Following the Global Pandemic commencing 2020, central business districts across the country have suffered higher than normal office availability rates. Philadelphia’s Central Business District (CBD) is no exception. For the fifteen years preceding the pandemic, Philadelphia’s office availability hovered between 12.0%-15.0%. In comparison, the challenges of the current market provide an office availability rate of 23.1%.
The never-ending news cycle of “Remote vs. Return-to-Office” has provided little real guidance on how Philadelphia’s office market will fare in the coming years. For tenants, the issue has become “right sizing” an office presence while maintaining employee morale and hosting a corporate culture that encourages growth and innovation. For landlords, the challenge has been keeping existing occupiers and attracting new tenants while mitigating any debt obligations. Throughout this uncertainty, the whisper of residential conversions and asset reimagination has remained in the conversation. Many articles have cited the challenges of such conversions. The expense associated with these conversions, the risk involved, and the capital stack complications of these assets present daunting challenges for such a venture. Developers and landlords alike continue to assess which buildings have the potential for a conversion to residential or mixed-use.
There are a host of variables that will impact return-to-office and availability norms in Philadelphia. This piece examines how there may be a path back to healthier market conditions through targeted conversion and/or repositioning of certain office buildings. For consideration of such a change, Savills examined buildings with over 25% availability, outstanding debt obligations or potential risk of foreclosure, and significant lease rollover in the next three years. A trend we’ve seen since the pandemic is a “flight to quality,” where companies are choosing to relocate to nicer, newer buildings with more amenities for their employees and close to transit in an effort to “earn back the commute”. If companies can reduce the amount of square footage they lease, they can be in a nicer building without increasing occupancy costs. A consequence of this “flight to quality” is that the older properties without amenities are losing tenants and are facing higher availability rates. By converting these lower quality buildings to residential or mixed-use, it would remove available square footage from the office market, which would in turn reduce availability rates back to historical averages and bring supply/ demand metrics back to equilibrium. Philadelphia’s Central Business District has 48.8 msf of office space with 11.3 msf (23.1% of CBD) of such space being marketed as available. Currently, 4.9 msf (10.0% of CBD) of office space in the CBD is either actively being converted or is under consideration for a conversion to residential or mixed-use. Of the 4.9 msf of potentially converted buildings, 1.8 msf (3.8% of CBD) is currently available (and taken into account in current availability rates), leaving 3.1 msf (6.3% of CBD) of additional availability to be taken out of the office market. Post-conversions, the Philadelphia CBD office market would be reduced from 48.8 msf to 42.9 msf, and after removing the current and potential available space in converted buildings from the market, we could see 8.2 msf of available space, which is equivalent to a 19.2% rate post-CBD conversion.
In October’s edition, Downtown Rebound: The Data Driven Path to Recovery, a publication by Center City District, points out that although there is a large interest in office-to-residential asset conversations, it will take an “extraordinarily high number of new residents to compensate for any continuing absence of office workers”. The published work highlights that proximity to the work environment remains one of the key drivers for a resident’s choice to live downtown. For this reason, Savills explored the conversion of eight (8) potential assets that might be plausible as these buildings provide easy access to retail, entertainment, and corporate offices in the CBD. Alterra, the new owner of 1701 Market Street, the former Morgan Lewis building, has committed to converting the 464,562-square-foot former law office building to 299 residential units with a rooftop terrace and pool. This strategic repositioning is well received by many in Philadelphia and results in eliminating a large contiguous block of available and vacant square footage from the market. This begs the question, which buildings will be converted next?