Downtown Philadelphia's renaissance offers a compelling argument that the region is primed for additional growth. Known as Center City, the central business district's population has grown 13% in the past decade and now stands at 83,000.

Center City's population growth has been matched by retail, with grocery stores, restaurants and bars leading the way. In 1992, there were 65 fine-dining options. Today, there are over 200. Existing urban retail locations are a hot commodity and are attracing big power center developers. Center City is an important chapter of the Philadelphia story, and so is the economy.

Saying that he is “more optimistic about the region's economy than ever,” chief economist Mark Zandi of Economy.com believes that “the right mix of industries has Philadelphia well-positioned for growth in the next decade,” particularly in the healthcare, education and financial services sectors.

Living costs are lower in Philadelphia than in Washington or New York, he says. A Philadelphian earning $69,000 would have to make $91,000 in D.C. and $145,000 in Manhattan to maintain the same standard of living. Still, with a large lower-income population, the city has some mountains to climb, says Zandi. Annual budget deficits are met by reduced city services, an under-funded transit system, and a tax structure that is unfavorable to business. However, employment growth is solid, Zandi says. The jobless rate is 4.4%, and the net growth for 2004 was 20,000 jobs. The region's businesses should add 40,000 workers in 2005. “Growth won't be high-flying,” Zandi predicts, “but it will be strong and steady.”

Downtown condo uprising

Center City is condo-crazy. Fixed mortgage rates under 6% are turning renters into owners, and downtown draws suburban empty nesters heavily armed with equity. What's more, tax abatements have encouraged more condo construction. Condo unit sales range from $300 to $400 per sq. ft., and luxury units in high-demand locations command up to $1,000 per sq. ft., says realtor Allan Domb.

The regional median price per unit is $54,000, up 2% from 2003. Between 2002 and 2003, the price ballooned 25%. Sales of Class-A product have hit a record $140,000 per unit. By comparison, Class-B product sells for $60,000 to $80,000.

Outside of Center City, multifamily construction has remained flat for four years, hamstrung by development limitations and modest job growth. Still, “multifamily remains one of the key investment vehicles in the suburbs,” says Jeff Algatt, regional manager of Marcus & Millichap. “Because there is little new supply owing to the difficulty of obtaining approvals, we've reached equilibrium.”

The region's vacancy rate has climbed only 130 basis points since 2000 to 3.8% today. Asking rents, which started at $750 per unit in 2001, will likely reach $930 this year. Meanwhile, concessions are 3% of asking rents and declining.

For 2005, 1,450 units are set for delivery, but most are targeted for downtown. Cap rates, which now range between 7.5% and 8.5%, have dropped steadily for three years, but could rise if higher interest rates drive capital to other places.

In the suburbs, the top multifamily sale in 2004 was Ceebraid-Signal's $89 million buyout of Transwestern Investment Co.'s interest in the Cedarbrook Hill apartment complex. After $20 million in upgrades, the complex will be expanded to 1,260 units from 996, and the name changed to Trilogy.

Big boxes sprout around downtown

Retailers are scrambling to meet the needs of urban dwellers, adding 2.7 million sq. ft. in the region in 2004 and planning to complete 2.5 million sq. ft. in 2005. Much of the new retail product is in neighborhoods adjacent to Center City. Big-box retailers are attracted to the large tracts of former industrial space.

One retail project that underscores the area's growing vitality is South Philly's Columbus Commons, which was developed by Goldenberg Group of Blue Bell. The $65 million, 648,026 sq. ft. project — anchored by Swedish furniture retailer Ikea and Lowe's — has set up shop in the revitalized Center City perimeter. On the city's northeast side, the Goldenberg Group also developed a $39 million, 434,800 sq. ft. retail center anchored by Wal-Mart and Lowe's.

“There has been renewed focus on the city,” says Steve Gartner, president of Metro Commercial Real Estate in Conshohocken, “especially areas of the city that look like the suburbs, as well as high-income, newer suburbs.

