Capital market friction holding back Philadelphia’s office recovery

By Brenda Nguyen CoStar Analytics

Philadelphia's office market showed signs of stabilizing in early 2025, with positive annual net absorption for the first time in five years. However, challenges persist as office-occupying companies continue to downsize, effective rents remain under pressure, and prevailing interest rates depress asset valuations. Here's what CoStar market analytics is hearing from local industry players in the Philadelphia office market in early 2025.

Owners of distressed office buildings are willing to lower rents, but lenders have been a barrier

Several Philadelphia brokers mentioned they have had lease deals fall through after lenders refused to accept reduced rents due to mortgage clauses. Non-lenient loan constraints are exacerbating the recovery challenges in the office sector, creating a situation where even willing landlords and tenants cannot finalize lease agreements due to lender objections.

Office rents for lower-quality buildings expected to reset as distressed properties trade at deep discounts

A landlord and broker cited that the first office buildings had already reset rent after trading at lower valuations. For example, a 1980s-era asset in Center City recently traded at a roughly 60% discount from its previous sale price in 2018. The new locally based landlord lowered asking rents from the low $30s per square foot to the mid-$20s and already secured two new leases in the second half of 2024. Locals expect more rent-resetting building sales to occur in the market going forward.

Still waiting for well-occupied, Class A office buildings to sell to help determine the market's new pricing baseline

Local brokers mentioned that most office sales to date have involved distressed office properties. Of these sales, prices have dropped between 20% and 60%, with several buildings sold at a value lower than their replacement cost. Meanwhile, owners with well-occupied, premium office assets are holding out for improved financing conditions in hopes of achieving the highest value for their assets. Given the stratified market, the latest distressed sales comps don’t provide the full story.

Landlords more often offer generous concession packages rather than lowering base rents

Office brokers and landlords alike tell us that tenant improvement allowances range between $5 and $7 per square foot per lease year. The range can increase for a credit tenant signing a long-term, 10-year lease. Build-out allowances for first-generation office space can reach between $90 and $110 per square foot. Meanwhile, one month of free rent per year of lease term tends to be a market norm.

www.omegare.com