Mack Cali recently announced that it was selling its suburban office portfolio to Keystone Property Group, a privately owned real estate company headquartered in Bala Cynwyd. Mack Cali retained some land for future multi-family development and plans to invest the proceeds in additional multi-family projects. This is not a unique transaction in today’s real estate industry. Brandywine and Liberty Property Trust have sold off significant suburban office products in secondary and tertiary markets over the past few years and, like Mack Cali, Brandywine is investing more and more in multi-family opportunities. What do they know that we don’t know?
Everyone knows that the most important attribute of real estate is “location, location, location.” Good assets in prime markets like Radnor, Conshohocken and Bala Cynwyd will lease at good rates. They are well located near the homes of executives and have good access to public transportation. It’s the other markets that have institutional investors worried. The long term trends for other than the top commercial assets and markets do not look good.
Most suburban office parks that were built 20 years ago contemplated parking ratios of 3.5-4 spots per 1,000sf of office space. Space was cheap so companies tended to dole it out to their employees in generous quantities. With low density occupancy levels, parking was never a problem. That’s no longer the case. Cost conscious companies are consuming less and less space per employee thereby driving up densities. That means existing parking fields will not be able to accommodate many of today’s corporate users. This is especially true in markets like Horsham and Ft. Washington which lack good access to public transportation. Most employees drive to work. To address this, landlords will need to build structured parking (i.e., decks) or paint smaller stalls if they want to attract tomorrow’s tenants.
With corporate America consuming less space (through more open planning, fewer offices, telecommuting and the like), and negligible new job creation to increase demand for space, the savvy real estate owners see a surplus of space on the horizon. When supply outstrips demand, there is a flight to quality (i.e., Class A space in primary markets) and the secondary and tertiary markets suffer. The apparent strength of the office market in Center City, despite these corporate trends, is really a deception. Rents have stabilized, in large part, because so much office space is being taken off the market and being repurposed as multi-family (the AAA building, 260 S Broad, 1515 Walnut among others), institutional (new performing arts charter school at Three Franklin Plaza) or leased by the ever expanding health care systems and universities (170,000sf by Drexel at Three Parkway). Without these repositionings, the Center City office market would be in distress.
The bad news is that we may be quickly approaching the saturation point for multi-family as rents appear to be stabilizing even as thousands of new units are in the pipeline to arrive over the next 12-24 months. Just as the condominium bubble burst several years ago when too much space was converted to that use, the same will happen with rental units. Sooner or later, the office market will feel the pain of these trends as the inventory will stabilize but demand continues to shrink. Many companies who have been in their space for 10 or more years under less efficient space programs will shed their excess space as their leases come up for renewal and they adopt more current standards. In the law firm community , Ballard Spahr, Drinker Biddle, Reed Smith and others have already collectively shed over 100,000sf of space in the past 18 months.
What does this mean for tenants? There will be bargains in the future for other than the top assets and core markets. What does this mean for landlords? They’ll need to find ways to either control their market exposure or diversify their risk. Firms like Mack Cali and Brandywine are already doing both. To control their market exposure, they are concentrating their holdings in top flight assets in certain primary markets. For example, Brandywine now has dominant positions in the Class A market in Radnor and Conshohocken and the trophy market in Center City Philadelphia. This enables them to influence the market and minimize competition for their type of asset. Further, by investing more and more in multi-family, they can perhaps minimize the pain that will come when the office market bottoms out.
A lot can be learned about the future by watching what smart people do today. When the top owners and developers of office buildings become sellers and start investing in other asset classes, they are telling us something; and we should be listening.
For more information contact Glenn Blumenfeld