Current and Future Market Conditions Q2 2013

Current and Future Market Conditions Q2 2013

The Philadelphia Central Business District (CBD) witnessed nominal growth again in the Second Quarter with 12,443 square feet of positive absorption. The total vacancy in the CBD remains at 5.4 M SF and the overall vacancy rate remains flat at 13.2%.

Transaction highlights in the Second Quarter include Pepper Hamilton’s decision to renew its lease in Two Logan Square for 268,000 SF well into the next decade. Reliance Standard will remain in Two Commerce Square, where they renewed their lease for 12 years, and expanded by an additional 13,000 SF to 137,663 SF.  Philadelphia Health Management “PHMC” finally inked a new lease at Centre Sq East where they leased 120,207 SF and committed to an 18 year lease term. Beneficial Mutual Bancorp’s “Beneficial”,  announced they will relocate from their Market East headquarters of Penn Mutual Towers to West Market St. where they will occupy 95,764 SF in 1818 Market St. As a result of Beneficial’s 15 year lease commitment, the building was renamed, 1818 Beneficial Bank Place.

Large Tenants with decisions still pending include, Price Water House Cooper (161,000 SF), and FMC (156,000 SF).

While inbound demand and inherent expansion was positive for Center City Landlords, the possibility for any significant positive absorption is being offset by small, medium and large tenants who continue to rightsize. The Class A submarket continues to see a demand for tenants ranging in size from 10,000 SF to 50, 000 SF. Tenant’s continue to take advantage of Class A Landlords with high vacancy. These vacancies enable Tenants to leverage relocation/ renewal negotiations and secure lower base rents for longer periods of time during transaction negotiations. When possible, tenants continue to take full advantage of this opportunity to move into upgraded spaces without paying the historic premium between asset classes. This “flight to quality” is prevalent today but may be gone tomorrow.

Lease flexibility is a relatively new concept that has emerged during this down cycle. Properly leveraged transactions enable tenants to enjoy the right to expand, contract, or terminate their leasehold at specific times throughout their lease term. These options typically de-value an asset, but whether landlords like it or not, these accordion-style leases remain key components to any new lease.

Asking rates remain flat with Trophy Class Buildings at $35 SF, $27.00 SF for Class A space, $23.00 SF for Class B space, and $19.00 SF for Class C space. The asking rates are the weighted average of the published rate from all vacant spaces per building class.

Office Buildings are loosely classified on the quality of their construction, their features, and the status of their location according to guidelines from BOMA.

Trophy Buildings- Most prestigious buildings competing for premier office users, with rents well in excess of the average for the area.

Class A- Buildings have high quality standard finishes, state of the art systems, exceptional accessibility and a definite market presence.

Class B- Buildings competing for a wide range of users with rents in the average range for the area, building finishes are fair to good for the area and systems are adequate, but the building cannot compete with Class A assets at the same price.

Class C- Buildings competing for tenants requiring functional space at rents below the area average.

In Conclusion, very little has changed in the past three months. Underperforming assets continue to be removed from the inventory to allow for condo conversions. Most recently, 1429 Walnut St. “Chestnut Place” was sold to Alterra Property Group and is slated for conversion in 2014. Leasing in Trophy Class buildings remains strong with a reported 6% vacancy.  The removal of inventory coupled with practically, no vacancy in the Trophy Class buildings is both healthy, and encouraging to West Market Street Landlords.  With most, if not all of the corporate downsizing having taken place, and limited vacancy in the trophy buildings, the vacant space in the Class A buildings will begin to be absorbed over the next 18-24 months.

The Philadelphia Central Business District’s (CBD) witnessed nominal growth in the First Quarter with 38,412 square feet of positive absorption.  This brings the total vacancy in the CBD to 5.4 M SF. The overall vacancy rate remains flat at 13.2%.

Transaction highlights in the First Quarter include Drinker Biddle & Reath LLP’s renewal decision at One Logan Square where the firm renewed their lease for 15 years and downsized from 209,000 SF to 155,000 SF. The GSA announced they will relocate 135,000 SF from 801 Market St to the Dow Chemical Building where they signed a new 15 year lease commitment. The Securities and Exchange Commission decided to move west from 701 Market St and lease 42,000 SF in Suburban Station, bringing the buildings occupancy to 94%. The Art Institute of Philadelphia renewed its lease at 1622 Chestnut ST for 100,000 SF. Reinforcing the low vacancy in the Trophy market was Glenmede Trust Company’s decision to renew its lease in One Liberty Place for 92,000 SF for 12 years.

Large Tenants with decisions still pending include Philadelphia Health Management “PHMC” (90,000 SF), Beneficial Savings Bank “Beneficial” (125,000 SF), Price Water House Cooper (161,000 SF), FMC (156,000 SF) and Pepper Hamilton (220,000 SF).

The lengthening of deal terms continues to be a common theme. Tenants continue to take advantage of the down economy. The abundance of available space enables Tenants to secure lower base rents for longer periods of time during transaction negotiations. When possible, tenants continue to take full advantage of this opportunity to move into upgraded spaces without paying the historic premium between asset classes. This “flight to quality” is prevalent today but may be gone tomorrow.

Lease flexibility is a relatively new concept that has emerged during this down cycle. Properly leveraged transactions enable tenants to enjoy the right to expand, contract or terminate their leasehold at specific times throughout their lease term. These options typically de-value an asset, but whether landlords like it or not, these accordion-style leases that give tenants contraction and termination options remain key components to any new lease.

Asking rates are beginning to inch upward with Trophy Class Buildings at $35 SF, $27.00 SF for Class A space, $23.50 SF for Class B space, and $19.50 SF for Class C space. The asking rates are the weighted average of the published rate from all vacant spaces per building class. Aggressively negotiated transactions continue to be discounted within the 80% to 85% asking range.

In Conclusion; Since Q 2 2008 we have enjoyed a very aggressive and tenant friendly market.  Tenants’ and Tenant advisors like KCR, have enjoyed these times and have taken advantage of a weakened economy, high local unemployment and an abundance of space in the CBD.  However, we see this tenant friendly environment changing over the next 18-30 months. Why?  Most if not all corporate downsizing has taken place, or will have taken place, underperforming assets have been removed from the inventory to allow for condo conversions, and leasing in Trophy Class buildings remains strong with a reported 6% vacancy.  The pending relocation of PHMC (105,000/RSF) from 260 South Broad Street (converted to residential) to Centre Square and Beneficial’s announcement to relocate (125,000/ RSF) from Penn Mutual Towers to 1818 Market Street will result in positive absorption on West Market Street.  This absorption, coupled with practically no vacancy in the Trophy Class buildings is both healthy and encouraging to West Market Street Landlords.  With limited vacancy in the trophy buildings, the vacant space in the Class A buildings will begin to be absorbed.

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