In something of a good news, bad news situation, Philadelphia's office vacancy ticked down in the second quarter.

But the reason isn't a slew of new leases. Instead, a number of large blocks undergoing conversion to multifamily, hospitality or mixed-use were declassified as office space, according to a Q2 central business district report from Cushman & Wakefield.

Vacancy nudged down from 20.2% in Q1 to 19.7% this past quarter. That's mostly due to less space left on the market, starting with one major elimination.

Alterra Property Group has purchased and converted the former offices of 1701 Market St. into 299 apartment units. The adaptive reuse slashes 300K SF of office space from the central business district, which spans from the Schuylkill River to the Delaware River.

The completed 1701 Market conversion was the “first domino to fall” in a sector where many building owners and landlords have been waiting for interest rates to decline and people to return to office in prepandemic numbers, according to report author and Cushman & Wakefield principal Michael Hanes.

Building owners could convert up to 2.5M SF of office to alternative uses, knocking out 6.7% of current inventory from the Class-A office market, Hanes’ report shows. If that happens, just six landlords would control 51.8% of the top office space downtown. Cushman & Wakefield declined to name those building owners.

But with 1701 Market off the market, “others start to see it happen, then others will follow,” Hanes said.

“If the economic climate is what people expect or are predicting, [for the Federal Reserve] to go with some kind of rate cut, then that makes it maybe more real in the future. We’ll wait and see with a Fed meeting coming in September.”

Bisnow reported this month that a New York firm is in talks to buy the Wanamaker building at 100 E. Penn Square. Plans for the 1.4M SF office-retail building are not yet publicly available.

Other repurposings are set to unroll soon. MM Partners purchased the Jewish Services Building at 2100 Arch St. with plans to convert it into mixed-use residential space. Lubert-Adler plans to add apartments to the existing hotel and offices at The Bellevue Building at 200 S. Broad St.

Net absorption was a negative 261K SF over the quarter, according to the report. Hanes said the ownership consolidation in the central business district can make it harder for smaller entrants to compete in the market.

And between conversions and potential distress on the horizon, there is difficulty in projecting how the rest of the year will shake out, Hanes said. Right now, about 23.1% of Class-A office space is categorized as distressed, which could consolidate ownership further. Meanwhile, the pipeline of new Center City office construction has slowed considerably.

“We haven't seen, and I don't know what the feasibility is, of a multitenant office building today,” Hanes said. “And so it puts our market in a very interesting scenario.”