Monday, February 1, 2016

Why Philadelphia's central business district may end up in University City

Right under our noses, the rents in Center City have been steadily rising to levels not seen in recent memory.
There are several reasons for the rapid price increases beyond mere supply and demand including: (1) the consolidation of a large percentage of building ownership and leasing responsibilities into just a handful of players making it easier and quicker to move the market, and (2) a record number of buildings having recently changed hands with the new owners insisting on higher rents to justify the prices they just paid. Interestingly enough, the higher rents currently being realized in Center City may ultimately create new opportunities for tenants and longer term problems for building owners east of the Schuylkill River.

The average age of Center City office buildings is over 55 years and the skyline defining trophy towers that rose along West Market and 18th Street in the late 1980s and 1990s are now almost 30 years old. Many tenants, especially those employing young work forces, are now looking for something different that reflects a newer, dynamic office environment to support the way their people work and interact today.
Where are these types of workplaces? New buildings are popping up at the Navy Yard and in University City with many more in the planning stages. Drexel and it’s to be announced master developer have plans for up to 6,000,000sf of mixed use development including a lot of office space in Innovation Neighborhood just west of 30th Street Station. The University City Science Center, in partnership with BioMed Realty, have plans to develop about 4,000,000sf of new, mixed use development between 36th and 38th streets, just north of Market Streets at the old University City High School site.
Because for the past 20 years in Center City there was always plenty of available space in the existing office buildings and there was a price premium to move to a new building, almost no new office construction occurred in Philadelphia. However, that is starting to change. Many more tenants are starting to believe that the benefits of a brand new office building with better light, green space and amenities including outdoor space, social gathering places and a more human friendly scale justify the replacement cost rent premium as compared to the existing building stock. The proliferation of new office development at the Navy Yard and in University City clearly reflects this value assessment.
As rates continue to rise in the Central Business District and the existing buildings grow older, the price gap between current building stock and new construction will shrink, and the quality gap between existing buildings and new, state of the art buildings will widen. The interplay of these two phenomena will make it easier for companies to decide to move to new construction. When they make that decision, where will they go? While there will certainly be isolated building pad sites in the Central Business District, many of these will necessarily exist within the constraints of what is already nearby— a densely populated neighborhood of standalone, older buildings. Much like the Navy Yard (though on a smaller scale), Innovation Neighborhood and University City will provide opportunities for tenants to not only redefine their work environment within a shiny new building, but also become part of a larger, modern day community centered around public green spaces, recreational activities and neighboring state of the art buildings designed to a more people friendly scale.

Right now, for some companies, the Schuylkill River creates a psychological barrier that cannot be crossed. What happens, however, if we are lucky enough to land a Google, Microsoft, Uber or Oracle in University City because of its proximity to Penn, Drexel and 30th Street Station? What if three or four other well established corporations join FMC and the top firms at Cira Centre in locating major operations across the river? Given the changing economic and quality gap paradigms, isn’t it likely that other companies would want to join in the fun? What happens then? Demand for the current Central Business District will fall, rents will go down and it will be difficult for landlords to get tenants to come back without materially upgrading their product.
For most Philadelphians, the thought of our Central Business District shifting location seems farfetched. However, it happened here not that long ago and, to some extent, in other cities like Washington D.C. and now Boston. In the early 1970s, the center of the Philadelphia business world was South Broad Street. Most law firms, the largest occupiers of office space by industry in the City, were there. But the buildings got old and tired and new buildings started springing up along West Market Street and north 18th street where land was cheaper. The difference in product quality led some leading firms to move west even though the rent for these newer buildings was higher. Once a few established firms made the move, it became acceptable for others to follow. Eventually the Central Business District shifted west and north. The same thing happened in Washington, D.C. Up until the 1990s, there was little business presence east of 16th Street. However, as rental rates continued to rise in City Center and the existing building stock grew older and more tired, some pioneers moved east where the product was newer and, because land was cheaper, the rent premium was small enough to justify the change. The development of the Verizon Center and extension of the Metro helped make East End a more vibrant and accessible submarket. Once a few prominent firms moved east, more companies followed suit. While only one law firm was located in East End in the 1970s, today that submarket is home to many of the District’s largest law firms including Arnold and Porter, Venable, Covington, DLA Piper, Jones Day, Sidley, Hogan Lovells, Skadden, Morgan Lewis, McDermott, Crowell & Moring and White & Case.
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