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'Right Now Is As Good As It Gets' In Philly's Office Market

Multiple sectors of commercial real estate in Philadelphia have been experiencing growth for so long, questions like “Where are we in the cycle?” or “What inning are we in?” have been on the tips of everyone’s tongue for years now. And while the current cycle is not over yet, the city has appeared to reach its tipping point.

A rendering of 2400 Market St., which will house Aramark's new headquarters when finished in 2018

Even as top-of-the-line multifamily buildings continue to deliver, some buildings in Center City are softening their rent demands and offering concessions to keep their occupancy rates afloat, according to JLL director of research Lauren Gilchrist. The first quarterly reports of 2017 have revealed that the office market has peaked as well.

“Now is about as good as it gets,” CBRE research director Ian Anderson said. “It’s still good, and we continue to think rents are going to rise, and there’s still going to be more job growth. But we’re beginning to see the end of the tunnel coming near.”

Two factors pulling in opposite directions are contributing to the change. As Anderson noted, job growth is projected to continue, but at slower rates. The city added around 8,000 new jobs in the first quarter, as opposed to over 12,000 in the fourth quarter of 2016. That slowdown is predicted to worsen over the coming year.

The other factor working against the office market is the predicted increase in available new product at 3675 Market St., as well as the new building at 2400 Market that will be added by the end of 2018, neither of which are fully leased. That will only compound a growing problem with office rental, which is the densification of major companies all across the country.

Densification, companies shrinking the space each employee occupies, has arrived for one of Philly’s most high-profile businesses in PNC. The banking giant will be vacating 120K SF of offices, the largest in a number of similar moves across the city’s office market.

Just as the office market peaks there may come an unpleasant surprise with potentially far-reaching implications. CBRE predicts the next recession in 2019, just ahead of groundbreaking for Philly’s massive Schuylkill Yards project. But there are key economic factors that could change the tune back to a happy one almost as quickly as it goes sour.

President Donald Trump’s long-promised corporate tax cut, if it ever comes to pass, would serve as a short-term boost to many companies that would otherwise be scaling back in the years to come. And another bet, if it comes in, could have similar benefits without a similarly harmful effect on individuals.

Rendering of 3675 Market St., the next piece of University City Science Center's uCity Square project

“The housing market continues to grow,” Anderson said. “It’s been slightly sluggish, but if that continues to accelerate, the spillover effect to the market could be huge. And frankly, we’ve been banking on the housing market improving.”

More homeowners would mean more mortgages, which could give PNC a reason to grow again. It is difficult to estimate the impact of such a theoretical chain of events, but worth noting that there are ways in which a recession could be forestalled.

Even though the future isn’t as rosy as it appeared a few months ago, net absorption numbers have still looked very positive, largely driven by office tenants finding space in suburban submarkets traditionally seen as second-tier to hubs like King of Prussia, towns like Blue Bell and West Chester with considerable Class-B product. The overall effect is that vacancy is at its lowest point since before the housing crisis.

Retail remains an iffy proposition across the Philadelphia market, with King of Prussia and Center City remaining strong, but less central submarkets continuing to lose national tenants. Large-scale bankruptcies like J.C. Penney and Payless aren’t doing anybody favors. But the very cause of pain in retail, e-commerce, continues to be a massive boon in the industrial market.

Philly’s industrial vacancy rates continue to drop and rental rates continue to rise, almost entirely driven by southern New Jersey, where speculative projects built in Gloucester and Burlington counties have delivered and leased up rapidly.

“We are seeing pretty much all of the significant activity in the first quarter in southern Jersey, and that’s the way it’s been for the past two or three years,” Cushman & Wakefield research director Jared Jacobs said.

Such gains, interestingly enough, seem to have come from tenants relocating out of the New York area.

“What’s happened in South Jersey is that a lot of tenants that were looking in Central and North Jersey in previous years have been looking farther south,” Jacobs said. “Any activity we’re seeing in South Jersey has typically been tenants originally located in North Jersey.”

The demand for increased distribution and warehouse space can be entirely attributed to the rise of e-commerce, with Amazon always looking to add space and scores of competitors trying to keep up. It is a trend that promises to keep industrial thriving, even as other sectors may fall back, proved by its continued ability to fill spec buildings, something that office hasn’t done in years. With the market peaking without having delivered a spec office building at all this cycle, it may not happen again for a long time.