Wednesday, October 29, 2014

Predictions for Center City office market: Dark clouds for landlords

Philadelphia Business Journal

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 (180,000sf) 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 that 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 GlaxoSmithKline 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 the company 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. 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.

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