Despite the sagging economy, the Philadelphia real estate market is holding its own. Never a high-tech mecca, the city's office market avoided a huge upsurge in vacancies following the dot-com meltdown. Meanwhile, recent activity in the hotel and multifamily sectors has sparked a renaissance in the historic Center City business district.

Capitalizing on tourist attractions such as the Liberty Bell and Independence Hall, developers have constructed and revamped thousands of hotel rooms. In the multifamily sector, developers are taking advantage of a 10-year tax abatement program and converting dozens of old industrial buildings into luxury rental properties.

Hotels: Aging Properties Receive A Makeover

Five years of refurbishment have invigorated the look and feel of Philadelphia's Center City business district. The redevelopment process began with the completion of the Pennsylvania Convention Center in 1994. That lured Loews, Ritz-Carlton, Marriott and other chains, which transformed aging office towers, banks and train depots into opulent new lodging in the late 1990s, increasing the city's number of hotel rooms by 63% between 1998 and 2000.

Then developers built 2,000 more hotel rooms to accommodate the 2000 Republican Convention. That was unrealistic, says Dana Ramus, vice president at PKF Consulting in Philadelphia. “No one in his right mind would finance a hotel with a 30-year life for a two-week convention,” she explains. “But the good news is we have a much better overall hotel stock now.”

In May 2002, for example, Marriott International Inc. transformed a 1927 office tower across the street from Philadelphia's City Hall into a Residence Inn. The 270-room extended-stay hotel recently opened after a two-year, $58 million renovation.

Despite all the building, Philly's hotel sector has shown less signs of stress than other northeast markets. Occupancy inched up from 64.4% in September 2001 to 66.1% in September 2002, slightly higher than the national average of 61%, according to Smith Travel Research. Of course, the post 9-11 travel crunch affected Philadelphia — occupancy as of September 2000 was 68.7% — and ongoing labor problems at the convention center have driven up exhibitor costs and frightened away prospective conventioneers.

As a result, some Philly hotels have gone on the defense. For example, the 316-room Hotel Windsor, which was converted from apartments to hotel suites in 1998, switched a third of its units back to apartments in late 2001.

Now the city is looking to entice tourists by developing attractions such as the National Constitution Center under construction on a three-block expanse in front of Independence Hall. The $185 million, 160,000 sq. ft. project, expected to open July 4, will include 68,000 sq. ft. of historic exhibits and a new building for the Liberty Bell. A two-story tourist information center is already open.

Tourism is sustaining Philly's hotel sector until corporate travel rebounds, notes Ramus. “We don't have major new corporate customers coming into Philadelphia, and there is nothing on the horizon that's going to drastically improve that,” she explains. “Tourism is a steady growth area, but it's not enough.”

Multifamily: Fundamentals Remain Sound

Philadelphia boasts one the largest downtown residential populations in the country. And an influx of upscale renters has been good news for the multifamily sector. “There's been significant growth of the arts and entertainment community, along with dining venues,” explains Jeff Algatt, regional manager for Marcus & Millichap. Restaurants thrive around the Avenue of the Arts, a theater district along Broad Street that includes the $265 million Kimmel Center for the Performing Arts, which houses a 2,500-seat concert hall. “The whole concept of the ‘work, play and live’ combination has come to critical mass,” he says. “The young professional is what's driving all this.”

Another inducement for downtown developers is a 10-year tax abatement for turning abandoned buildings into rental units. More than a dozen industrial and office buildings built in the 19th and early 20th centuries have been converted since the law was enacted in 1997. The bill also was extended to include new construction in 1999. In all, about 2,400 units have been added to the Center City rental stock, with 1,000 more units scheduled to come on line in the first half of 2003.

A sluggish regional economy — unemployment is 7.7%, vs. the 6% national rate — pushed apartment vacancies up slightly to 2.7% in the third quarter of 2002 from 2.2% in the third quarter of 2001, according to Marcus & Millichap. Rents in the third quarter of 2002 averaged $850, up from $820 in the third quarter of 2001.

