis points year-over-year to 18% — a trend that affected 18 of the top 25 markets. In Austin, a flood of new construction pushed vacancy rates up 290 basis points to 22% in January; rents fell 0.4%. Vacancies were even higher in Detroit, Seattle, Houston, and San Francisco. Office-using employment levels dipped last year in 56 of the 120 markets studied. Miami was one of the exceptions with a 4.4% jump in office users.

Even so, 97.2 million SF of office space nationally was under construction at the end of January – 1.4% of existing stock – with another 4.8% planned. In 2023, for the fourth year in a row, life sciences were a major contributor; they made up 27.8% of all office starts or 11.5 million SF. In Boston, 7.6 million SF of life sciences space is expected to come online in 2024. The city had 14.5 million SF of office space under construction in January, equal to 5.8% of its inventory. Manhattan’s office development pipeline slowed over the course of 2023 to 3.3 million SF, or 0.7% of existing stock, but its asking rents remained the highest at $68.27 per SF, a 10% drop from the previous year.

The Midwest’s office market remained one of the least active nationwide. Chicago’s rents were well below the national rate, while Minneapolis-St. Paul and Detroit’s were among the lowest in the country.