Much is going right in the city of brotherly love, and the future is looking even better

Commercial real estate activity is picking up in this East Coast metro area of 6 million located near the halfway point between Washington, D.C., and New York.

"Philadelphia has always been an underrated market," says Arthur Fefferman, president of New York-based AFC Realty Capital. Historically an industrial-based market that has often been overlooked by investors, it has made the transition to a service economy during the past 10 years, he says. "Philadelphia in particular, and the Delaware Valley in general, fared moderately well during the recession."

Suburban office market perspectives

According to a report from the Philadelphia office of San Francisco-based Grubb & Ellis, vacancy is declining in all major subsectors of the city's office market. As of June 1996, vacancy in the suburban market stood at 12.9%, the report notes, the result of 211,577 sq. ft. of absorption during the first two quarters of the year. The Southern New Jersey sector of the market was 19% vacant, absorbing 141,133 sq. ft. Meanwhile, the CBD/center city office market had 15.5%, or just under 6 million sq. ft., of its inventory vacant, absorbing 340,000 sq. ft. of space from January through June 1996.

Industry players are very optimistic about the area's suburban office market. "The suburbs, especially to the west and north, have clearly exhibited a surprising level of recovery over the past two years," says James Still, president and CEO of Philadelphia-based Bell Atlantic Properties. With strong demand generated by healthcare, pharmaceutical and financial services firms, "There are very few large blocks of space available out there," he says.

The suburban office market has improved dramatically, says Dick Jones, president and CEO of Philadelphia-based Jackson-Cross * ONCOR International. "We are seeing single-digit vacancy rates in many suburban submarkets, along with higher rents." There is no speculative construction under way yet, says Jones, "but I am sure there is going to be some soon."

Rental rates for high-quality suburban space are significantly higher than those for comparable space in center city Philadelphia, says Walter D'Alessio, president of Philadelphia-based Legg Mason Real Estate Services. "Vacancy rates are quite low, there is no free rent and no concessions for tenant improvements, which means we have a fairly nice market going," he says. From the investment perspective, D'Alessio sees "some portfolio and individual office property trading."

Center city outlook

The dynamic is a bit different for the center city office market. In contrast to the suburbs, "the Philadelphia CBD is a tenant's market," says John Gaghan, executive vice president of Philadelphia-based Corporate National Realty. "There is space to be had for direct lease and still a lot of sublet space on the market."

"Downtown continues to be in a tough spot," says Still. There has been very little true job growth in center city Philadelphia, he notes, a situation exacerbated by a tax on wages earned by workers within the city that approaches 5%.

"Having said that," Still continues, "one of the encouraging signs we're seeing is that a number of center city buildings have been changing hands lately." The new owners "are coming in at a much lower basis than the old ones, which will enable them to be more flexible when it comes to bringing in new office space users and retaining existing ones."

Kevin Donohoe, president, of Philadelphia-based Kevin F. Donohoe Co. Inc., is optimistic in his outlook for this market. From the leasing standpoint, "high rents in suburbs are making tenants realize what a bargain the CBD actually is," he says. "The city has stabilized its finances, cleaned itself up and polished its image," particularly with the completion of the $200 million Pennsylvania Convention Center, he says.

Hospitality market strong

The center city may have more than its share of vacant office space, but empty hotel rooms are not commonplace. "The hospitality market is doing very well," says Peter Tyson, president of Horwath Hospitality Consultants, Philadelphia. "It's amazing what a brand new convention center and a 1,200-room convention hotel will do for a center city."

Prior to the opening of the Pennsylvania Convention Center in June 1993, average hotel occupancy had dropped as low as 59% in 1991, Tyson says. Spurred by the opening of the convention center and the subsequent opening of an adjacent Marriott convention hotel, occupancy has steadily improved, "and should finish 1996 at over 70%."

The hotel market is also strong in the Philadelphia International Airport area, which has recently added a 400-room Marriott to its inventory, says Tyson. Despite the health of the Philadelphia hotel market as a whole, however, "there are virtually no properties under construction now, save for a few limited-service/economy properties," he says.

Apartment market highlights

Apartment rents are rising to the tune of 2% to 3% annually, while occupancy in most major metro submarkets is in the 94% to 96% range, according to Joe Sweeny, vice president of Reilly Mortgage, speaking from the firm's Philadelphia office. "Monthly rents for a quality two-bedroom apartment run anywhere from $650 to $900, with not much available in the way of concessions."

A recent study of Philadelphia's suburban apartment market (Bucks, Chester and Montgomery counties) by Grubb & Ellis shows monthly rental rates for a two-bedroom apartment ranging from around $650 to $760 as of the end of first quarter 1996. The report notes that of the 17,051 units surveyed in complexes with 50 units or more, only 2.1% were vacant.

Even though rents and occupancies are rising, significant new apartment construction is unlikely in the Philadelphia market anytime soon, says Sweeny. "New construction will be limited due to the controlling factors of land availability, costs and achievable rents," he says.

The apartment investment market is slow, says Sweeny. "Sales have been flat for the past couple of years, with more potential buyers in the market than there are sellers."

Retail review

Philadelphia "is a very under-chain-stored area compared to other major markets," says Andrew Baker, executive vice president of Corporate National Realty, Philadelphia. Penetrating this market can be a difficult undertaking for a retailer, he says. "This is a very expensive advertising market," says Baker, adding that the area has cumbersome zoning/re-zoning procedures in the myriad municipalities that make up the region.

Still, there's lot of retail activity going on in the metro market, says Baker. "It's a chain-store world here; anyone who is a regional or national player seems to be grabbing for market share with new locations." Big-box retail development has been the hottest sector of the market for the past five years, "with perhaps another three to five years left in that cycle," Baker says.

Discount chains are actively adding new stores, according to Baker. And, in the grocery-store arena, some national chains are opening new locations, "but it's really a regional play," says Baker.

Largely as a result of chain-store activity, facility and site prices are high in this marketplace. Site prices in good locations average around $7 to $12 per sq. ft. Meanwhile, strip-center rental rates for small-shop space in prime locations have gotten as high as $35 per sq. ft., he says, although they are typically running in the $16 to $22 range.

Power center development continues at a brisk pace in this market, says Pat Berns, senior vice president and director of retail leasing at the Rubin Organization.

Industrial notes

Sales and leasing activity is picking up, space is getting harder to find and construction is on the rise in the Philadelphia-area industrial market which, according to Grubb & Ellis, totals about 121.6 million sq. ft. "It's getting difficult to find space," says Jon Gelman, principal of Philadelphia-based Gelcor Realty Inc.

Three segments of the marketplace account for the increased activity, says Gelman. On the sales side, "institutions and REITs are still buying product," at prices for quality bulk space that run in the $33 to $42 per sq. ft. range, he says. On the leasing side, a growing base of small, entrepreneurial users has taken the place of major manufacturers when it comes to taking space in the market, says Gelman, with deals in the 10,000 to 30,000 sq. ft. range especially in evidence. Public warehousers comprise another active segment of the marketplace, says Gelman, resulting in the construction of several large facilities in the area.

With rents healthy and vacancy running as low as 4% to 6% in some areas, construction is occurring in this industrial market, says Gelman. REITs are active in both speculative and build-to-suit projects, he says, with the product of choice being bulk warehouse.