The “flight to quality” has become a popular topic of discussion across all parties in the commercial real estate sector. Several factors influence this trend’s growth, including economic instability, the COVID-19 pandemic, market volatility, and an increased demand for sustainable real estate.
In this article, we take a closer look at the flight to quality in commercial real estate, the current state of the market, and the outlook for the future.
What Exactly Is “The Flight to Quality” in Commercial Real Estate?
The “flight to quality” phenomenon in commercial real estate refers to a tendency of investors looking to acquire high-quality assets, especially Class-A office space, in response to market dynamics.
These properties are known for their modern amenities, prime locations, stable income streams, and their ability to survive economic downturns and allay market volatility, which makes them increasingly desired by investors and tenants.
What’s Driving the Flight to Quality Trend?
Given today’s ongoing economic uncertainty (instigated by the pandemic, geopolitical tensions, and more), the CRE market has experienced notable fluctuations and adaptations in recent years.
Let’s look at these global circumstances closely:
Pandemic Impacts
In our post-pandemic world, remote work has become the new normal for businesses. Many companies have reduced their demand for traditional office space in order to prioritize employee safety and flexibility. As a result, companies reassessed their office space needs, driving up overall vacancies and slower leasing activity in major urban centers
However, many companies are now transitioning back to the office, but they’re doing it differently this time around; by focusing on quality, flexibility, and safety in the workplace, they aim to provide an appealing environment that encourages employees to return.
This shift in focus is affecting the commercial real estate industry, with more companies investing in high-quality office spaces, contributing to the flight to quality trend.
Economic Uncertainty and Market Volatility
Due to the uncertain economy and market volatility, businesses face tight budget scenarios, revenue losses, and financial pressure, resulting in lower demand for regular office space and fewer interested investors.
However, despite economic challenges, class-A office space prices have remained steady, offering stability and competitive advantages for both tenants and investors, and ultimately driving the flight to quality.
Evolving Investor and Tenant Expectations
Investor and tenant behavior has also changed in past years.
Tenants have evolved their use of office spaces, focusing on flexibility, technology, and adaptability. It’s now crucial for companies to have offices that suit different work styles and prioritize employee well-being.
In addition, sustainability and ESG have become increasingly important factors for both investors and tenants when making real estate decisions.
Investors seek out properties with strong ESG performance to match their sustainability goals, while tenants will pay a premium for office spaces managed by companies that demonstrate progress against their carbon commitments. On average, three out of every four new lease requirements among the top 100 office occupiers in major U.S. markets will be tied to a carbon commitment between 2023 and 2030, according to JLL.
So What’s the Outlook for the Flight to Quality Trend?
Forecasts for the flight to quality trend over the next 2-3 years seem to be optimistic for some industry experts. It is expected that high-quality assets will remain in demand regardless of the economic scenario.
As the hybrid work model becomes a trend, companies are likely to prioritize spaces that offer flexibility, advanced technology, and amenities that support employee well-being. Consequently, tenants will likely continue to prioritize class-A buildings to address those needs.
According to Deloitte’s report, new construction designed to accommodate hybrid work teams has absorbed more than 100 million square feet of unused space.
Likewise, premium office space will become more competitive as the flight to quality trend intensifies, so there may be an increase in rents at the top of the market due to the lack of supply and sustained demand.
Other experts, however, warn that a lack of supply and rising costs could lead to potential risks for occupiers. Due to rising costs and limited financing opportunities, several global markets are experiencing a slowdown in office deliveries in many global markets. Additionally, existing office assets are facing challenges due to financial difficulties, making it difficult to maintain and upgrade them.
The demand for new office space cannot also keep up with the construction of new buildings. According to JLL, the demand for high quality, low carbon workspace will outstrip supply by 75% across major U.S. markets by 2030.
Regardless of where this flight to quality trend lands, building owners and operators remain under pressure to cut costs, meet ambitious carbon reduction targets, and satisfy their tenants. As energy prices continue to rise across the nation, unmanaged energy spend and consumption is a major missed strategic opportunity.
Our team at Gridium is here to help you find ways to increase the value of your assets, through comprehensive and strategic energy management. Whether you have significant net-zero targets to meet, cost-reduction goals to hit, or need to demonstrate decarbonization progress in your next sustainability report, we can help.
Interested in learning how we can help increase the quality of your assets? Contact us today.
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