Pandemic Silver Lining: Philly's Office Market Is Closing The Gap With Other Cities
The office market in Philadelphia has begun to stir after over a year of dormancy, and it finds itself in a better position relative to its neighbors than before the pandemic began.
As with nearly every other major city in the U.S., Philly has experienced occupancy losses in the past year, especially in its downtown core. But due to the lack of new office construction in the previous economic cycle, Class-A and trophy office buildings are relatively stable in terms of occupancy, while greater concessions have been able to prevent asking rents from cratering, panelists at Bisnow’s Philly State of Office event on Oct. 14 agreed.
“Compared to some of the markets we’ve been in, [rent and concessions] have been very, very controlled,” American Real Estate Partners Senior Vice President of Leasing Kerri Thomas said at the event. “We’re not overbuilt in Philadelphia. In Washington, D.C., for example, we’re going to be in this for another five years — there’s a lot of overbuilding all over the city, and it’s very, very tough.”
With construction costs similar to those of New York but rents far cheaper, Philadelphia hasn’t had the fundamentals for developers to undertake speculative office projects for generations. Also suppressing the creation of new office stock has been Philly’s poor recent track record of recruiting out-of-state companies to move their headquarters to the city, creating a well-known environment of Philly’s most prestigious tenants bouncing between the city’s best office space.
That game of musical chairs, and the more national trend of shrinking office footprints, was on full display mere weeks ago when news broke that GlaxoSmithKline will soon leave its 200K SF build-to-suit headquarters in the Philadelphia Navy Yard for two floors at the FMC Tower totaling less than 50K SF. But the Navy Yard’s new tenant came from outside the market, demonstrating Philly’s opportunity to break the cycle.
National pharmacy chain Rite Aid announced in September that it will be moving its headquarters from the Central Pennsylvania town of Camp Hill to a 24K SF office at 1200 Intrepid Ave. in the Navy Yard as part of a shift to a “remote-first” corporate workforce. As the headquarters’ primary function will be as a gathering place, an office in a major city near an international airport and a highway connector to the rest of the Eastern Seaboard made more sense than a rural area, Rite Aid’s announcement stated.
For the large quantities of companies assumed to be adopting a hybrid work model going forward, smaller footprints will be commonplace, panelists agreed. Though they aren’t as valuable to an office landlord as anchor tenants taking hundreds of thousands of square feet, small leases are already what drive the Philly office market. Landlords can afford to be more sanguine about their situation than in places like San Francisco and D.C., where pre-pandemic pipelines now look out of step with reality.
“There'll be issues with absorption,” Arts & Crafts Holdings General Partner Craig Grossman said. “Maybe we're going to take one step back before we take two steps forward, but it is what it is. And we'll adapt, and we'll just continue to move forward.”
Even if the situation is milder in Philadelphia than elsewhere, the downsizing of tenants over the next few years will correspond with a flight to quality that renders several office buildings obsolete, Brandywine Realty Trust CEO Jerry Sweeney said.
“I think the pandemic has made a number of buildings economically, functionally obsolete,” Sweeney said. “And I think that is going to create a marketplace with a higher probability today than a couple years ago of being [divided between] the haves and the have nots.”
Many landlords are attempting to get a jump on pivoting those properties by marketing vacancies as potential life sciences conversions, though not all buildings will be up to the task.
For all the office buildings that won’t be able to fill space vacated by shrinking or moving tenants and don’t have the infrastructure to support lab space, conversion to multifamily is a time-tested formula for Center City, one that was the primary driver of new residential units around the turn of the 21st century, Levy said. But before landlords go pulling the plug on older office buildings, they should wait to see just how many tenants will go bargain hunting for small blocks of space in the central business district, including a potential bumper crop of New York companies looking for sweet deals for hybrid work hubs.
To that end, Center City District has engaged with office brokers in New York and launched ad campaigns on multiple websites and publications to sell Philly to New York tenants looking for smaller, cheaper office footprints, Levy said.
“As more people in New York are tired of their 60- and 90-minute commute, New York firms have started looking for remote locations to cluster workers,” he said. “We already know we have more people from New York moving to Philadelphia than vice versa; that's been going on since 2015. This is the moment where we can draw people in.”