The largest new retail development to meet this need is Centerton Square, a $125 million, 732,000 sq. ft. project in the Philadelphia suburb of Mount Laurel, N.J., anchored by Target, Costco and grocer Wegman's.

Well-anchored retail is the most competitive investment segment. Sale prices for fully leased neighborhood centers average $165 per sq. ft., with power centers fetching $170 per sq. ft. The typical cap rate is 8%, but lower for highly sought after properties. Meanwhile, the region's retail vacancy rate remains steady at 8.8%, but only 5% in Center City.

Office vacancy rate grows

There is three times more office construction downtown than in the suburbs, but adding 2 million sq. ft. to a market with a chronically high vacancy rate will push that rate even higher, at least in the short term, says James Vessy, senior director of financial services at Cushman & Wakefield. Indeed, the downtown vacancy rate increased to 17.2% in 2004, up significantly from 13.9% in 2003.

Two buildings account for the 2 million sq. ft. of office space downtown due to come on line. The Comcast Center is a 1.2 million sq. ft., $465 million, 57-story office tower to be completed in 2007. The 727,725 sq. ft. Cira Center, a 28-story office tower, is due to open in October.

Cira Center, built by Brandywine Realty Trust, is 80% leased. Tenants include law firm Dechert LLP with 244,189 sq. ft. — vacating roughly the same space at the downtown Bell Atlantic Tower — and SCA North America with 101,606 sq. ft.

Although leases were signed in 2004 for 2.23 million sq. ft. by major corporations such as oil giant Sunoco and international consulting firm Towers Perrin, the negative absorption jumped to almost 1 million sq. ft. in 2004, up from 400,000 in 2003.

Average metro area Class-A rents overall dropped by less than $1, to $25.61 per sq. ft. and concessions in the city and suburb office markets remain high. Among the major acquisitions of 2004, Transwestern Investment of Chicago acquired the 1.5 million sq. ft. 1601/1700 Market Street for $172.2 million. Meanwhile, Brandywine took ownership of 1.3 million sq. ft. in One and Two Logan Square as part of its $600 million acquisition of Rubenstein Co.'s assets.

In the suburbs, Tishman Speyer acquired 1.1 million sq. ft. in One, Two and Three Bala Plaza in Bala Cynwyd at an undisclosed price as part of its $1.85 billion agreement with GIC Real Estate involving properties in eight cities.

Tourism boosts hotels

The Philadelphia CBD, which accounts for 27% of the region's 45,000 hotel rooms, enjoys a healthier occupancy rate and higher RevPar than the region as a whole. Smith Travel Research reports that RevPar in the fourth quarter of 2004 rose to $136.54 in the CBD, compared with $129.37 during the same period in 2003. The occupancy rate also spiked to 71.4% in the fourth quarter compared with 65.8% in the fourth quarter of 2003.

The turnaround in the downtown hotel market has been gaining steam for some time. Occupancy rates began falling after the 2000 Republican National Convention, for which 2,000 rooms were added, reaching a low of 59.9% in 2001. But occupancy has climbed steadily since then, thanks to increases in tourism and successful promotional campaigns.

The hope is that downtown's resurgence will spread to the rest of the metro area, which is more directly tied to the fortunes of the soft business-travel segment. Smith Travel reports that RevPar registered $92.09 in the fourth quarter of 2004 for the metro area vs. $88.14 a year earlier.

The occupancy rate is also cause for optimism, rising from 49.3% to 56.7% during the same period. To put those vital signs into perspective, Philadelphia's RevPar is far below New York's $230 and Boston's $111, but in line with New Orleans, Chicago, and Orlando. “We have a very good stock of quality hotel rooms at a sufficient number, but we still need to build a rate structure that is comparable with that of New York, Boston and Washington,” says Dave Arnold, executive vice president of PKF Consultants.

Two driving forces could potentially spur hotel construction. The first is the $632 million convention center expansion, due for completion in 2009. Given the long lead time required to book major conventions, however, it will be several years before the city's hotels experience the full benefit of the new convention complex. The other driving force is casino gambling. The state has also allotted the city two slot-betting parlor licenses. Caesar's Entertainment spent $64 million in January on waterfront industrial property for one of the casinos. When they are finished, the casinos are expected to give Atlantic City a run for its money.

