Vacancy in Center City is now above 16% (up from about 10% pre-pandemic). Sublet space offerings are over 1M SF which is more than triple pre-pandemic numbers. And yet, “market” rental rates have remained relatively flat at about $34.50/sf. How can that be?

Is it because rents, like gas prices, just go up quickly but are slow to respond to downturns? Is it because too few people control too much of the inventory, or is there something(s) more are work here?

Let’s take a look.

1. Some of it is pure math. A disproportionate amount of the leasing recently has been newer construction (University City, Morgan Lewis, Chubb etc…) and lab space. These rent at much higher numbers so the “average” reported rent is higher.

2. Some of it is due to the fact that, to date, most of the trophy buildings, which trade at higher rents, are doing just fine. This may change as over 225,000sf of trophy space came on the market in two trophy buildings in just the past month signaling a future contraction in even our best buildings and, perhaps, the need for future price adjustments.

3. Some of it is necessity. Today’s predominate owners– private equity firms and REITs– unlike wealthy families and life insurance companies in the past who took longer term views, need to grow short-term value or else very bad things happen. If they lower their rents, their building/share values go down and their equity and promotes disappear. As a result, they are first offering extraordinary tenant concessions (tenant improvement allowances, free rent etc…) to boost their rents before taking more drastic measures. If this strategy doesn’t work in filling vacancies, rent reductions will follow.

4. Lenders are not yet ready to take write-offs (which happens if building valuations go below the outstanding loan balances) so many are not authorizing their borrowers to agree to rents below pro forma numbers. This process of loan write-offs will eventually have to occur in many cases as demand for office space across the country is contracting due to remote work and now increasing job layoffs. When the loans get reduced, rents will be able to adjust downward.

5. Historically high construction costs are making it more expensive for tenants to move so, unless they are really downsizing or their existing space is completely obsolete, they are remaining in place. The immobility of tenants decreases competition among landlords for new deals which translates to higher rents. As construction costs decline, tenants will start moving in greater numbers, competition will increase, and rents will decline.

There is great frustration among many tenants who, after reading all the stories in the papers of doom and gloom, are expecting a strong buyers’ market with every landlord falling at their feet offering too-good-to-be-true deals. In many cases we are not there yet. But trust me, the time is coming.