Philly Office's Game Of 'Musical Chairs' Is About To Start Up Again

Philadelphia's office real estate is finally on the cusp of major expansion, and the market is itching to grow into the extra space.

In both Downtown Philly and the suburbs, more new office space is on the horizon than has been in years. With some deep-pocketed tenants eyeing trophy-class space, some large blocks are due to open up in older Class-A buildings in the next couple of years, and the class of tenants that would replace them is growing, according to multiple Q3 research reports from real estate services firms.

For years, construction costs similar to those in New York have combined with far cheaper rental rates to make new construction an unrealistic proposition for the vast majority of office occupiers. But that lack of new construction has gradually applied pressure to the top of the market, and the upcoming run of expiring leases may finally be enough to burst it open.

“The aging office stock and a flight to quality from occupiers, in order to attract the best talent, are kind of coming together,” Cushman & Wakefield Philadelphia Research Director Casandra Dominguez told Bisnow. “So there’s a limited availability of this type of product in the region, which is driving rents to the point where some are considering new construction.”

A handful of large tenants have leases due to expire between 2021 and 2024, and at least some of them appear to be willing to pay the rent premium that comes from anchoring new construction.

Among those reportedly in the market for new construction are law firm Morgan Lewis & Bockius and insurance giant Chubb, each of which has been linked with one of the two new office buildings Parkway Corp. is planning in Market West.

Brandywine Realty Trust, whose FMC Tower is the most recent ground-up, multi-tenant office development, is also reportedly courting Chubb to anchor a 34-story office tower as the first new construction of its Schuylkill Yards megaproject. Farther west, One uCity Square could accommodate office as well as lab space.

In suburban submarkets like Conshohocken and King of Prussia, a similar dynamic is at play. Trophy-class office space is so scarce that tenants like AmeriHealth Caritas and AmerisourceBergen opted to lease an entire build-to-suit each.

AmeriHealth will take a five-story, 378K SF building in Equus Capital Partners' Ellis Preserve in Newtown Square, while AmerisourceBergen will have its 11-story, 429K SF corporate headquarters at Keystone Property Group's SORA West in Conshohocken. One new construction opportunity remains: Brandywine Realty Trust's 100K SF building at 650 Park Ave. in King of Prussia, for which it has already demolished the older model that stood on the site, according to JLL's Q3 report.

None of the proposed downtown buildings seem likely to get underway until they secure a commitment for at least 50% of their office space, but in order to be ready for some of the major expiring leases, those commitments would need to solidify by the end of next year. Alternately, those tenants could negotiate short-term extensions with their current digs if a new home isn't ready, Dominguez said.

Whenever those occupiers vacate for new digs, they will be leaving behind large blocks of space in Class-A buildings. But in recent years, those not-quite-trophy buildings have had few problems backfilling behind their major departures and densifying tenants with multiple smaller leases.

FMC left behind 1735 Market St. in 2016 to anchor its own tower across the Schuylkill, and while the 1.3M SF tower could be considered trophy-class, it only has one 57K SF block of space still vacant today, Dominguez said. Across the street, 1700 Market St. has backfilled space Deloitte gave back in short order.

“Not being trophy-class does not mean that these buildings are undesirable; they’re still Class-A and you’ll see companies looking to move into high-quality buildings," CBRE Research Operations Manager Joseph Gibson said. "That really has been the story of Philly since 2000, with lower-quality office buildings being converted to multifamily or hospitality."

Developers removing obsolete office stock by converting it has shortened the list of available blocks of space, kept vacancy rates healthy and helped to grow the residential population of vibrant Center City. What office space remains on the market has had good enough bones and location to remain Class-A properties through renovations and updates over the years.

"What has happened in the past 20 years is that the office stock has been improved," Gibson said. "So it’s a bit of musical chairs when somebody leaves behind a space, but Philadelphia has proven to have strong demand long-term, and backfill the space left behind.”

Among the most frequent occupiers to move into Class-A and not trophy buildings at the moment are the "Eds and Meds," Philly's economic engine. As research and medical space are such a precious commodity in University City, Drexel University and the University of Pennsylvania have moved some back-office functions to Center City, Dominguez said. Jefferson's voracious expansion included taking over the 1101 Market St. building Aramark left behind for 2400 Market St.

Another likely backfill candidate in the next few years is coworking, multiple reports said. Though WeWork may no longer be in expansion mode overall, it recently took an additional floor at its under-construction location in East Market's 1100 Ludlow. Even without any further locations for the embattled industry leader, there are around 270K SF of coworking requirements in Philly, Newmark Knight Frank Research Manager Lisa DeNight wrote in a recent market report.

Though some macroeconomic factors may be worrying for global markets, Philly looks like it is still playing to its slow-and-steady nature. In the past two years, job growth in the Philly metropolitan area has outpaced the rest of the top 25 cities in the U.S., Center City District reports — a reversal of decade-plus trends.

The fact that new construction is even being realistically discussed at all in Philadelphia is a sign that its business community believes in its ability to expand and attract talent, Dominguez and Gibson said. Philly has been patiently setting itself up for new construction, and it seems ready.

“Even though we’ve already seen significant densification, the fact that it hasn’t really affected vacancy speaks to the strength of the market,” Dominguez said.