Industrial treading water

Space users in need of more than 20,000 sq. ft. of new flex/industrial space are struggling to find available product. Ground costs are the problem, says Peter Greenhalgh, a Cushman & Wakefield broker. The price per acre — when land is available — runs about $160,000. The end result is that very little spec space is being built.

As the economy improves, the spec market is expected to improve as well, says Greenhalgh. The present market is dominated by build-to-suit projects. Meanwhile, older industrial buildings downtown are being converted to residential, helping to reduce the supply glut.

With interest rates still relatively low, there is pent-up demand from investors to buy product, but there is little for sale. “If you want 500,000 sq. ft. to 1 million sq. ft., you'll have to go out toward Harrisburg or the Lehigh Valley,” both about 100 miles from Center City.

The industrial vacancy rate in metro Philadelphia stands at 11.7%, compared with 11.4% in 2003, and has changed little since 2001. What has changed dramatically is net absorption. In 2003, it was a negative 1.17 million sq. ft. In 2004, it was a positive 2.55 million sq. ft., reversing a three-year trend.

Net rental rates are $5.18 per sq. ft., down 12 cents from 2003 and a penny less than they were in 2002. The average sale price is $51 per sq. ft. Industrial product with long-term credit leases in place trades at cap rates ranging between 7.5% and 8.5%. One of the largest projects due for completion in 2005 is DHL/Airborne's 215,000 sq. ft. warehouse near Philadelphia International Airport, consolidating operations scattered over eight buildings. The largest suburban leases in 2004 included Schwartz Paper in Bensalem for 386,560 sq. ft., and Colonial Electric in King of Prussia for 380,000 sq. ft.

Alan Heavens is a Philadelphia-based writer.

Philadelphia - BY THE NUMBERS

POPULATION OF METRO AREA:

6.7 million

UNEMPLOYMENT RATE:

4.4%
Source: Wachovia Bank

LARGEST EMPLOYERS:

  1. University of Pennsylvania
    22,000 employees

  2. Temple University
    11,000 employees

  3. E.I. Dupont de Nemours
    10,000 employees



Source: Greater Philadelphia Chamber of Commerce

METRO AREA STATS Office:

19.8% vacancy, 4Q 2004
19.7% vacancy, 4Q 2003

Rent per sq. ft.: $25.61 4Q 2004

Source: Cushman & Wakefield

Multifamily:

3.8% occupancy, 4Q 2004
3.8% occupancy, 4Q 2003

Rent per sq. ft.: $902 2004 avg.

Source: Marcus & Millichap

Retail:

8.8% vacancy, 4Q 2004
8.8% vacancy, 4Q 2003

Rent per sq. ft.: $18.10 4Q 2004

Source: Marcus & Millichap

Flex-Industrial:

11.4% vacancy, 4Q 2004
11.7% vacancy, 4Q 2003

Rent per sq. ft.: $5.18 4Q 2004

Source: Cushman & Wakefield

Hotel:

56.7% occupancy, 4Q 2004
49.3% occupancy, 4Q 2003

Average daily rate: $92.09 4Q 2004

Source: Smith Travel Research

MAJOR PROJECTS UNDER CONSTRUCTION:

Comcast Center

Type: Office tower

Height: 57-story

Sq. ft.: 1.2 million

Cost: $435 million

Completion: 2007

Developer: Liberty Property Trust

Cira Centre

Type: Office tower

Height: 28-story

Sq. ft.: 727,725

Cost: $177.6 million

Completion: 2005

Developer: Brandywine Realty Trust

Symphony House

Type: Luxury high-rise condo

Height: 31-story

Units: 163

Cost: $125 million

Completion: 2007

Developer: Dranoff Properties

(see related sidebar on page 38)

Philly developer Carl Dranoff capitalizes on condo market

Considering downtown's real estate momentum, veteran Philadelphia multifamily builder Carl E. Dranoff's latest project is truly a no-brainer. It's called Symphony House, a $125 million, 31-story, 163-unit luxury condo high-rise a few blocks south of City Hall on Broad Street. Next to it is the $265 million Kimmel Center for the Performing Arts, the three-year-old home of the Philadelphia Orchestra.

