Office vacancies are falling across the big metros of the Northeast as robust user demand outpaces the supply of new construction. Deliveries in the last year have primarily been limited to Class A, build-to-suit properties and mixed-use developments. Meanwhile, office tenants are seeking high-end amenities at favorable prices.
Nationally, the office vacancy rate stood at 16.8 percent in the second quarter, up slightly from 16.6 percent a year ago, according to real estate research firm Reis. Net absorption for the quarter totaled 3.2 million square feet, down from 3.9 million square feet a year ago. The average asking rent was $33.79 per square foot, up 2.2 percent on a year-over-year basis.
Approximately 11.1 million square feet of office space was under construction at the end of the second quarter across Philadelphia, New York and Boston, according to CoStar Group. Helped by approximately 8.3 million square feet of absorption in the second quarter, the average vacancy rate across all three markets was 8.1 percent.
Rather than undertake costly new ground-up construction projects, many developers are choosing to redevelop existing assets and efficiently incorporate office space into mixed-use
projects.
Coworking tenants occupied 54.2 million square feet of office space nationally at the end of the second
quarter, according to CoStar. In Philadelphia, New York and Boston, the tech and coworking sectors dominate office leasing and set the standard for Class A office development.
Key features of these spaces often include access to public transit and surrounding retail and restaurant options. Even single-tenant offices are moving away from classic cubicles in favor of “flexible,” or collaborative, environments where employees are not assigned to specific desks and can freely work wherever they feel comfortable.
Philly Market Undersupplied
A decade of minimal office construction in Philadelphia is driving up demand for new supply and putting upward pressure on rents.
According to CoStar, the vacancy rate in metro Philadelphia was 8.7 percent in the second quarter, with 784,000 square feet of net absorption. A lack of buildable land in the city proper has driven developers to the suburbs, and most of those projects are preleased before building begins.
Of the nearly 1.9 million square feet under construction during the second quarter across metro Philadelphia, approximately 221,000 square feet was speculative office space, or 12 percent of the total amount.
“Demand for Class A office space in Philadelphia is high, but there’s nothing out there for tenants that want new product,” says Les Hagget, first vice president of advisory and transaction services at CBRE’s Philadelphia office. “Even as the population has steadily grown, the city has maintained its character of passion and grit. It’s a great place to live and work, and that increases the demand for great office space.”
Higher education and medical facilities have historically led Philadelphia’s economic growth, but more recently there has been an uptick in demand from life sciences and biotech companies. Lab space is in especially high demand in the University City submarket, which includes The University of Pennsylvania, Drexel University, the University of the Sciences and the Restaurant School at Walnut Hill College.
Tenants in Philadelphia’s office market value amenities related to wellness and quality of life. Employees who walk and bike to work value onsite gyms with lockers and showers to change clothes before or after work. New construction and renovation projects are incorporating large windows for natural light, higher ceilings and larger rooms.
“The supply of coworking and flexible office plans in Philadelphia has increased by 20 percent in the last year, and it’s only going to increase more,” says Hagget. “The good news is the demand for that type of space is keeping up with the new supply, and larger companies want to have a more flexible office space.”
A joint venture between PREIT and Macerich recently launched Fashion District Philadelphia, a 900,000-square-foot mall redevelopment bringing dozens of shopping, dining and entertainment destinations to the Center City area. Within the development, coworking office providers REC Philly and Industrious will occupy 10,000 and 47,000-square-foot spaces, respectively.
Rents in Center City are growing 5.5 percent year-over-year, averaging $33 per square foot as of the second quarter. By comparison, CoStar reports that rent growth in Philadelphia’s central business district has averaged 3 percent annually for 15 years.
Keystone Property Group has begun construction on Sora West, a 427,333-square-foot mixed-use project in Conshohocken that will also include restaurant, retail and hotel space.
In the suburbs of Plymouth Meeting, Brandywine Realty Trust plans to develop Metroplex Two, a 280,000-square-foot Class A office building. The property will join the existing Metroplex One at the site, but construction will not move forward until an anchor tenant is secured, according to CoStar.
Building Skyward in NYC
As tech and coworking powerhouses absorb much of the highest-quality office space in New York City, developers in the area are turning to mixed-use projects and vertical construction to keep up with the demand for new space.
CoStar reports that New York City’s vacancy rate stood at 8.3 percent in the second quarter, with net absorption totaling 4.8 million square feet.
