Philadelphia’s diverse local economy, healthy hiring trends and area-employers’ ability to draw fresh talent from the metro’s deep college-graduate pool, continue to attract businesses to the area and support improvements in the office property segment.
In 2016, Philadelphia firms increased payrolls by 1.9 percent with the creation of 54,000 new positions. Hiring was driven by office-using employment sectors which, over the four-quarter period ending with the second quarter of 2016, accounted for the addition of 21,700 jobs, or nearly 37 percent of all new hires. This year, it is expected that the local workforce will add 49,000 to its ranks, representing a 1.7 percent expansion. Hiring will continue to be strong among office-using companies, as well as in the healthcare and education segments.
Mark Taylor, Marcus & Millichap
In the first half of 2016, developers sluggishly completed 178,000 square feet of new office space. In the second half of last year, the construction pipeline exploded, and by year-end 1.2 million square feet of office space had been delivered to the marketplace, with a significant amount of completions pre-leased, which helped mitigate any effects to vacancy levels. Office projects completed in 2016 were spread throughout the metro within the submarkets of Delaware County, Lehigh-Northampton, Harrisburg Area West, South Camden County, South New Castle County and Navy Yard, as well as several facilities that came online in the city of Philadelphia.
In 2017, builders are projected to complete 1.8 million square feet, which will not have a negative impact on vacancy.
The need for all classes of office space in Philadelphia has remained steady over the last six to seven years prior to 2016, during which time vacancy hovered between 15.0 percent and 15.9 percent. Last year, robust absorption of new space, coupled with high demand, worked to depress vacancy to a seven-year low. Despite the deluge of deliveries in the second half of the year, the vacancy rate fell 20 basis points to 15.0 percent by the end of the year. Falling vacancy last year also contributed to rental improvements.
Looking at the year ahead, vacancy is anticipated to fall 50 basis points to 14.5 percent in 2017. This, however, will not be at the expense of rental growth.
In the 12-month period ending September 30, 2016, the average asking rent surpassed historic highs across all asset classes. On average, Class A rents rose 1.7 percent to $27.72 per square foot. Class B/C rents climbed an average of 4 percent in the same period to $21.38 per square foot. Overall, the metro’s average asking rent in 2016 reached $24.31 per square foot for a 3.6 percent year-over-year increase. This rental growth helped attract investors and drive transaction activity.
This year, office rents are projected to further increase by an additional 4.6 percent.
Investors were eager to invest capital into Philadelphia’s office assets in 2016, given stable sales prices and cap rates, amid an environment of strong job creation and low vacancy. The competitive buying environment intensified over the course of the year as out-of-metro buyers found the area’s office properties an attractive alternative to assets in nearby Washington, D.C., and New York City due to Philadelphia’s relatively higher returns. Competition was greatest among investors injecting $1 million to $10 million into office space where typical first-year returns ranged between 7 percent and the low-8 percent tranche. The majority of transactions last year involved small-portfolio or one-off Class B/C property deals.
In the four-quarter period ending with the third quarter of 2016, transactions sold for an average of $162.41 per square foot, and the market’s average cap rate over the same period was in the low-7 percent range.
In 2017, investors will remain active in Philadelphia’s office property marketplace with deal flow expected to accelerate while buyer-seller pricing expectations generally remain aligned.
— By Mark Taylor, senior managing director of investments at Marcus & Millichap. This article first appeared in the February 2017 issue of Northeast Real Estate Business.