This segment of Broad Street, known as the Avenue of the Arts, represents a 10-year, multimillion-dollar effort to revitalize the thoroughfare as a 24/7 venue. Twenty-two months before its February 2007 completion, with not even an on-site sales office or a backhoe in the parking lot, the 642,000 sq. ft. Symphony House has pre-sold nearly 100 units, ranging from $458,000 to more than $1.4 million.

Ahead of the curve

“Carl is a guy with a sense of vision as it relates to urban development. He has the ability to understand where opportunities exist when others don't,” says Frank Grady, chairman of the Philadelphia Industrial Development Corp., which sold Dranoff the site in an effort to get the Avenue of the Arts moving down Broad Street. “He builds a high-quality product that's almost a brand level in the marketplace.”

Symphony House is just one of three projects Dranoff is tackling. He's set to convert an old RCA building on the Camden waterfront into a 10-story, 99-unit loft condo project with 8,000 sq. ft. of retail. The $22 million project is called Radio Lofts. The other project, Venice Lofts, in the city's Manayunk neighborhood, will involve the conversion of a 200,000 sq. ft. textile mill into 160 luxury lofts at a cost of $32 million.

The luxury condo market is hot, which is part of the reason lenders didn't require pre-sales. The other reason is Dranoff himself, who has a reputation as a “smart guy,” says longtime CBD developer Ken Balin of AMC Delancey. Although this is his first new construction project in almost 25 years, the Philadelphia native's name has become a household word. “I never imagined it would,” says Dranoff, whose late father operated a dry-cleaning service in northeast Philadelphia.

For the Symphony House project, Dranoff is partnered with Philadelphia record impresario Kenny Gamble, whose company, Universal Homes, holds a 10% stake and helped the developer through approvals and a $5 million state grant for the performing arts theater.

Condo Conversion King

Dranoff made his name in conversions — he has 72 under his belt, including 22 in the CBD — but shifted to new construction in the CBD “because there's just not enough big and old ones left,” a common complaint among developers.

Those conversions began in 1982 in partnership with Steve Solms as Historic Landmarks for Living. Their first project was the Wireworks, a factory in the Old City neighborhood.

“We went to 20 banks to obtain financing,” Dranoff recalls. “But such rehab projects were a new idea, and lenders considered them iffy propositions at best. Historic Landmarks completed more than 60 multifamily conversions of warehouses and factories in Philadelphia and elsewhere during its run.

When that business dried up in the early 1980s, Dranoff became president of the Rubin Organization's residential division, responsible for developing and managing 7,000 multifamily units. He left Rubin in 1997 to launch Dranoff Properties.

Reputation for edgy projects

His first project at Dranoff Properties was the $24 million conversion of the National Book Publishing Co. into a 260,000 sq. ft., 152-unit luxury rental building. The banks were wary, but the building was rented fully when it opened in 1999 at rents ranging from $750 to $1,650. Even edgier projects ensued, but Dranoff'sreputation made financing easier.

He moved on to the University of Pennsylvania campus and spent $58 million turning the 700,000 sq. ft. General Electric building into the Left Bank of 282. Luxury apartment rents ranged from $900 to $3,200.

Even edgier was his crossing the Delaware River to the Camden waterfront to convert the vacant 525,000 sq. ft. RCA Victor building to 341 luxury rentals. Financing was complex, involving Fleet Bank (a $30 million conventional loan), the New Jersey Casino Redevelopment Authority and the Delaware River Port Authority, with the two agencies coming up with $19 million in loans and grants.

Equity from Dranoff and the sale of historic-restoration tax credits totaling $11 million completed the $65 million financing. Completed in September, it is 75% rented, with one-bedroom units starting at $975.
— Alan Heavens