Meanwhile, approximately 27 million square feet of office space was under construction. The $26 billion Hudson Yards mixed-use development in Manhattan accounted for roughly half of that amount. The diverse mix of tenants preleasing space at Hudson Yards — including BlackRock, Time Warner and Pfizer — has spurred speculative construction and redevelopment of office space in the area.
The 1.9 million-square-foot Two Manhattan West office that is currently under construction is slated for completion in 2022. Moynihan Train Hall at the Penn Station Complex will offer 767,000 square feet of speculative office space catering to tech tenants by the end of 2020.
WeWork was the largest office tenant in the market in the metro area at the end of the second quarter, occupying more than 5 million square feet. The company recently leased 362,000 square feet at 437 Madison Avenue but will not move in until January 2021.
“The tech boom is continuing this year,” says Eric Anton, associate broker at Marcus & Millichap’s New York City office. “Tech companies are flexible, and they usually value amenities more than square footage. New York City has an extremely limited amount of land to build on, so building owners and developers are instead choosing to amenetize existing assets.”
Outdoor amenities seem to be the most highly prized office features from the incoming millennial workforce, according to Anton. Developers are incorporating green space, balconies and terraces into Class A office buildings, along with indoor lounges and media rooms. Coffee bars, either staffed with baristas or automated, are another popular trend. Office gyms are in lower
demand as condo and multifamily properties are increasingly supplying that amenity.
“People didn’t used to care as much about amenities in an office space, but now it’s super important,” says Anton. “I don’t see a big pipeline of new product being delivered over the next few years, but the
coworking and tech sectors have driven demand for flexible workspace.”
Silverstein Properties completed the development of 3 World Trade Center in June 2018. The 80-story, 2.5 million-square-foot tower is anchored by advertising media company GroupM, which occupies 700,000 square feet. Now, Uber is set to lease 300,000 square feet for a new headquarters office on seven floors of 3 World Trade Center.
The Related Companies is currently developing 50 Hudson Yards in Manhattan. The 2.9 million-square-foot building will be New York City’s fourth-largest commercial office tower when completed in 2022. Global investment firm BlackRock will relocate its corporate headquarters to the 58-story building, where it will occupy 850,000 square feet on 15 floors.
Boston Market ‘On Fire’
Growth in the education, technology and medical fields has led to strong tenant demand for flexible workspace in metro Boston. In particular, the life sciences and coworking sectors are generating a significant amount of leasing activity.
“The Boston office market is on fire,” says Aaron Jodka, managing director of client services at Colliers’ Boston office. “Vacancies haven’t been this low since the fallout of the dot-com bust. Coworking has been a massive disruptor in the Boston area, and mixed-use is primarily driving new construction.”
CoStar reports that Boston’s office vacancy rate registered 7.3 percent in the second quarter, with net absorption totaling 2.7 million square feet. Wayfair, DraftKings and Verizon Wireless were among the major space lease signings in 2018 while tech and coworking firms accounted for half of all leasing in Boston, says Jodka.
From late 2018 to mid-2019,
WeWork absorbed approximately 1.6 million square feet of office space, and the coworking giant is now the second-largest tenant in Boston behind Fidelity Investments.
“Boston has access to a workforce of 250,000 college graduates from world-renowned institutions such as MIT, Harvard and Boston University,” says Jodka. “This, along with an abundance of new residential housing, has prompted new office construction throughout the city, with an increasing number of those developments being speculative in nature.”
There was approximately 10.1 million square feet of office space under construction in the Boston metro area at the end of the second quarter. Of that total figure, approximately 4.3 million square feet was
speculative space.
New developments are responding to a high demand for quality-of-life office amenities such as gyms, bike storage and green space. The workforce is driving demand for shared conference facilities, coffee lounges and especially access to public transit.
Millennium Partners is developing the Winthrop Center, a more than 1 million-square-foot mixed-use development in the Financial District, which will include 750,000 square feet of office space as well as residential and retail tenants. The developer is expected to deliver the project in early 2022.
HYM Development Group is developing One Congress, a 1 million-square-foot office tower in the Bulfinch Crossing mixed-use development. When construction is complete in 2023, financial services firm State Street Corp. will anchor the tower with a 510,000-square-foot lease for 15 years.
“Office tenants in Boston are hyper-focused on making their employees experience the best it can be,” says Jodka. “The latest differentiator in the amenities arms race is access to food halls. Since most dedicated office assets are not able to accommodate that kind of service themselves, mixed-use leasing is the name of the game today.”
— By Alex Patton. This article originally appeared in the October 2019 issue of Northeast Real Estate Business magazine.