The turbulent office market presents ‘a blend of danger and opportunity.’ Here’s how Philly’s top commercial landlord is handling it.

Construction workers used a crane on a sunny Tuesday afternoon last month to place the final beam atop a 14-story building that, when completed, will be the latest addition to a growing skyline taking shape in West Philadelphia.

It was a sign of progress in a $3.5 billion development spanning 14 acres in University City — an ambitious project undertaken by Brandywine Realty Trust and Drexel University known as Schuylkill Yards that will feature luxury housing, public space, and offices and labs for the city’s growing cell and gene therapy market.

The project, expected to take a decade, “will drive the growth trajectory of the city for the next generation,” Brandywine CEO Gerard H. “Jerry” Sweeney told an audience of unionized construction workers, politicians, and others gathered for a ceremony to mark the occasion. Underscoring the project’s significance to the city, Cherelle Parker, the Democratic nominee for mayor, stopped by and took a picture with Sweeney.

The congratulatory speeches at 31st and Market Streets stood in sharp contrast to months of headlines warning of a potential office apocalypse that some economists say could doom commercial landlords and cities alike.

Amid the rise of remote work, office vacancy rates in Center City and the suburbs have soared. Some landlords are facing big debt payments at much higher interest rates as they lose rental income from departing tenants. A Federal Reserve survey recently cited commercial real estate as a potential risk to financial stability in the United States.

In some ways, Brandywine, Philadelphia’s dominant office landlord, is a counterpoint to that post-pandemic narrative.

“Majority opinion is not a test of validity. It’s like everyone has basically said, ‘OK, the office business is dead.’ And the reality is, it’s not,” Sweeney said in an interview Wednesday.

“The reality is that the connective tissue that physical spaces provide company culture and productivity gains is still valid,” he said. “And I think you’re seeing that by this emergence of the quality thesis — as executives are thinking about what’s the best way for them to weather the storm they face in their business, having the capacity to have people together in a high-quality, thoughtful environment that will generate productivity gains is top of their list.”

While Philadelphia’s vacancy rate climbed to 19% as of September, according to real estate services company Jones Lang LaSalle, Brandywine’s properties in the city are 95% occupied and 97% leased.

In recent months, Wells Fargo and law firms Fox Rothschild and Post & Schell announced they were reducing their Center City footprint — leaving non-Brandywine properties — and signing leases at high-quality buildings owned by Brandywine.

And in September, Brandywine announced a new lease with law firm Goodwin Procter at its first ground-up building at Schuylkill Yards, the recently completed West Tower — a 28-story, 570,000-square-foot mixed-use building that includes 326 luxury apartments.

Even so, Brandywine, which is a publicly traded real estate investment trust, or REIT, is facing skepticism from investors who have soured on the office market. Brandywine’s stock is down 38% over the past year and more than 70% since the spring of 2022, when the Federal Reserve started raising interest rates to tame inflation. The stock’s performance is comparable to similarly sized REITs. It closed at $4.25 a share on Friday.

While the company’s reported results for the three-month period ended Sept. 30 “point to a better environment compared to the sky-is-falling fear-driven office real estate sentiment, we see little to get excited about anytime soon,” analyst William A. Crow of investment bank Raymond James & Associates said in an Oct. 30 note to clients.

Given uncertainty over the economy, prospective tenants have been slow to sign new leases, Sweeney has said, and in September he announced the company wouldn’t begin construction on its next Schuylkill Yards building — its 775,000-square-foot mixed-use East Tower — until at least 50% of the space is pre-leased.

How the 67-year-old Sweeney navigates these challenges — what he called “a blend of danger and opportunity” — will have implications that go beyond his company’s shareholders, as Brandywine remains a major developer in the city and suburban municipalities such as Radnor and Plymouth Meeting.

Brandywine owns 74 properties, the vast majority of which are offices, totaling about 13.2 million rentable square feet. More than half of them are in Philadelphia and its suburbs. The company is also active in Austin, Texas, and the Washington, D.C., area.

Its biggest tenants include IBM, gene therapy company Spark Therapeutics, Comcast, and chemical manufacturer FMC.

Even as commercial real estate faces economic headwinds in the aftermath of the pandemic, Brandywine has benefited from what industry insiders refer to as the “flight to quality.”

In the new era of hybrid work, many companies are downsizing and seeking out the highest-quality amenities in a bid to attract and retain talent. That’s been welcome news for Brandywine, which owns the most so-called trophy buildings in the city.

“What we’ve seen over the last 18 to 24 months emerge is a real flight to quality and a real division among office assets of haves and have-nots,” said Lauren Gilchrist, executive vice president at commercial real estate services firm Newmark. For owners of top assets, like Brandywine, “the story is overwhelmingly positive.”

In the most recent quarter, Sweeney said, tours of the company’s real estate by prospective tenants were up 29% over the previous three-month period and exceeded pre-pandemic levels. And among its wholly owned properties, 53% of all newly signed leases “is the result of this flight-to-quality thesis,” he said.

