A year ago, corporate mergers and downsizings threatened to flood Philadelphia's office market with 1.8 million sq. ft. of unused space. Despite those uncertain times, industry leaders remained optimistic. Now, with an active office leasing market pushing vacancy rates downward and rents upward - and with an improving investment market - their optimism has been rewarded.

Within this active office market there is a shortage of Class-A facilities. Center City rents are not high enough to justify new construction of Class-A buildings, but surrounding South Jersey communities are developing new office complexes, retail centers and industrial construction. Strong office sales, high occupancy rates, less available space returned to the market and conversion of older office buildings to hotel or residential use have helped improve the market.

Economy drives office leasing William G. Luff Jr., senior managing director and Philadelphia branch manager of New York-based Cushman & Wakefield, reports a vastly improved, multifaceted local economy. Statistics provided by Luff for the first half of this year show an 11% vacancy rate for the CBD's 38.1 million sq. ft. office market, leasing activity of 1.4 million sq. ft. and net absorption of nearly a quarter-million sq. ft. of space. According to Cushman & Wakefield, the nine-sector suburban office market west of the Delaware River has an inventory of 42.8 million sq. ft. and a 90% occupancy rate. East of the Delaware, South Jersey's Camden and Burlington counties have a 10.5 million sq. ft. inventory, which has an 88.1% occupancy rate.While there is no speculative office construction in downtown Philadelphia or South Jersey, more than 1.7 million sq. ft. of new buildings are under construction in the western suburbs.

The Rubenstein Co., Philadelphia, controls a portfolio of nearly 5 million sq. ft. of prime space in a half-dozen downtown office buildings, including 600,000 sq. ft. Class-A office tower One Logan Square. Rubenstein's newest tenant, Drinker Biddle & Reath law firm, took 165,000 sq. ft. at One Logan Square, making the occupancy of Rubenstein buildings nearly 100%. Peter A. Talman, head of Rubenstein's brokerage unit, reports that part of the drop in office vacancies is a result of older buildings being converted to other uses, forcing tenants into the Class-A market.

Walter D'Alessio, president and CEO of Philadelphia-based Legg Mason Real Estate Services, is also encouraged by the Philadelphia real estate market. D'Alessio attributes the healthy market to brisk office leasing and concurs with Talman on alternative-use building.

Recently, Legg Mason's Corporate Services and Equity Group handled the $165 million sale-leaseback of the 810,000 sq. ft. Independence Blue Cross headquarters building located at 1901 Market St. - one of the largest downtown office market transactions.

Newtown Square, Pa.-based Brandywine Realty Trust went on an acquisition drive last year, expanding its portfolio by more than 50 office buildings and 27 industrial properties totaling nearly 7 million sq. ft. Earlier this year, Brandywine sold the bulk of its industrial portfolio, 17 properties totaling 1.95 million sq. ft. in Pennsylvania, New Jersey and Maryland.

Retail waits in the wings The office sector's success has clearly spilled over into the retail market. According to Jonathan Weller, president of Fort Washington, Pa.-based Pennsylvania Real Estate Investment Trust (PREIT), its five-project retail development schedule of more than 2 million sq. ft. has helped to fuel this success. Metroplex, a 780,000 sq. ft. shopping center in Plymouth Meeting, Pa., is one of the largest centers under construction, and will have anchors Target, Lowe's and Giant Eagle.

PREIT is developing Metroplex as a joint venture with The Goldenberg Group Inc., Blue Bell, Pa., also PREIT's partner in The Pavilion at Market East, a $175 million, 500,000 sq. ft. retail and entertainment complex. DisneyQuest, a five-story, 80,000 sq. ft. interactive theme park, has signed as an anchor.

Also competing for retail tenants is Penn's Landing, a center being developed on the Delaware riverfront by Indianapolis-based Simon Property Group. The center is scheduled for completion next summer and will feature an interactive museum, 24-screen theater, 500,000 sq. ft. of shops and restaurants, and a 350-room Hyatt Regency hotel.

Apartments from office space Some of Philadelphia's obsolete office space has been converted into student housing. The Flynn Co., Philadelphia, has developed a quarter-million sq. ft. of obsolete downtown office space, reports Kevin D. Flynn, principal. The Flynn Co., with co-broker Philadelphia-based Colliers ABR, negotiated the 10-year lease to the Art Institute of Philadelphia for 16 of 17 floors of 1346 Chestnut St., a 256,000 sq. ft. former office building. The Art Institute will house 688 students there, with retail on the ground level.

Center City is getting its first luxury high-rise rental apartments in more than a decade. Boston Financial will develop St. James Court, a 300-apartment residential and retail complex.

According to a report by the Center City District and Central Philadelphia Development Corp., downtown Philadelphia's apartment market is the strongest in years.

Hotel development exceeds goal Mayor Edward G. Rendell's goal of adding some 3,000 rooms to total 10,000 hotel rooms in the city before the GOP National Convention is being exceeded. Twelve projects totaling more than 3,700 rooms are in the pipeline.

The Economic and Business Development Department of PECO Energy, the region's largest electric utility, reports that the booming hotel activity has been promoted by the prospects of aid from the city. The Philadelphia Industrial Development Corp. operates a low-interest federal loan program with $100 million available to finance hotel construction.

The 279-room Hilton Garden Inn, the most unusual new project, rises four stories above an existing six-story garage adjacent to the Reading Terminal Market. Philadelphia-based Switzenbaum Realty Capital and New York-based Pace Management Service Corp. are co-developers. The hotel is unique because it is being built on air rights leased from Philadelphia's Redevelopment Authority, which owns the land leased to and occupied by the privately owned and operated garage. The garage's exterior will be integrated into the hotel's facade.

Industrial behind but improving Although the industrial market is not doing as well as the office and hotel markets, it continues to improve. The former Philadelphia Naval Shipyard, comprising more than 1,200 acres midway between Central City and Philadelphia International Airport, provides significant industrial development potential. The U.S. Navy transferred control of the property to the city for $2 million.

Kvaerner ASA of Norway, the largest shipbuilding company in Europe, will lease 115 acres for a shipbuilding operation. Another component of this complex may be marketed as a gated, mixed-use business and light industrial complex.

Luff reports there is no industrial development in Philadelphia, but there is 465,000 sq. ft. of it in the suburbs and nearly 1.2 million sq. ft. in nearby South Jersey.

Philadelphia and its real estate investment market are riding on the coattails of a robust national economy, but there is room for improvement. While rising interest rates may slow forward momentum, most indications point to the city showing continuing gains in the months ahead and into the new millennium.