The Covid19 pandemic will undoubtedly significantly impact the way we live, work, and play. It has already caused a fundamental change in how we look at and use office spaces, and it’s clear that there is no way back to how things used to be.
2020, the year of irreversible change for commercial office space
Before the pandemic, office spaces became more open, more flexible, more technologically-advanced, and more crowded. Remote work was not hugely widespread, particularly for traditional office sectors such as financial services or banking. Available office space was scarce, especially in buzzing markets like New York City, Los Angeles, or San Francisco. The high demand for quality office space in busy business districts fueled development and redevelopment in neighborhoods like Hudson Yards, Chelsea, Flatiron, and even other boroughs. Class A office towers had started to crowd the Brooklyn and Queens skyline as developers began to run out of space in Manhattan.
In 2020, commercial real estate as we know it took a sharp turn. The emergence of the new coronavirus in the U.S. and the subsequent lockdowns forced companies across most industries to embrace remote work, and many of these companies are not going back. Facebook, Twitter, Salesforce – these are just a few of the office-using giants that allow employees to work from home indefinitely. As a result, leasing activity in cities like New York fell sharply; according to JLL research, leasing of Class A Manhattan office space dropped 75% in 2020, signing just 60 deals with rents over $100 per square foot. Looking at the numbers, it might seem like interest in Manhattan office space waned considerably in 2020; however, if we look beyond Class A spaces, the numbers paint a different picture.
Class A office space is no longer good enough
Commercial office buildings in the U.S. are usually ranked by building class, according to their location, completion date, amenities, and other such factors. At the moment, Class A office space is regarded as best-in-class, and it’s the most desirable type of office space for big companies and large corporations. However, Class A office space is not cheap, especially in highly active markets like Manhattan or San Francisco. Class A offices in neighborhoods like Hudson Yards or the Plaza District usually command $100 per square foot or more, which means that they’re not accessible to smaller companies or startups. Smaller businesses tend to look instead for Class B assets or even Class C properties, which command significantly lower asking rents.
The slowdown in leasing velocity in NYC during 2020 has led to a significant drop in asking rents across building classes, creating enormous opportunities for smaller tenants. Startups and midsized companies now have access to amenity-rich, transit-oriented Class A spaces in prestigious submarkets like the Financial District, Madison, or Fifth Avenue. Over the past year, NYC has turned into a tenant’s market, as more and more companies choose to downsize their office footprint, switch to a remote work style, or opt to open satellite offices outside central business districts.
The Class A – Class A+ divide
While the decrease in prices and the switch to a tenant’s market create new opportunities for smaller businesses looking for office space in Manhattan, the building classification system creates confusion. A recent article by Propmodo suggests that the ‘flight to quality’ triggered by the Covid19 pandemic requires a rethinking of the current building classification system.
Class A no longer means what we think it means, and a vast range of value has been created within this segment over the past years. Over the past years, additional classifications have been added to the commercial real estate vocabulary, including ‘trophy office space,’ ‘Class A+,’ ‘Class A.A. or AAA,’ and ‘ultra-luxury.’ These properties differ from traditional Class A definitions, adding a plethora of additional amenities and increasing prices.
Tenants are more drawn to Class A+ offerings than ever, as the need for state-of-the-art technologies to ensure social distancing and workers’ health continues to intensify. From touchless access, cutting-edge air filtration and HVAC systems, and intelligent technologies that provide disinfection to temperature scanning equipment and energy-saving features, these are the amenities that office tenants look to nowadays, and they’re not negotiable.
Is it time to rethink the A-B-C of building classes?
Given the broad price and amenity gap within the Class A office category, perhaps it’s time to rethink the typical A-B-C building classification system that most commercial properties in the U.S. rely on. The Class A+ category is now in a league of its own, with space in this upper-tier class up to 15% more expensive than Class A spaces, according to Propmodo. While brokers and seasoned industry professionals can easily recognize the differences between Class A and A+, potential tenants are not always privy to this insight. There’s no clear delimitation separating the Class A range’s differences as of yet; for now, each broker will have to rely on and come up with their classification.