Wells Fargo’s former Market Street office building is crippled. Can it survive and adapt?
On paper, 401 Market St. looked rock-solid just over a month ago.
The 484,643-square-foot office building was fully leased with a big-name anchor tenant. Revenue was the best it had ever been, and cash flow was strong. Ownership was up to date on its mortgage, which was still more than a year away from maturity.
Then October arrived and everything changed.
Wells Fargo’s lease on 349,770 square feetexpired, sending 401 Market’s occupancy rate plummeting from 100% to 28% and forcing the $52.4 million loan on the property into special servicing.
Now saddled with eight floors of vacant office space, what comes next is a major question for the building’s owner.
How it started
West Conshohocken-based Miller Investment Management bought 401 Market St. for $78.5 million in 2015, according to property records.
Bank of New York originated a $56 million loan on the property to Miller in September of that year, with the note subsequently securitized and sold off to investors in a commercial mortgage-backed securities (CMBS) trust, according to CMBS reports. The loan was underwritten assuming 100% occupancy.
The 11-story building, constructed in 1973, is in a traditionally desirable Old City location on Market Street between 4th and 5th streets, next to Independence Mall and the Independence Hall subway stop on SEPTA’s Market-Frankford Line. The building was renovated in 2015, CMBS reports show.
Wells Fargo had anchored 401 Market since it acquired Wachovia in 2008, taking over the bank’s lease and having the Wells name emblazoned on the facade. The remainder of the building is occupied by the American Bible Society, which has a lease on 134,873 square feet until 2041. The American Bible Society has its offices on the eighth and ninth floors of the building, and in 2021 opened the Faith and Liberty Discovery Center museum in ground-floor space on the corner of 5th and Market streets.
The building’s leasing revenue has increased every year since 2016 except one, dipping only slightly coming out of the pandemic in 2022, according to CMBS reports. Revenue from the building totaled $9.1 million in 2023 while expenses were less than $3.8 million, the reports show. The property’s net cash flow of $4.9 million last year was more than enough to cover Miller’s $3.5 million in debt service payments on the loan. Through the first six months of this year, with Wells Fargo still paying rent, revenue was on pace to top $9.2 million.
How it’s going
The office building at 401 Market St. formerly had prominent signage for Wells Fargo, the property’s largest tenant before its lease expired at the end of September.
Wells Fargo informed Miller last year that it would not renew its lease, citing the need for less space given the growth of hybrid work during the pandemic. Even with the bank’s departure still a year away, the CMBS loan on the property was placed on a watch list because of concerns that Miller would be unable to make payments in the long-term. In March, the American Bible Society permanently closed its first-floor Faith and Liberty Discovery Center, though its lease on the museum space remains in effect. The Museum of Illusions also occupies a 5,000-square-foot retail space on the first floor.
Wells Fargo vacated its space at 401 Market in phases over the last year.
The building’s June rent roll showed Wells Fargo accounted for 27.8% of the building’s effective gross income, according to a CMBS report. Based on last year’s $9.1 million of revenue, Wells Fargo’s departure would cost Miller about $2.5 million per year and lower the building’s net cash flow below the $3.5 million of debt service paid on the CMBS loan in each of the last three years.
David Putro, senior vice president for credit rating analysis agency Morningstar Credit, said 401 Market St. is in a “precarious spot.”
Following the expiration of Wells Fargo’s lease, the loan was transferred to special servicer Rialto Capital last month. CMBS reports cite imminent monetary default with the loan set to mature in October 2025.
“My guess on this one is that it’s going to have to get some sort of workout,” Putro said. “I just don’t see it servicing its debt payments or being able to [refinance] at maturity at [28]% occupancy.”
Stockton Real Estate Advisors is marketing the Wells Fargo space for lease.
What’s next?
The building is at the center of Philadelphia’s evolving post-pandemic office market. The city ranked first in the country in distressed office space at the end of the second quarter, according to a report from bond rating agency KBRA.
Across the street from 401 Market, 400 Market St. is being converted into 176 apartments and the Bourse building is being converted into wedding and event space and a 152-room hotel. To the east, the office building at 399 Market St. sold at a steep discount earlier this year and is now being leased at competitive rates.
With change swirling around the building and $52.4 million still owed on its loan, according to CMBS reports, 401 Market St. faces an uncertain future.
Miller’s next steps could indicate where the city’s office market stands. The firm referred questions about the building to Stockton Real Estate Advisors’ Jim Paterno, who is handling leasing efforts for the vacant Wells Fargo space.
Paterno said he’s heard from multifamily developers interested in converting part or all of 401 Market into residential units. The Wells Fargo space could be filled by a combination of tenants, rather than just one, he said.
Backfilling almost 350,000 square feet of office space at a 51-year-old building in the Market East submarket is a challenge. The available space also presents an opportunity for Miller to reinvent the building.
Miller has tasked Paterno with focusing on luring tenants interested in at least several floors. The biggest challenge, Paterno said, is office leases of more than 200,000 square feet are rarely signed in Philadelphia. The most common office leases are 10,000 square feet or less in the age of hybrid and remote work policies.
“We have been spending a lot of time thinking about how to take this building, which has pretty much been a very quiet and benign presence, and to respond to the changing work environment and to reintroduce it for the future of work,” Paterno said.
Office space in the Market East submarket was 21% vacant in the second quarter, according to JLL. The submarket had a negative net absorption of 126,761 square feet in the first half of the year, meaning more office space in Market East became vacant than became occupied. That trend is occurring as office tenants gravitate toward the Philadelphia’s newer, higher-quality buildings, most of which are clustered west of City Hall.
Wells Fargo occupied floors 2 through 7 plus floors 10 and 11. That means a new tenant could lease just the top two floors. Miller can also offer signage atop the outside of the building if a tenant commits to at least four floors total, Paterno said. Paterno’s strategy is to pursue an anchor tenant along with smaller tenants. The ideal anchor tenant would take at least five of the eight available floors, he said. That amounts to more than 220,000 square feet because of the building’s 44,000-square-foot floor plates.
“We’ve had no shortage of interested parties that want a floor or two floors,” Paterno said. “The question is at what point do we decide to aggregate those smaller tenants and embark on a renovation and upgrade and do multiple deals versus seeing if there’s a bigger user that would take a larger chunk in one fell swoop.”
As Paterno and Miller look for future office tenants, they’re considering ways for the building to improve and respond to what prospective tenants want. That includes features like a high-end food and beverage operator on the ground floor, lounge areas, conference centers, indoor and outdoor event space, accommodations for neurodiverse populations, and LEED certifications for sustainability measures. Anything that could help draw office tenants.
“It’s a great, clean canvas to do that,” Paterno said.
Paterno said Miller isn’t focused on a possible sale of 401 Market because the ownership group prefers to own assets for generations. With a handful of distressed office buildings in the city recently selling for half of their assessed value, Morningstar’s Putro said the proceeds from a sale at this point might not cover the $52.4 million balance of Miller’s CMBS loan. The city’s most recent assessment of 401 Market St. put the building’s value at $43.1 million.
While rebuilding the tenant roster is “not impossible,” Putro said trends aren’t favorable for finding a company to take the bulk of the space vacated by Wells Fargo. “It certainly can happen,” Putro said. “Just looking at pure numbers, it looks like a challenging story.”
Original Article: https://www.bizjournals.com/philadelphia/news/2024/11/03/401-market-st-occupancy-wells-fargo-leasing.html