Flight to Quality Among Firms Has Not Taken Hold
By Joshua Ohl CoStar Analytics June 11, 2021 | 1:25 P.M.
Across the San Diego office market, occupancy levels have increased in four- and five-star inventory by more than 400,000 square feet since the beginning of the second quarter of 2020, but that has largely been driven by several deals that were negotiated before the outbreak.
Among the notable moves include the Navy taking occupancy of more than 350,000 square feet in downtown San Diego at the end of 2020, Fate Therapeutics taking possession of its new 200,000-square-foot headquarters at Scripps Northridge in Scripps Ranch, and several firms moving into the newly built, 300,000-square-foot One Paseo in Carmel Valley since it delivered in the third quarter of 2020.
With asking rents flat across the market and even declining in some areas, combined with weakened demand and rising concessions, it would have been reasonable to expect a flight to quality from firms able to take advantage of the economic dislocation and looking to move up into better space. That’s particularly relevant given that more companies competing for younger, well-educated employees are increasingly turning to highly amenitized office space and buildings to differentiate themselves in a crowded field of potential employers.
But there has only been a half dozen new office leases signed amid the pandemic for more than 50,000 square feet, five of which were for four-star buildings, and none of those tenants have taken possession yet.
The flight to quality, given that rents in four- and five-star inventory have declined by 1.1% over the past 12 months and now average $3.50 per square foot, has not taken hold. From 2017 through 2019, 8.1 million square feet of new leases were signed for high-end inventory, amounting to 38% of the total leasing volume over that period. Three-star properties gained the plurality of leasing volume, with 8.7 million square feet of new leases, or 41% of the total, while lower-tiered one- and two-star buildings accounted for 21%, or 4.62 million square feet of new leases.
But since the beginning of April 2020, the share of four- and five-star leasing volume has fallen to 32% of total leasing volume, or 1.8 million square feet. Three-star leasing has held steady, accounting for 42% of total new leasing volume, or 2.4 million square feet, while lower-tiered inventory has increased to 26% of the total leasing volume in the region, or 1.5 million square feet.
The amount of sublet space that has been leased since last April accounts for 9% of the overall leasing volume. Available sublet space has trended at historical highs, providing another outlet for firms to move into higher-end space at a discount. The average asking rate for direct space in four- and five-star inventory commands a nearly 60-cent premium over sublet space among that inventory.
Subleasing in that segment accounts for 44% of sublet leasing volume, or 254,000 square feet, while mid-tier inventory accounts for 48%, or 280,000 square feet of new sublease deals signed.
Office tenants continue exercising caution with their space needs, and it will take time for demand to fully recover in the office market. But it’s likely that many firms will employ a hybrid model for the foreseeable future, where employees could work from home part time. At the same time, it’s also possible that many office buildouts will include more physical distancing between workstations in the event of another pandemic. Either way, uncertainty will likely hover over office-using decisions for some time.
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