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 longer term problems for building owners there.
The average age of Center City office buildings is over 55 years and the trophy towers that rose along West Market and 18th Street in the late 1980s and 1990s are now almost 30 years old. Many tenants are now looking for something different that reflects a newer, dynamic office environment to support the way they 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.
Since historically in Center City, there was always plenty of available space in the existing buildings and there was a price premium to move to a new building, little new office construction has occurred in the past 20-25 years. 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 rent premium over the 30-50 year-old 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 continue to age, 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 built 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? 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 a long time, landlords in the Central Business District have suffered with flat or declining rents. They have taken their lumps and no one should deny them their day in the sun as rents have now started to rise. However, there are limits to how high these rents can rise before tenants start making different business decisions that could permanently change the landscape. Increasing rents without investing significantly in the underlying assets will ultimately have consequences that short term owners may not care about. Demand for CBD space is not completely inelastic so if the premium gets small enough, people will pay to go to something newer and better.
Conclusion
First class cities need first class office buildings in order to attract new, and retain existing businesses. Our office stock is getting long in the tooth and, perhaps as a result, we are losing major corporate occupiers and trailing other top tier cities in our efforts to attract new ones. If you were the CEO of a new, cutting edge business looking to relocate or expand your business into a new city, which buildings in Center City would blow you away and make you decide you have to be here?
Businesses don’t operate the way they did 50 years ago. As a result, we need more new office buildings and master planned urban business communities that can support the companies of tomorrow. While tenants may lament the fact that rents are currently rising in the Central Business District, it may be just the catalyst we need to kick-off the projects that are necessary to keep Philadelphia competitive. When these new office developments come, they may well spring up across the Schuylkill River thereby creating a very viable alternative to, or even replacement of, our current Central Business District. And if that happens, rents along West Market Street could once again look a lot different.
For more information contact Glenn Blumenfeld