Faced with new rounds of corporate consolidation, Philadelphia's center city is struggling to maintain the modest momentum it has gathered since the market hit bottom a year and a half ago. But most of the suburbs, particularly the western submarkets where vacancies have dipped into the single-digits, are tight, driven by burgeoning health care and biotech industries.
Following major infrastructure investments like center city's $200 million convention center and the retention of pharmaceutical, health care and computer firms, the long-term view for the historically rich Philadelphia metro area is positive. This year employment in the metro area, which is the fifth largest in the United States with 5.2 million people, is expected to rise a modest 1.3% by year-end, according to the Pennsylvania Department of Labor and Industry. By 2005, employment is projected to jump 24%.
"The market has improved significantly," says Walter D'Alessio, president and CEO of Legg Mason Real Estate Services, a Philadelphia-based commercial mortgage banking firm. "We had a little false start last year, but the market is gaining ground again. Certain parts of the metro area are pretty robust."
The suburban markets, particularly Bala Cynwyd, Conshohocken and King of Prussia, are among the stalwarts. Industry sources say there are dozens of tenants with requirements of 100,000 sq. ft. or more looking in the suburbs, and most of these are firms that are expanding.
"Growth in the suburbs is fueled internally and it's (net) growth," says Carol Chiodo, vice president of portfolio management at Philadelphia-based Bell Atlantic Properties, which owns or manages 5 million sq. ft. in the metro area, including 3 million sq. ft. of office space in the Philadelphia suburbs. "Not all of these firms will make, but they are looking at alternatives."
The Prudential Realty Group, Newark, N.J., another owner of a major suburban office park in Bala Cynwyd, reports a strong first half of 1995. Occupancy at its 1.1 million sq. ft., threebuilding park increased to 90%, with 71,000 sq. ft. leased in the first six months of the year.
According to Jackson-Cross [center dot] ONCOR International, ONCOR International, a Philadelphiabased full-service firm, leasing in the four-county suburban market (consisting of Bucks, Montgomery, Chester and Delaware counties) totaled 1.15 million sq. ft. in the first six months of the year. Net absorption was 320,000 sq. ft., which pushed the average suburban vacancy down slightly to 16%. About 9%, or 320,000 sq. ft., of the vacant inventory is sublease space.
Dick Jones, president and CEO of Jackson-Cross [center dot] ONCOR, expects another 1.5 million sq. ft. to be leased in the second half, which would bring the vacancy rate down to 14% by year-end. In this case, he anticipates net absorption to be slightly ahead of last year.
"Suburban Class-A space is leased up, and, as we go through this cycle with no new (construction) in the pipeline, tenants will see fewer options," he says.
"There's been significant absorption and no new development in the western suburbs, which has fueled speculation that we'll see a new building or two in the next year," says Paul Garvey, regional vice president of the Philadelphia office of The Galbreath Co.
"I hear people talking about new development, but I think we're getting ahead of ourselves," adds Bell Atlantic's Chiodo. "Rental increases haven't outpaced increases in operating expenses. I don't think the rates are there to justify development even in the best markets -- but stranger things have happened."
There are some build-to-suits under construction. An 80,000 sq. ft. build-to-suit project is under construction here for ASTM (the American Society of Testing Materials), which will move from center city Philadelphia.
There's quite a discrepancy between the individual suburban markets, with Bala Cynwyd considered the tightest. Robert W. Walters, executive vice president of CB Commercial Real Estate Group, reports a 5.93% vacancy rate in this near western submarket that consists of about 3 million sq. ft. Conversely, across the Delaware River in Southern New Jersey, vacancies are about 21%.
Among the major suburban requirements is U.S. Healthcare's search for a 100-acre to 200-acre office campus. The firm is currently located in Montgomery County. Another firm reportedly in the market is Armour, a subsidiary of Rhone-Poulenc Rorer, which is relocating from Chicago.
In addition, Cephalon, a biotech firm based in suburban Philadelphia, recently received approval from the U.S. Food and Drug Administration for one of its products. The firm has made public its desire to build a 1 million sq. ft. corporate campus.
"The firm could be an (biotech) anchor for the area the way Amgen is in Southern California," says Greg Byrnes, director of economic development for Philadelphia Electric Co. (PECO) and chapter president of NACORE.
Center city lags suburbs
The corporate consolidation that rocked the industry four years ago continues to affect the center city market, dulling an already-deliberate recovery.
"We've seen the worst of (the consolidation), but we haven't seen the last of it," says Michael Antonoplos, executive vice president of Philadelphia-based Binswanger Commercial. "I don't anticipate the onslaught of sublease space we had two or three years ago, but there will be enough to keep things in check and prevent the cycle from going full circle."
The office vacancy in downtown dropped slightly to about 14.5% at midyear, Jackson-Cross [center dot] ONCOR says. Leasing through June totaled about 800,000 sq. ft., while absorption totaled 237,000 sq. ft.
"The sublease market was a great contributor to holding rents down, but it is a problem that's greatly diminished," Jones says. The inventory of sublet space is down to about 280,000 sq. ft. from 750,000 to 850,000 sq. ft. Six months ago, Jones says he was trying to place Hunt Manufacturing in about 50,000 sq. ft. Unfortunately, he was competing against IBM, which was offering the prospect sublet space at a significant discount from the market rate. Hunt eventually signed with IBM at 11 Penn Center for about $14 per sq. ft. -- compared to a market rate of $22.
