Predictions for the Center City Office Market: Dark Clouds for Landlords

For any tenant looking to lease Class A office space in Center City Philadelphia today, they are encountering something they haven’t seen in quite some time: a landlord’s market. While there are still some buildings experiencing softness, many of the higher end towers are at near record occupancy levels and, therefore, commanding much higher rents than we saw in 2008-2010.  The good news for tenants?  Over the next three years, several scenarios are playing out which could very likely throw the Center City market into a tailspin.

Here are 10 scenarios which, individually and in the aggregate, could put significant downward pressure on Center City rents by 2017:

  1. In mid 2016, FMC Tower at Cira Centre South will open with about 200,000sf of speculative office space.  Unless this space is leased by new tenants in the market or new demand from growing tenants in the City, this space will likely create net vacancy in the Center City market.
  2. Comcast’s new Innovation and Technology Center is slated to open in 2017. Until then, Comcast has been accommodating its growth by leasing up short term space around the City.  Comcast will soon have close to 500,000sf of office space in the City outside of Comcast Center.  If a good portion of this Comcast space consolidates into the new tower in 2017, it will create significant vacancy in the City’s Class A market.
  3. FMC (200,000sf), Sunoco (200,000sf) and Bank of New York/Mellon (180,000) sf have all announced that they are either vacating Mellon Bank Center (FMC and Sunoco) or significantly downsizing (BNY Mellon). With close to 500,000sf of vacancy in Mellon Bank Center by 2017, this will create downward pressure on rents.
  4. Cigna recently announced it is downsizing its Center City presence by close to 150,000-200,000sf and may decide to vacate Two Liberty all together. In addition, the Two Liberty owners recently changed their mind about converting the top of the tower into a hotel (the planned condos haven’t been selling well).  If the owners decide to convert this space back to its original office use, this increase in inventory will drive down rents in other trophy towers and Class A buildings.
  5. One Franklin Plaza, which was vacated by Glaxo Smith Kline last year, has still not come back onto the market. Unless all of this building is repurposed for university, health care system, apartments and/or hotel, it could provide another option for office tenants.  To date, Center City landlords have been spared any negative impact from Glaxo’s move to the Navy Yard. When GSK moved, it freed up over 800,000sf of office space in the CBD which many landlords feared would put significant downward pressure on rents.  However, Three Franklin Plaza (200,000sf) was quickly purchased by a new performing arts charter school and One Franklin Plaza (600,000sf+) remains in limbo while the owner, Commonwealth REIT, figures out what to do with it.  If One Franklin Plaza comes back into the office building inventory, especially if it is renovated and upgraded, it could change the landscape for office rents.
  6. 1900 Market Street will soon have close to 300,000sf of vacancy when Cozen O’Connor vacates in 2015.  The owner, Brandywine Realty Trust, will deal with this vacancy carefully as it could negatively impact the value (and rental rates) of its remaining and substantial Center City portfolio. As the largest property owner in the City, no one is more aware of the pending threats to the office market than they are.
  7. The trends in corporate space utilization continue to go in the wrong direction for landlords. Companies are consuming less and less square feet per employee and corporate America hasn’t even truly embraced hoteling or telecommuting in a big way yet.  These emerging trends could transform office demand across the globe.  Glaxo went from close to 300sf/employee to less than 150sf/employee when it moved to the Navy Yard.  And virtually every large law firm in the City has given back one or two floors of space as their leases have expired over the past three years.  As general demand continues to shrink, rents should drop.
  8. Two important trends have saved Center City landlords over the past five years: (1) office buildings have been converted into apartments at a dizzying pace thereby reducing total office supply and (2) health care systems and universities have been leasing up center city office space to free up “on campus” space for core business uses. These two trends may both be coming to an end. Recent reports show that apartment rent growth is slowing in the region with a large number of new units still in the pipeline.  If the multi-family bubble bursts and conversions are no longer economically viable, the office inventory will stabilize.  Drexel is planning an Innovation neighborhood in University City.  As and when development proceeds, Drexel may bring their folks back near campus freeing up office space in the CBD.  If Innovation Neighborhood takes off, it could draw other Center City tenants west of the Schuylkill.
  9. The KOZ period for Cira Centre will be expiring at the end of 2018. It remains to be seen if any of the tenants who came to or stayed in the City for the material tax savings will choose to remain once these benefits expire.  One thing is for sure, there are 700,000sf of office tenants at Cira who are starting to think seriously about the taxes they will face in 2019 and they will be making real estate decisions that impact the market well before then.
  10. Finally, we are already experiencing one of the longest post recession recoveries in United States history and yet this extended boom has resulted in limited office job growth in Philadelphia. How much longer can this recovery last and, when it eventually ends, will we have a major down cycle with resultant job losses? Sooner or later the party is going to end. We can only hope that the lack of significant office job growth during the post 2010 boom in Philadelphia will also mean a smaller decline when things finally do turn.

For the past year or two, things have been going well for Center City landlords. With two new office towers under development, many people would have us believe that all is well in the world of real estate.  However, real estate is a long term play. Thus, in planning a corporate leasing strategy, companies should be looking down the road to see what the world might look like in the future.  The fact of the matter is that there are a lot of significant things that will be happening in Philadelphia over the next few years that could significantly impact the office market. If even half of them go the wrong way (and some are certain), things may get frightening for area landlords.  The fact that Center City office building owners have been selling their properties at a pace not seen in decades might be a sign that we are not the only ones seeing dark clouds on the horizon.

For more information contact Glenn Blumenfeld http://www.tactix.com/team.php#Glenn

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