Tenants aren’t just seeking the best amenities — they want to make sure their landlords will have the resources to pay for improvements, according to Sweeney and independent analysts.

With at least three Center City office towers in financial distress, “the landscape of viable options for tenants may shrink,” analysts for Jones Lang LaSalle wrote in a recent report.

For example, advertising agency LevLane moved its headquarters to Brandywine’s One Logan Square in October after leaving the Wanamaker building, which was placed in receivership in September, Philadelphia Business Journal reported.

Tax breaks help attract tenants, too. The Schuylkill Yards development is located within state and federal Opportunity Zones, offering incentives to businesses.

But even Brandywine has seen weaker leasing. The company commenced or renewed leases totaling 175,000 square feet in the most recent quarter, down 40% compared to its 12-month average, according to Bank of America. That “will add pressure to earnings and [the] company’s overall leverage,” Bank of America analysts wrote in an Oct. 30 report.

While Brandywine maintains that its topflight buildings can withstand the pressures inflicting pain on the broader office market, the company says it’s also positioning itself to be a leader in another sector in which working from home isn’t really an option: life sciences. That sector’s vacancy rate in the Philadelphia market was just 4% as of September, according to commercial real estate services firm Cushman & Wakefield.

Brandywine began that pivot before the pandemic, starting with its 2016 partnership with Drexel on Schuylkill Yards.

Since then it has redeveloped a 283,000-square-foot building once occupied by the former Bulletin newspaper across from 30th Street Station and revamped a nearby building for lab space. Those buildings are now home to Spark Therapeutics, a gene therapy company founded by researchers at the Children’s Hospital of Philadelphia and later acquired by Swiss pharmaceutical giant Roche for $4.3 billion.

Brandywine sees the sector as a growth opportunity. Venture capital funding in Philadelphia-based early-stage life science companies increased fivefold from 2018 to 2022, according to Brandywine, and over that time period the Philly market was the top recipient of National Institutes of Health funding — $317 million — for cell and gene therapies.

“The aggregation of talent and companies in place — whether it’s University City, or at the Navy Yard, is … a powerful magnet,” Alan Greenberger, vice president for real estate and facilities at Drexel, said during a conference hosted by Saul Ewing last month.

The sector currently makes up just 3% of Brandywine’s portfolio, but the company aims to increase that share to 23% of its square footage on land it already owns or controls, “as market conditions allow,” Sweeney said on the most recent earnings call.

It’s against that backdrop that Brandywine is nearing completion of a life sciences building at 3151 Market St. — the one Sweeney and local officials celebrated last month. Sweeney said the company has exchanged “a number of proposals” with prospective tenants.

Broadly, Sweeney has said potential tenants have expressed concerns about the direction of the economy, rather than Brandywine itself.

There’s been other progress, though. Brandywine last year launched a 50,000-square-foot life sciences incubator with the nonprofit Pennsylvania Biotechnology Center at Cira Centre, a tower it built in the 2000s adjacent to 30th Street Station. Tenants include an immuno-oncology company focused on cancer care and a biopharmaceutical company developing antibody-based therapies for pets.

Brandywine is now also converting another Cira Centre floor from office to graduate lab space. The hope is that as start-ups grow, they’ll eventually move into Brandywine’s Schuylkill Yards buildings, Sweeney said.

The life sciences space is facing its own challenges, though. U.S. venture capital funding in the sector dropped 26% in the past year, according to Cushman & Wakefield, as the Fed’s interest rate hikes have discouraged investment in risky start-ups. That’s also reduced demand for office space, though analysts said they expect that to rebound along with increased funding in the coming months.

At least for now, investors still associate Brandywine with the beleaguered office market.

The company reported funds from operations — a measure of profitability — of $50.6 million in the third quarter, beating Wall Street expectations.

But Brandywine cut its quarterly dividend, from 19 cents to 15 cents a share, for the first time since 2009 and only the second time in the company’s history, according to analyst Michael Lewis of Truist Securities. REITs are not managed to maximize annual profits but rather to distribute cash to shareholders as dividends and leave little in annual profits to be taxed.

Brandywine said the cut was necessary because of “the ongoing volatility” in financial markets.

During Brandywine’s Oct. 25 earnings call, Lewis asked Sweeney if the worst is still ahead. Lewis pointed to the stock’s decline: “The market’s not really buying this.”

In the interview with The Inquirer, Sweeney acknowledged “turbulent times” in commercial real estate and said the company wanted to cover its “danger points.” He added the company has plenty of cash and available credit, and noted that compared to its peers, Brandywine has substantially fewer expiring leases over the next few years.

“Investors want a risk-adjusted rate of return. Today, it’s hard to quantify the risk in the short term,” Sweeney said. “… That’s why you see such volatility in the stock market. Nobody’s really sure … where rates settle in. No one’s sure where inflation goes.”

“We’re very focused on obviously continuing to deliver value to our shareholders and stakeholders, making the right real estate decisions to ensure that proposition, and then waiting for the market to recover.”

Staff writer Joseph N. DiStefano contributed to this article.