Trophy Office Space Is Hot. What Will It Take To Build More?

The shiny office towers that developers have built in U.S. downtowns in recent years have increasingly drawn tenants away from older buildings, but the demand shift toward top-tier space hasn't been followed by new supply. 

New year-end data has shown high demand for top-quality space and shrinking vacancy in the trophy and Class-A segments across major U.S. markets like Miami, D.C., New York and Chicago. But experts in those cities tell Bisnow they anticipate the headwinds facing the overall office sector will continue to restrict new supply and make the market for trophy tenants even tighter. 

Lenders seeking to reduce their overall exposure to office are either unwilling to finance new projects or are requiring a higher level of pre-leasing commitments, developers and brokers said. In some markets, potential tenants aren't able to plan ahead enough to sign the deals necessary to move projects forward. 

"I've got some groups I think that would be interested in leasing, but I can't get it financed unless they commit, and they're not going to commit three to four years out," said Cushman & Wakefield Vice Chairman Brian Gale, based in Miami. "It's that Catch-22 between the pre-leasing and what the lender will lend on."

Nationally, the office construction pipeline at the end of the fourth quarter was less than half of its 2020 peak and is predicted to continue to slow, according to Cushman & Wakefield's year-end U.S. market report. This has made it hard in some markets where tenants are looking for large blocks of space in trophy and Class-A buildings.

The subleasing market is also seeing a bump in activity from tenants looking for trophy space. In Q4, trophy subleases represented 27.6% of all sublease activity nationally, a 26% increase from 2020, according to Avison Young's year-end U.S. market report. Combined with Class-A space, the two segments made up 71.8% of total sublease activity in the quarter.

In New York, there has been a shrinking availability of newer space, with buildings developed in 2010 and later seeing just over 9% vacancy compared to the citywide rate of 15.6%. The Big Apple has 15M SF of new construction expected to deliver in the next five years, a 66% drop from the five years ending in 2023, according to JLL.

"The new construction is definitely two different buckets. The bigger buildings, that are 1M SF buildings, it’s hard to kick those off without an anchor tenant,” JLL Vice Chairman Cynthia Wasserberger, based in New York, told Bisnow. “The boutique market, we are seeing some speculative building coming online ... I think the reins are loosening on that for sure.”

In Miami-Dade County, 3.2M SF of office was under construction at the end of Q4, according to Colliers' Q4 2023 report. Positive net absorption totaled 147K SF in Q4, and the county saw rental rates rise 1.8%. 

Gale said rents have even doubled in some submarkets like Brickell because of the lack of supply and the demand from outside companies that are migrating south. But it has still been difficult to obtain financing for new office construction. 

"It's like a bad word to these lenders: 'I'm not gonna lend on office, are you crazy?' But when you really peel back the onion and you look at it, the new stuff is doing great," Gale said. "So if you build, you're gonna do great." 

In Chicago, Riverside Investment & Development Executive Vice President Drew Nieman said he doesn’t expect to see more trophy office projects break ground this year.

"Unless it's considered such a great site, meaning the location can't miss or it would have to be a combination of campus and you've got an anchor tenant that could help offset that,” he added. 

Nieman said that in the last four weeks, the company has seen around 200K SF of new leasing activity in Chicago. Riverside Investment & Development is working on several trophy projects in Chicago, Denver and Charlotte.

Class-A properties in Chicago have seen much lower availability rates than Class-B properties, with the two biggest gaps coming in River North with a 13% difference and the East Loop with a 12% difference. Nieman said that although more tenants are looking for better quality space, lenders aren't ready to jump on board and finance these projects.

He said that lenders that once would finance projects in Chicago that boasted 30% to 35% pre-leasing are now expecting projects to be closer to 50% pre-leased.

"Today when the capital markets are dysfunctional ... and you can't get either refinancing or there are no outside buyers at the moment of office space, you know that's it's quite a risk to go ahead and build a building and then realize in two or three years when you normally would unload it and you can't," Nieman said. 

Without enough new product coming online, cities that have recorded increased trophy and Class-A leasing demand will continue to see the market tighten for tenants. 

D.C.'s trophy office vacancy rate dropped in Q4 from 11.8% to 11.5%, the lowest level in at least a decade, according to CBRE. There was 1.6M SF of trophy space available in the city at the end of the year, compared to 16.6M SF of Class A and 8.1M SF of Class-B and Class-C space. Just two new projects are under construction in the city with tenants already committed for over half of them. 

"Occupiers are densifying their footprints and are actually prioritizing quality spaces — flight to quality, flight to experience, flight to safety, flight to stability," CBRE Executive Vice President Amy Bowser said at a CREW D.C. event on Jan. 10. "We have a situation in D.C. where our construction pipeline is very anemic. So we have a real challenge with our inventory. Our demand and our supply is not aligned."

"When they’re out with their clients looking to find quality opportunities, they’re not finding the quality that they need in D.C. right now," Bowser added.

Marisha Clinton, senior director of Northeast regional research at Savills, said the accelerating flight to quality space is also creating downsides for cities because of the obsolete buildings that are being vacated. 

"Those tenants who can, those who have the deep [pockets] and are in the market looking for the latest and greatest best product," Clinton said. "When they're taking up this space, what's left behind?"  

Developers are still moving forward with planning for new trophy projects in hopes of securing tenants and financing to complete them. 

"The upper echelon of the market, the super prime real estate, is showing great signs of leasing at much higher rates than pre-Covid," Shvo CEO Michael Shvo said on CNBC on Jan. 4. "Tenants today want new products or historically important buildings that are operating as new buildings."

Last month, Shvo received final approval on The Alton, a six-story, 170K SF office building in Miami that is expected to begin construction early this year. In Atlanta, Hines last month announced plans to build more than 600K SF of office as part of the second phase of its Atlantic Yards project. And last week in Houston, Midway announced plans to build a 320K SF Class-A office tower. 

Riverside's Nieman said he will be more confident in the market for new office construction once interest rates and economic headwinds subside, leaving a more stable environment to begin development.

"There are no capital markets to support it, but when that kind of softens up and comes back and now you offset two years or three years, whatever to commence a new building, your best bet is to do a building that would be at the higher-end trophy, A-plus or A location that supports that," Nieman said.

Emily Wishingrad and Ethan Rothstein contributed reporting for this story.