Current and Future Market Conditions Q4 2011

Current and Future Market Conditions Q4 2011

Fourth Quarter statistics appear to reflect market stabilization in the CBD with 96,000 SF of positive absorption. Vacancy has decreased from 14% in Q 3, to 13.7% to conclude 2011. This brings the total vacancy in the CBD to 5.5 M SF. Absorption for the year was strong posting 281,000 square feet for the year. For comparison purposes, at the conclusion of 2010 vacancy was 14.7%, and the total vacancy in the CBD was 5.9m SF. 2011’s gains are a step in the right direction but are modest and still a far cry from the peak of the market in 2007 when vacancy was sub 10% and the total vacant space was just under 4M SF.

Perception vs. Reality:       

It took a while but asking rates in the CBD have begun to recede. The asking rates in the CBD are   $26.00 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 space per building class. Aggressively negotiated transactions continue to be discounted in the 80% – 85% of asking range.

Landlord Concessions:

Free rent is extremely prevalent in today’s market with tenants receiving one month or more for every year of lease term. A once reluctant landlord community has slowly come to the realization that contraction, termination and expansion rights are essential to any new lease document.  Tenant improvement allowances have ranged from $30/$35 SF in Class B buildings to $40/$50 SF in Class A buildings.

Renewal vs. Relocation:

The most attractive transaction to a landlord is a renewal. There is limited capital outlay, and virtually no downtime.  Until the market is fully leveraged with viable relocation alternatives, renewals will continue to be high.  In a market that is 13.7% vacant, tenants should continue to take advantage of the unstable economic climate and begin to address real estate relocations and renewals 15 to 18 months prior to their present lease expiration date. New opportunities continue to emerge daily. Relocation alternatives with adequate leverage and time will enable tenants to achieve similar economic concessions, regardless if you elect to relocate or renew.

Lease Securitization:

Due to a significant amount of capital being expended for new construction or improvements to existing space, today’s landlords are much more focused on the credit-worthiness of tenants. Landlords will look to deposits and letters of credit for security. Lease securitization ranges from 25% to 50% of the transaction costs depending upon the credit-worthiness of the tenant. Lease security, like landlord concessions, free rent, and annual rent are highly contested and should be addressed early in the decision making process.

Landlord Capital:

As landlords want to be assured of their tenants’ financial stability, tenants should also be comfortable that existing and future landlords are stable and able to fund transactions.

Early in the process, tenants should be asking landlords to furnish documentation from their prospective lenders to provide proof they are in good standing and able to fund new transactions. Any lease document should insure a tenant’s right to offset their base rent as a remedy in the event the landlord cannot perform services or fund tenant improvements.

Leasing activity amongst major tenants in 2011:

• GlaxoSmithKline announced they would vacate 850,000 square feet from One & Three Franklin Town in the CBD to the Philadelphia Yard.
• Morgan Lewis renewed its lease at 1701 Market St for 289,432 square feet
• CHOP announced they would expand their CBD presence in the Wanamaker Building from 190,000 SF to 260,000 SF.
• Penn Medicine, part of the University of Pennsylvania Health System leased 153, 242 square feet at 8^th & Market Street.
• Janney Montgomery Scott signed a new lease at Three Logan Square where they have leased 147,000 square feet.
• Comcast will expand at Three Logan Square from 50,000 square feet to 125,000 square feet.
• Reed Smith will be relocating from One Liberty Place in early 2014 to Three Logan Square where they leased 115,000 square feet.
• Ernst & Young is relocating from Two Commerce Square to One Commerce Square where they are leasing 74, 240 square feet.
• Zurich American Insurance will relocate from 1818 Market St to 2000 Market St where it leased 51,300 square feet.               

*Sublease/Direct

Since the vast majority of vacancy is still located in Class A assets, these landlords are willing to offer significant economic concessions to entice new tenants. When possible, tenants are taking full advantage of this opportunity to move into upgraded spaces without paying the historic premium between asset classes. This “flight to quality” will continue to result in more vacancy in the B/C Class office buildings while those Landlords scramble to retain their existing tenants.

Given all of the above, a lackluster job growth environment, the competition for tenancy will remain heated in Center City for the foreseeable future, Tenants seeking long-term leases will continue to negotiate attractive base rent schedules, free rent concessions, and sizable construction allowances.

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