The Changing Dynamic of Class B Assets

Author: Aaron Jodka

By Aaron Jodka | APRIL 2019

The narrative around Class B is changing, but nobody’s talking about it. It seems everyone is wrapped up in the strength of the tech market and venture-backed companies, and therefore assuming Class B is the beneficiary. That logic is sound,  at least if history is any guide. But today’s market has fundamentally changed.

Class B was all the rage coming out of the downturn, and for good reason. From the second quarter of 2011 (when absorption turned consistently positive coming out of the downturn) through the first quarter of 2014, cumulative absorption pushed toward 1.6 million SF. However, since then, cumulative absorption fell to a negative 158,000 SF, and that trend became even more pronounced over the past 12 months (absorption has been negative 256,000 SF in the last year). Vacancies ended the first quarter at 11%, a full two percentage points above second-quarter 2017 levels. But it isn’t all bad news. Rents are still rising (up 7.5% over the past year).

What happened? Coworking. Coworking overshadow Class B_no bkgdWeWork, which entered Boston in 2014, now occupies 1.2 million SF and is on track to become the largest space occupier in Boston in 2019 reigns supreme. In total, coworking and flexible office providers have a three million SF footprint in Boston and Cambridge and keep growing. This type of work environment, while more expensive on a $/SF basis than direct space in most cases, provides ultimate flexibility, and tenants love it. It is eating into what has historically been a Class B landlord’s bread and butter.

In past cycles, startup companies or those looking for a small footprint regularly ended up in Class B properties. Class B has offered value relative to Class A in the past, and that appeals to firms getting a business off the ground. In this cycle, while Class B rent levels have been below that of Class A, Class B overall rent growth has been stronger. It was only a few quarters ago that Class B properties in the Seaport had higher asking rents than in the low-rise portion of Financial District towers. Today Class A rent growth is outpacing Class B growth, and absorption is strong. 

With that backdrop, what’s a Class B landlord to do? Get an honest perspective on your property. Do you match other B assets in terms of amenities (fitness, bike storage, shared conference space, security, location, outdoor space) and cool factor? Are you doing spec suites to show the space as best you can and allow tenants to move right in? How flexible are the floor plates for different types of users? Should you cut rent in order to get more tenants in the door and close a deal? It is an incredibly competitive market. Class B rents are up 49% since absorption started to stall and turn negative. Class B isn’t the value it has always been, and tenants and landlords are coming to grips with that.

Ironically, the savior of the asset class could be the same industry that has caused the recent havoc. WeWork is on the hunt for Class B spaces with small floorplates for its Headquarters concept of single-floor suites for one user, similar to what Class B has always offered tenants in the past. The main difference is the convenience that WeWork provides. As their building tours dry up, landlords struggling to get traction for their properties may want to consider coworking outfits. If you can’t beat ’em, join ’em—by leasing them space.

 

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