The office landscape is changing in Center City and it will lead to opportunity for tenants by 2015. Over the past 12 months, a game of musical chairs has been playing out before our eyes as some large tenants have committed to move, in several cases filling vacancies in better quality assets and leaving holes in lesser ones. Glaxo Smith Kline is preparing to vacate approximately 800,000sf of space in the Franklin Plaza complex as they move to a new building in the Navy Yard, Janney Montgomery Scott is moving from 10 Penn Center to Three Logan, Cozen O’Connor is moving from 1900 Market Street to Reed Smith’s old space at One Liberty Place and Reed Smith is moving from One Liberty Place to Three Logan (formerly Bell Atlantic Tower).
When the dust settles, there will be over 800,000sf of space at Franklin Plaza that Liberty Property Trust and Commonwealth Realty Trust will need to reposition. 1900 Market will be a ghost town in need of substantial capital investment to attract new tenants (assuming it is not converted to a hotel or rental apartments) and 10 Penn Center will need to spend money to fill the hole left by Janney. That’s a potential for approximately 1,200,000sf of upgraded buildings (Three Franklin Plaza is already the third newest building in the City but there are potential plans to upgrade it). That’s good news for Center City and for tenants.
Historically, in Philadelphia, there has been a flight to quality when vacancies rise in trophy and Class A towers. In 2004 there was approximately 4,000,000sf of vacancy in the trophy sector including the newly committed Comcast Center and Cira Center. To attract tenants, the owners of the older trophy towers lowered their rents to within striking distance of the Class A and A- buildings thereby enabling tenants to move up in asset class without taking a huge hit to their earnings. This created a fundamental problem for the lesser quality buildings which lost tenants. As many of these landlords didn’t have the financial resources to upgrade their assets in order to remain competitive, they simply cut their rents in order to attract tenants from lesser quality buildings. Ultimately, many of the tenants in Class B buildings moved up to Class A buildings and the tenants in Class C buildings moved up to Class B buildings. Many of the Class C buildings which were devastated by the tenant exodus were converted to condominiums or otherwise repurposed. In sum, as there has been little job growth in Center City over the last 10 years, overall absorption hasn’t materially changed; occupancy just gets redistributed from time to time.
Today, the Class A-/B buildings that are losing tenants are owned mostly by substantial institutions with the money and inclination to upgrade them. That’s good for tenants. Any tenant with a lease expiration in the 2015-2016 timeframe should be excited. There will be places to go and landlords hungry for their business. This should create a very tenant friendly environment as landlords offer aggressive renewal deals to keep their existing tenants and upgrade their buildings to remain competitive with these repositioned assets. The wild card, of course, is whether 1900 Market and the Franklin Plaza buildings change use in whole or in part.
There is also talk of new buildings in the City. Brandywine has plans for a new 400,000sf tower at Cira South and Liberty would like to build a new 350,000sf tower at 19th and Arch. If one or both of these buildings get developed, it will increase the inventory and, absent the migration of a substantial number of new jobs into the city, it will put further downward pressure on rents for existing buildings. With 4,000 new residential rental units coming on line in Center City over the next 12 months and the condo market already overly saturated, commercial office building owners will have few alternatives for repositioning their assets. They will need to invest to remain competitive as office buildings.
Real estate is a long term proposition. As a result, it’s important that tenants always be aware of what’s happening down the road. I think the future is looking good for those Center City tenants who play their cards right.
For more information contact Glenn Blumenfeld