Right under our noses, the rents in Center City have been
steadily rising to levels not seen in recent memory.
There are several reasons for the rapid price increases
beyond mere supply and demand including: (1) the consolidation of a large
percentage of building ownership and leasing responsibilities into just a
handful of players making it easier and quicker to move the market, and (2) a
record number of buildings having recently changed hands with the new owners
insisting on higher rents to justify the prices they just paid. Interestingly
enough, the higher rents currently being realized in Center City may ultimately
create new opportunities for tenants and longer term problems for building
owners east of the Schuylkill River.
The average age of Center City office buildings is over
55 years and the skyline defining trophy towers that rose along West Market and
18th Street in the late 1980s and 1990s are now almost 30 years old. Many
tenants, especially those employing young work forces, are now looking for
something different that reflects a newer, dynamic office environment to
support the way their people work and interact today.
Where are these types of workplaces? New buildings are
popping up at the Navy Yard and in University City with many more in the
planning stages. Drexel and it’s to be announced master developer have plans
for up to 6,000,000sf of mixed use development including a lot of office space in
Innovation Neighborhood just west of 30th Street Station. The University City
Science Center, in partnership with BioMed Realty, have plans to develop about
4,000,000sf of new, mixed use development between 36th and 38th streets, just
north of Market Streets at the old University City High School site.
Because for the past 20 years in Center City there was
always plenty of available space in the existing office buildings and there was
a price premium to move to a new building, almost no new office construction
occurred in Philadelphia. However, that is starting to change. Many more
tenants are starting to believe that the benefits of a brand new office
building with better light, green space and amenities including outdoor space,
social gathering places and a more human friendly scale justify the replacement
cost rent premium as compared to the existing building stock. The proliferation
of new office development at the Navy Yard and in University City clearly
reflects this value assessment.
As rates continue to rise in the Central Business
District and the existing buildings grow older, the price gap between current
building stock and new construction will shrink, and the quality gap between
existing buildings and new, state of the art buildings will widen. The
interplay of these two phenomena will make it easier for companies to decide to
move to new construction. When they make that decision, where will they go?
While there will certainly be isolated building pad sites in the Central
Business District, many of these will necessarily exist within the constraints
of what is already nearby— a densely populated neighborhood of standalone,
older buildings. Much like the Navy Yard (though on a smaller scale),
Innovation Neighborhood and University City will provide opportunities for
tenants to not only redefine their work environment within a shiny new
building, but also become part of a larger, modern day community centered
around public green spaces, recreational activities and neighboring state of
the art buildings designed to a more people friendly scale.
Right now, for some companies, the Schuylkill River
creates a psychological barrier that cannot be crossed. What happens, however,
if we are lucky enough to land a Google, Microsoft, Uber or Oracle in
University City because of its proximity to Penn, Drexel and 30th Street
Station? What if three or four other well established corporations join FMC and
the top firms at Cira Centre in locating major operations across the river?
Given the changing economic and quality gap paradigms, isn’t it likely that other
companies would want to join in the fun? What happens then? Demand for the
current Central Business District will fall, rents will go down and it will be
difficult for landlords to get tenants to come back without materially
upgrading their product.
For most Philadelphians, the thought of our Central
Business District shifting location seems farfetched. However, it happened here
not that long ago and, to some extent, in other cities like Washington D.C. and
now Boston. In the early 1970s, the center of the Philadelphia business world
was South Broad Street. Most law firms, the largest occupiers of office space
by industry in the City, were there. But the buildings got old and tired and
new buildings started springing up along West Market Street and north 18th
street where land was cheaper. The difference in product quality led some
leading firms to move west even though the rent for these newer buildings was
higher. Once a few established firms made the move, it became acceptable for
others to follow. Eventually the Central Business District shifted west and
north. The same thing happened in Washington, D.C. Up until the 1990s, there
was little business presence east of 16th Street. However, as rental rates
continued to rise in City Center and the existing building stock grew older and
more tired, some pioneers moved east where the product was newer and, because
land was cheaper, the rent premium was small enough to justify the change. The
development of the Verizon Center and extension of the Metro helped make East
End a more vibrant and accessible submarket. Once a few prominent firms moved
east, more companies followed suit. While only one law firm was located in East
End in the 1970s, today that submarket is home to many of the District’s
largest law firms including Arnold and Porter, Venable, Covington, DLA Piper,
Jones Day, Sidley, Hogan Lovells, Skadden, Morgan Lewis, McDermott, Crowell
& Moring and White & Case.
For a long time, landlords in our Central Business
District have suffered with flat or declining rents. They have taken their
lumps and no one should deny them their day in the sun as rents have now
started to rise. However, there are limits to how high these rents can rise
before tenants start making different business decisions that could permanently
change the landscape. Increasing rents without significantly updating and
improving the underlying assets will ultimately have consequences that short
term owners may not care about. Demand for CBD space is not completely
inelastic so if the premium gets small enough and the quality gap gets large
enough, people will pay to move someplace newer and better. It happened in the
1980s and 90s and it can happen again.
Conclusion: First class cities need first class office
buildings in order to attract new, and retain existing businesses. Our office
stock is getting long in the tooth and, perhaps as a result, we are losing
major corporate occupiers and trailing other top tier cities in our efforts to
attract new ones.
Businesses don’t operate the way they did 30 years ago.
That means we need more new office buildings and, ideally, master planned urban
business communities that can support the companies of tomorrow. While tenants
may lament the fact that rents are currently rising in the Central Business
District, it may be just the catalyst we need to kick-off the projects that are
necessary to keep Philadelphia competitive and provide tenants with newer,
better choices When these new office developments come, they may well spring up
across the Schuylkill River thereby creating a very viable alternative to, or
even replacement of, our current Central Business District. And if that
happens, rents along West Market Street could once again look a lot different.
Glenn Blumenfeld is one of three principals of Tactix.
Since joining Tactix in 2003, Glenn has managed or co-managed many of the
largest and most complex real estate transactions in Philadelphia and the
Delaware Valley including representing the anchor tenants at the only two
speculative office towers in Center City Philadelphia in the past 20 years:
Cira Centre (Dechert and Woodcock Washburn) and FMC Tower at Cira Centre South
(FMC). Glenn‘s other clients include West Pharmaceutical Services, NutriSystem,
CDI, Safeguard Scientifics, Blank Rome, Klehr Harrison, Franklin Square Capital
Partners, Aberdeen Asset Management, and Hamilton Lane.
Source: Philadelphia
Business Journal
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