A few years ago, a lot of people were pointing to 2017-18 as the time when the Central Business District (CBD) office market might start to soften up, providing relief to tenants who might be looking for space. A “perfect storm” of factors all indicated that vacancy should be picking up this year and into 2018. That really hasn’t happened. We’ll explain why.
First let’s summarize the tenant friendly future we were contemplating back in 2014-2015; then we’ll discuss how five unexpected things helped change the market we were expecting.
What we were expecting and why
New Inventory. The pending development of FMC Tower and Comcast Innovation and Technology Center, together with the redevelopment of 2400 Market Street was scaring a lot of Center City landlords. With approximately 2,000,000sf of new office space coming onto the market, they understandably worried how this was all going to be absorbed. Certainly, Comcast was going to take most (and, as it turned out, all) of the new Innovation Center but most people expected that, in doing so, they would vacate the approximately 600,000sf of space they were currently leasing at Two and Three Logan and other buildings. FMC would soak up a large part of the new FMC Tower but there was still 200,000sf of space to fill in the new building. FMC’s departure from Mellon Bank Center would also create a 200,000sf vacancy there.
Center City landlords had already dodged (at least temporarily) a major bullet when GlaxoSmithKline vacated approximately 800,000sf of CBD office space in 2013 to relocate to the Navy Yard. To their relief, none of this vacated office space came back on the market as Three Franklin Plaza was sold to a charter music school and One Franklin Plaza was mothballed (it’s currently in redevelopment and ultimately 200,000sf of office space will soon add to available inventory). Could they dodge another bullet of excess inventory in 2017-18?
Significant Center City departures and downsizings. Some major corporations and space occupiers had announced they were leaving the City or were at least going to be downsizing significantly. Among the big users that left the City were Sunoco and Dow. Those significantly downsizing their Center City presence included BNY Mellon and Cigna. Landlords were justifiably concerned that these pending vacancies would put further downward pressure on rents.
More efficient space trends. It’s well recognized across the industry that companies are consuming much less space per employee as they move to new, more efficient utilization concepts such as open plan environments, smaller offices, hoteling and telecommuting. Law firms, for example, who used to plan for 750-850sf/attorney in the early 2000s are now down to 600-650sf/attorney in many cases. Large corporations who used to have a ratio of offices to open seating of 3 or 4 to 1 are now flipping the paradigm to 1 to 3 or 4. When companies use less space, it drives down demand putting even more downward pressure on rents. This trend is probably not going to change any time soon and, as existing leases continue to expire, more and more firms will be implementing these space saving programs. Landlords had more reason to worry.
Well, they shouldn’t have worried.
Here are five unexpected events that helped save the CBD office market for landlords.
- Comcast grew faster than expected.While nothing definitive has been decided, it does NOT look like Comcast will be vacating most of the office space it currently occupies outside of their two-building urban campus. The 500,000-600,000sf of space that many landlords feared would open in Two Logan and Three Logan may only be a fraction of that now. Comcast will not only fill up it’s beautiful new Innovation and Technology Center, but it appears they will also still need several hundred thousand of square feet of overflow space on top of that. Even if Comcast goes ahead with their third tower currently on the drawing board, that will be at least four or five years down the road and Comcast will need interim space to house their growth while that building gets developed.
- Aramark moved west.Facing a 500,000-square-foot office development down the street at 2400 Market, West Market Street landlords were praying that an out of town tenant would come along and soak that up before their own tenants defected there. They got the next best thing. Aramark surprisingly announced that it would be relocating its headquarters from Aramark Tower at 11th and Market into approximately 300,000 square feet at 2400. While this move was clearly a blow to the East Market Street sub-market, it was a Godsend to the landlords on West Market Street. Though there’s still close to 200,000 square feet of office space available at 2400 Market, this big office project won’t have the negative impact on West Market Street that many initially feared.
- WeWork loves Philadelphia.If corporate tenants were taking less office space and no big, new companies were moving into town, landlords needed some sort of miracle to absorb the pending vacancies. Enter WeWork. They have quietly leased close to 100,000sf of space between 1900 Market Street and 1601 Market Street that won’t be occupied by their own employees. It will ultimately be occupied by lots of entrepreneurs, small businesses and even large companies with temporary staffing needs. In many cases, these occupants would never have ended up in these buildings because they are too small, don’t have the credit or wouldn’t commit to long enough lease terms. By packaging up all of these types of users under one roof, they have increased demand for Class A office space across the country. With WeWork, the whole is more than the sum of its parts.
- Spark Therapeutics came out of nowhere.Remember all that new space in FMC Tower that was going to draw existing tenants from the trophy towers along West Market Street? Well, a firm very few people had ever heard of, Spark Therapeutics, who has been quietly knocking the cover off the ball in University City, just leased 75,000 square feet of space at FMC Tower and are rumored to be taking a bunch more at Schuylkill Yards. They are a Philadelphia success story that landlords around town should be lining up to thank.
- Two distinguished law firms finally join their friends along West Market.Back in the late 1980s and early 1990s, the center of the universe for Philadelphia’s law firms moved from South Broad Street to the shiny new, trophy towers being built along West Market Street and north 18th Street. There had been some holdout firms in non-mainstream locations including Montgomery McCracken at 123 South Broad Street and Berger Montague at 1622 Locust Street. Well, they are now unexpectedly joining their friends on West Market and soaking up another 100,000 square feet of space in the process.
Predicting markets, or anything for that matter, is an inexact science. We all assess the facts, weigh the probabilities and make an educated guess about the future. Sometimes, however, unexpected variables enter the equation and change everything. Real estate markets rise and fall as ours has and will continue to do in the future. We’re in a tight market that will eventually turn. Maybe just not as fast as we all thought.
This article was published in the Philadelphia Business Journal on February 23, 2017.
For more information contact Glenn Blumenfeld