Few are working full-time in the office anymore, but some argue it’s nowhere near a ‘real estate recession’ in Philly

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The people who are typically behind the scenes buying, selling, leasing and developing Philly’s Center City skyline and beyond questioned what’s next for commercial office space in 2024.

Especially up in the air is the future for any building that’s not considered prime real estate — or Class A — office buildings. It’s those Class B, Class C and below commercial properties that have languished, despite sporadic renovations whether in any city center or in surrounding suburban communities.

Most of the office building stock, “at this point have become functionally obsolete,” said Cat Bianco, managing director of Tactix Real Estate Advisors at the Urban Land Institute’s annual economic forecast and real estate trends event in mid-November.

The economic forecast did not offer a virtual option to attendees — and hundreds gathered inside The Bellevue Grand Ballroom on South Broad Street in Center City.

One key question discussed is what happens when there’s erosion to the property tax base in communities when an office building defaults on its existing debt.

Whether that debt is taken on for renovations or is a previous mortgage — lenders such as banks — are typically not interested in becoming property owners and managers. Especially when there’s less demand than ever for office leases, that means the building owners aren’t generating the same amount of money with tenants inside the property.

In the suburbs, there’s likely more restrictive zoning than within city limits which could be, “a difficult process for a lot of developers thinking about what to do with some of these buildings that should be something other than what it’s currently,” Bianco said, which is why conversations between municipal leaders and developers need to happen sooner rather than later, she argued.

“You may ask why is the township [or city] going to be interested in having this conversation [about office space] with a bunch of developers,” Bianco queried.

The woes of the office building market might seem like only a problem for commercial real estate professionals, but Bianco said it should be an economic development issue for everyone.

“If all of these [Class B and below] buildings are sitting around and they’re vacant and they’re not being looked at and adapted, that tax base is going to suffer,” she said. “And those communities are going to suffer.”

For a city like Philadelphia, which relies on a combination of city wage taxes, business taxes and property taxes for its budget — some worry about the city’s shrinking revenue as there are fewer high wage earners working within city limits because they’ve opted to keep working remotely and the business they work for are no longer leasing office space in Center City.

As such, more than $94 million was refunded to employees of companies working remotely in the surrounding suburbs of Philadelphia in 2021. Another $85 million was refunded to those workers from city wage taxes in 2022.

In 2019, it was not uncommon for there to be more than 50,000 daily visits on an average weekday for non-resident workers — aka commuters — in the West Market Street and JFK Blvd. office district, according to data compiled by the Center City District. In 2020, that dropped to fewer than 5,000 commuters in that office district that runs from City Hall to the Schuylkill River. In 2023, there are roughly 30,000 such commuters going to work in office buildings west of City Hall, data shows.

The average professional services business pays tens of thousands of dollars each year – often more, excluding utilities, to rent several thousand square feet of office space in Philadelphia’s Center City.

For generations, the concept was that there’s value for colleagues of the same company to commute as individuals and work in person next to each other.

But after the COVID-19 pandemic forced many office workers into remote work situations — which have transitioned into hybrid office hours — many question the value of a standard multi-tenant brick-and-mortar office building of which there is a plethora of in an old city like Philadelphia.

For example, there’s a Class B office building along Walnut Street. It was built in the early 1900s with elevators that transport visitors up and down 16 floors. The highest floor isn’t an office — but residential condo spaces, city records show.

Of the remaining 15 floors, with 77,000 square feet of office space available in that property — there’s 15,587 square feet of office space for lease on four different floors spanning between 2,000 and 4,300 square feet each, marketing material shows. 

For an office space on the 12th floor of roughly 2,000 square feet, the broker is trying to rent it for at least $23 per square foot for a minimum of 1 year, if not a 5 year lease term.

One of the open offices was once leased by the Red Bull Mid-Atlantic Region as its Philadelphia office hub, the broker boasted in marketing materials. 

On a recent Saturday, an entire page of visitors to the property shown on the sign-in sheet at the security desk, were for the emergency dentist office on the 6th floor.

But until those offices on several floors are leased, those spaces will sit empty, seven days a week — not just on weekends.

That doesn’t mean the office doesn’t still need janitorial services, security guards, basic utilities and other maintenance — it does — but now there’s less revenue to pay for those things.

For a building of this size, scope and location, it’s already been retrofitted for technology companies with smaller office spaces instead of 10,000 square feet of sprawling open space.

Whereas there are other office buildings that have even less demand, would need even more money for renovations of a historic property and an owner willing to spend capital as a long-term investment in a city like Philadelphia.

Beyond that, the 1,300 square foot ground floor retail next door — which appears to have catered to office workers for breakfast and lunch years ago — is still not yet leased but also sits vacant.

It’s not like hard times haven’t happened before.

During the Great Recession, some in commercial real estate saw what happened when there was really no money available to lend, said Anne Cummins, chief operating officer at Gattuso Development Partners.

Gattuso is a Philadelphia-based company that has worked on high profile projects such as the Comcast Center, the Navy Yard, and the Camden Waterfront.

“Now if you want capital you can find it,” Cummins said. “It might be higher interest rates. You might not like the [deal] terms, but there is liquidity.”

Cummins remembers what happened when the economy collapsed and banks failed starting in 2008. The concept of an economic recession was not “up for debate” as it is today, she said.

But in general — office buildings need to change — and that takes investment, she said.

“The standard Monday through Friday nine-to-five office is probably no longer going to be the future of our economy,” she said. “We need to be really thinking about how we improve the spontaneity of our interactions when we are meeting [in office] because that’s really where the magic happens. When people come into the office, how do we make our real estate work — a lot of times it’s meeting places, huddle rooms, amenities, and bringing people together.”

Brian Berson, president of Parkway Commercial Properties — a Philly parking giant best known for its lots in Center City — says that while the economy might boom and bust, prime real estate stays profitable.

“In [2008] we thought there would be breadlines. We thought it was 1927 again going into it,” Berson said. “But well-placed, well-built real estate is always going to be valuable.”

But unlike during the Great Recession, when the economy was still moving despite uncertainty and financial market collapse, it was a different experience to try and do business during COVID-19. At least during the recession, brokers could still market buildings for future buyers.

“You could be delusional and think that the world was going on like normal. In COVID, there was no delusion,” he said. “There was an unrecognizable planet.”

While most economists forecast that there’s no deep recession on the horizon, the New Year will more clearly show any potential cracks in the foundation for real estate developments poised to struggle.