Wednesday, March 11, 2020

Center City Philadelphia Office Landlords Not Afraid to Ask for More

By Adrian Ponsen CoStar Analytics
Given the city’s notorious wage tax and slow-but-steady pace of office leasing, Center City Philadelphia office owners aren’t used to seeing their market listed at the top of the charts in national rankings. This is particularly the case given that the list of office tenants moving into Center City, while growing, is still somewhat limited.

However, Center City Philadelphia’s office market does stand out nationally for its low average vacancy, minimal new construction and a surge in college-educated residents moving into the Philadelphia area’s urban core. These trends are providing local office landlords and brokers the pricing power they need to raise asking rents at some of the fastest rates of any major central business district in the U.S.

The chart above draws on more than 5,400 office space listings with asking rents that have been posted on CoStar since the beginning of 2019. In order to provide a clearer picture of where office landlords are more bullish versus more bearish, this analysis focused on office listings that either increased or decreased their asking rent. Other changes in term or service types, for example from gross rent to triple net, were excluded.

The key takeaway: Office landlords and brokers have raised asking rents by 5% or more on a third of the office space listings in Philadelphia's Market Street West and Market Street East submarkets since the beginning of last year, while almost no landlords lowered listed rents. The strong average increases in asking rents outshine central business districts in many of the country’s largest cities including New York, Washington, D.C. and San Francisco.

This is one of the factors that appealed to investors who made large Center City Philadelphia office acquisitions over the past two years.

Manhattan-based Silverstein Properties and locally based Arden Group were responsible for last year’s largest Center City office acquisition, with their joint-venture purchase of the trophy-class BNY Mellon Center for $451.6 million, or $351 per square foot.

“When we acquired 1735 Market we knew that we were getting the premier multi-tenant office building in the city in the best location at 18th & Market St. directly across the street from the Comcast world headquarters,” Arden Group CEO Craig Spencer said in a statement provided to CoStar. “Combining the iconic trophy quality of the property with Philadelphia’s dynamic job growth, millennial population growth and residential migration into Center City has created an exciting environment where we have been able to grow rents much faster than we initially anticipated.”

“We and our partners at Arden Group and Migdal love Philadelphia for a lot of reasons,” he said. “The city has a fantastic lifestyle that is attracting young, creative people to live and work here. It has some of the country’s top colleges and universities and is strategically located between Washington, D.C. and New York City. The bottom line is that Philadelphia is a global destination that continues to attract leading businesses and their employees. Growth in office rents is a natural byproduct of the city’s continued growth and success.”

Meanwhile, Philadelphia’s notoriously high construction labor costs have helped to keep the amount of new office space coming to market to a minimum. This restrained growth in new office supply is likely another key contributor to rising asking rents.

However, high construction costs also mean increased tenant improvement allowances, which have partially offset the market’s recent rent gains.

“Five years ago, the average 10-year Class A office deal was getting around $50 per square foot in tenant improvement allowances. Now, that figure is looking more like $65 to $80 because of rising construction costs and sophistication of desired tenant build-outs. While we’ve seen great rent gains across the city’s office inventory, effective rates – what landlords are taking in after TI and concessions have been factored out – have seen more muted growth.”
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