Brokers say rents are stable in center city, with asking rents for Class-A space in the $23 to $24 per sq. ft. range.
"Everytime you think absorption has started to pick up, there's another announcement of consolidation," says Joseph F. Coradino, president of Rubin Strouse Realty, a division of The Rubin Organization Inc., Philadelphia. "It's difficult to recover when these decisions continue to happen."
"Leasing activity [downtown] has improved, but there's been a continuation of corporate downsizing and bank mergers that will provide significant sublease opportunities," says David Mackey, vice president of the Philadelphia office of Premisys Real Estate Services.
Premisys leases and manages two buildings in center city, one for The Prudential Realty Group and one for its pension fund advisory group, Prudential Real Estate Investors. Its center city buildings include the 841,000 sq. ft. 1700 Market Street, which recently signed a 65,000 sq. ft. lease with a growing user group -- health care. Mercy Health Plan, a managed health care provider, moved some of its staff from a suburban location to downtown to take advantage of the relative soft conditions and locate closer to a larger labor pool, Mackey says.
Philadelphia is the second-largest health care market in the country. Pharmaceutical and biotech firms along routes 202 and 422 employ about 50,000 people. Pharmaceutical giants like Merck Sharp and Dohme, SmithKline Beecham, Johnson & Johnson and McNeil are located in the area. In addition, more than 200 high-tech companies also dot the metro area.
"Rents are slightly more favorable for landlords now, but there won't be any significant improvement until the beginning or middle of 1996," Antonoplos adds. "I thought the market was going to turn sooner.
"Philadelphia is not considered a dynamic city, but it's a stable market with a good infrastructure," he adds, saying that rents could spike in the next 12 months.
Power centers flex muscles
Big box retailers have targeted the Philadelphia area, fueling an aggressive power center development campaign. Last year, The Rubin Organization finished Pier 70 Plaza, a 40-acre power center on a former industrial port along the Delaware River near center city. Home Depot opened last summer in the 400,000 sq. ft., followed by Wal-Mart late last year. Wal-Mart also plans to build a Sam's Warehouse Club at the site, but construction is not yet under way.
"The market is not overstored in terms of power centers," says Rubin's development director Douglas S. Grayson, adding that K mart and the northeastern discount chain of Caldors also are in the area. "There are retail opportunities for new concepts and for chains that don't have a presence in Philadelphia."
Rubin reportedly has plans to develop 3 million sq. ft. of power center space in the metro area over the next three years.
Other big box retailers looking at the market for the first time or expanding include Target and Best Buy Co.
"The power center market is expanding," says Pat Berns, senior vice president and director of retail leasing at The Rubin Organization. "If (retailers) can't get into a market with a certain number of stores to achieve an economy of scale, they will go somewhere else."
Home Depot, for instance, plans on opening 10 stores in the near term.
Perhaps the biggest retailin the area is the $125 million redevelopment and expansion of The Court and The Plaza at King of Prussia in this western suburb. Philadelphia-based Kravco Co. will add three new anchors, including the first stores in metro Philadelphia for Nordstrom and Neiman Marcus. Lord & Taylor is the other anchor and will open in November. The other anchors will open next year.
The project will also add 100 specialty stores. When completed, it will include 2.8 million sq. ft. and nine department stores (in addition to the three mentioned above, Sears, JCPenney, John Wanamaker, Blooming-dale's, Macy's and Strawbridge & Clothier will be anchors) and 450 specialty stores, according to Joseph C. Esposito, vice president of development for Kravco.
Hotel development to surge
"Philadelphia has been the sleepiest hotel market in the country for over a decade," says Michael French, principal in charge of hospitality and gaming in the Philadelphia office of Coopers & Lybrand, adding that the city may be victimized by its own accessibility, with many New York and Washington, D.C., business travelers opting for day trips vs. overnight stays. But, with a rising stock of hotel rooms, the city can appeal to a broad range of business and convention travelers.
The city's 13-month-old Pennsylvania Convention Center has revitalized the hotel industry, and Marriott Corp. is the first of the major chains to capitalize on the renewal. Adjacent to the $200 million, 435,000 sq. ft. convention center, the Washington, D.C.-based hotel firm opened a 1,200-room convention hotel in January. Through June, occupancy in the hotel was running at 65%, says John Fenton, the hotel's communications director, with rooms priced at $169.
"We projected a high (occupancy) of 67% and a low of 64%," Fenton says. "We're excited about the numbers."
French predicts an occupancy rate in the mid-70% range beginning next year.
"When a market operates in the mid-70% range, it's close to capacity," French explains, adding that another 1,000 rooms will likely be added to the supply in the next two to four years. "Occupancy is reaching a high, advance bookings are strong and the lending environment is possibly more responsive to hotel development."
Including the new Marriott, the city's hotel stock is thin compared to other Northeastern cities. With just 6,700 rooms, Philadelphia has less than half the number of rooms in New York and Washington, D.C., and about 75% of the inventory in Boston, according to Hendersonville, Tenn.-based Smith Travel Research.
There are at least four new hotels proposed for center city. They include a Hyatt at Penn's Landing, the renovation of the 1920's PSFS building into 600 rooms across from the convention center, the redevelopment of a building into a 400-room Westin two blocks from the convention center and a 400-room hotel on Cityline Avenue.
Marriott is also looking at the suburban market. It expects to complete a 419-room full-service hotel in November that will be connected to Terminal B at the Philadelphia International Airport.