The Greater Philadelphia office market is seeing a few exciting development projects and steady interest in investment opportunities.
Southern New Jersey
The office sector in Southern New Jersey has exhibited overall strong fundamentals, underpinned by increased new investments from outside of the Greater Philadelphia region and economic inflows to support local economic expansion. The U.S. economy continues to grow moderately and add jobs, with the national unemployment rate dropping to a 16-year low. These conditions are helping to generate demand that is reverberating throughout the real estate sector, especially for office space.
Jason Wolf, WREC/CORFAC International
Office leasing activity has been on an upswing in 2017. The overall tone is positive, and vacancy rates have been stable for the past few quarters, hovering just above 10 percent. The second quarter posted approximately 395,155 square feet of new leases and renewals. This is a 24 percent increase in activity from the first quarter and an incredible 58 percent increase compared to the second quarter a year ago. New leases represented approximately 43.4 percent of all deals for the quarter. Notable deals ranged from 5,000 to 31,000 square feet.
The office investment and sales market is also showing increased activity. Buyers continue to take advantage of the sustained low interest rate environment. Some 554,590 square feet of office space traded hands at a combined value of more than $46.1 million during the second quarter. The previous quarter was even higher. Investment-grade property prices have been holding stable, but are still off from pre-recession levels. Over the past few years, commercial real estate values have risen while cap rates continue to strengthen.
Many new investors have been entering the region, while the REITs and local/regional owners have continued to reposition their holdings. Our records show approximately 3.1 million square feet on the market or under agreement. The selloff continues a trend of ownership turnover that started almost six years ago when Liberty Property Trust and Brandywine Realty Trust began reducing their presence in a market they once dominated. Now Mack-Cali is seeking to exit.
The pursuit of higher yields and the improving job market have attracted investors based outside the region. The market has several new private owners, including Somerset, Tequesta, Zamir, Nassimi, Crown, Endurance, and Keystone Property Group.
Healthcare, insurance, technology, and service businesses increased their occupancy needs during the second quarter, and we note an increase in capital spending, construction hiring, and expansions of small- and mid-size companies.
Another major trend in recent years is the transition of local business owners from rent-paying tenants into owner-occupied investor positions.
Rental rates have held steady in a higher range, and there are clear signs of significant mid-sized business expansion and job growth. These conditions have helped to boost confidence and lending conditions.
While Burlington County leads the market in terms of deal flow, there has been an increase in volume and repositioning activity in Cherry Hill and western Camden County, where a higher level of vacancies makes for excellent below-market opportunities. This shift was expected to happen, as large blocks of quality space have become scarcer in Burlington County.
Southern New Jersey has a persistent surplus of vacant space, which it must absorb. Until that happens, new spec construction will be limited, and most will be geared toward build-to-suits or specialty and redevelopment opportunities.
Philadelphia
The Philadelphia office market has witnessed a resurgence, giving the submarket an A rating across the board. Positives include a diversified employment base, with education and medical, pharmaceuticals and life companies, as well as the traditional fire, insurance and real estate companies representing. The largest deals in the market are dominated by build-to-suits including the new Aramark headquarters building under construction in Center City.
Notable investment sales have included international buyers for both Cira Square and Two Liberty in the central business district. Other significant sales transactions include Saint Gobain in Malvern and One Washington Square in the Independence Hall submarket (both of which were recent IRR Philly assignments) and the Science Center in University City.
Cap rates are reaching all-time lows. We anticipate a slight increase over the next few quarters in line with forecasted interest rate growth, albeit nominal as there remains inherent spread between 10-year treasuries and cap rates. The anticipated interest rate growth and potential for inflation appears to be “priced in.” International investors from Asia have recently entered the market, seeking secure investments. Their presence in Philadelphia is significant because “gateway” markets have lower yields and these investors flock to Tier II central business district markets such as Philadelphia for better yields. This could counter-balance cap rate increase for the trophy assets — or, in other words, shield this asset class from the macro risks of the larger office market.
While we anticipate significant rent growth, particularly in the CBD and in core suburban markets, there still remain some challenges with older CBD office properties, which are fast becoming obsolete, as well as those in secondary markets. Some bright spots include Plymouth Meeting, Conshohocken, Radnor, which are seeing positive growth.
Our discussions with builders indicate that new high-rise construction costs exceed $500 to $600 per square foot. With recent sales, such as Two Liberty, at half that amount, the market values are well shielded by replacement costs going forward.
The new Aramark building is being developed by PMC; the space will be built upon the existing/former Philadelphia Market Design Center. The utilization of the existing shell offers significant savings while offering an effectively brand new office asset at modern design specs in Center City.
Additionally, FMC Tower is nearly complete and the Comcast Innovation and Technology Center is redefining the Philadelphia Skyline.
According to Costar, the largest suburban lease transactions are the 86,621-square-foot lease by Cotivitti at Woodlands 1, the 68,846-square-foot deal signed by Centene at 300 Corporate Center Drive in Central Pennsylvania, and a 40,000-square-foot lease signed by Equus Capital Partners at 3843 West Chester Pike at Ellis Preserve in Newtown Square, Pennsylvania. Equus is moving from Centre Square Towers in Center City Philadelphia to the suburbs, which bucks the recent trend of companies moving from the suburbs to Center City.
Both CBD and suburban office supply and demand indicators remain positive and continue to reflect growth.
— By Jason Wolf, managing principal, WCRE, CORFAC International. This article first appeared in the September 2017 issue of Northeast Real Estate Business magazine.