Multifamily development hot spots include Old City, a historic neighborhood nestled in the shadow of the Benjamin Franklin Bridge, and the downtown loft district six blocks east of Old City and closer to the CBD, where several high-end construction and conversion projects are under way. Miles & Generalis Inc. of Center City recently converted about 400,000 sq. ft. of industrial space to luxury lofts at a cost of $100 per sq. ft. to $250 per sq. ft.

Other luxury projects include the 242-unit Dockside at Penn's Landing, located on Pier 30 along Christopher Columbus Boulevard, scheduled for completion this summer. The 307-unit St. James Court in the Washington Square district also is scheduled for 2003. The Phoenix, a 267-unit apartment project, is taking shape inside the former INA headquarters building, along with 56,000 sq. ft. of office and retail space.

Retail: Big Boxes at the Dockside

Like multifamily, Philly's retail sector has remained steady through the events of 2001 and 2002. Vacancies edged up to 8.8% in the third quarter of 2002 from 8.3% a year earlier, according to Marcus & Millichap. Rental rates averaged $16.75 per sq. ft., up from $16.55 per sq. ft. for the same time periods.

Construction activity added 3.5 million sq. ft. of new retail space in 2002, but that pace is expected to slow to about 2 million sq. ft. in 2003, reports Marcus & Millichap. Among the new projects: the $60 million Penn's Port Pavilion, a 600,000 sq. ft. retail complex being developed by The Goldenberg Group of Blue Bell, Pa.

After much discussion with city officials, Goldenberg bought 44 acres from CSX Corp. at Snyder Avenue. Officials at the Philadelphia Regional Port Authority were concerned the retail complex might cramp their expansion in the area, but were swayed by the promise of 1,000 new jobs and $4.2 million in annual tax revenue. The project is scheduled for completion in 2004.

Goldenberg is planning another big-box center, the 450,000 sq. ft. Whitman Square on Roosevelt Boulevard at the city's north end. A Lowe's Home Improvement store will anchor the development, along with Wal-Mart, Barnes & Noble and Pier 1 Imports.

Retail also is strong along the riverfront retail strip served by the heavily traveled I-95 artery in south Philly. A 300,000 sq. ft. Ikea superstore and a 135,000 sq. ft. Lowe's Home Improvement warehouse are slated to join big-boxers Wal-Mart, Home Depot and Target there.

And in the University City area, near the University of Pennsylvania, the Bridge Cinema DeLux is due to open by year-end 2002. It will include two restaurants and retail components in addition to the six-screen theater.

Office: Softening

Philadelphia's office market, albeit lackluster, has not been severely affected by the recession, primarily because of its lack of exposure to the ailing tech sector. CBD vacancies registered 16.5% in the third quarter of 2002, up from 13.7% in the third quarter of 2001, reports Cushman & Wakefield.

Rental rates have barely budged, averaging $23.92 per sq. ft. in the third quarter of 2002, compared with $23.90 per sq. ft. a year earlier. Philadelphia's CBD had 933,750 sq. ft. of sublease space on the market in the third quarter of 2002, up marginally from the 932,862 sq. ft. at the same point in 2001.

Like their comrades across the country, brokers in Philadelphia see little chance of a market turnaround until companies start hiring again. “We're only dealing with corporate downsizing,” says Carl Neilson, an investment broker with Grubb & Ellis.

According to Julien J. Studley Inc., no fewer than 12 large firms, including KPMG, Ernst & Young and Pricewaterhouse-Coopers, are subleasing medium- to large-size blocks of unwanted space in the city. “Concessions are up, free rent is back and tenants are slow. They sit back and don't pull the trigger,” says Tim Monahan, a senior broker at Studley.

“They say, ‘If I hold out for another 60 days, I can get more of a break in the rent.’ Now there are so many spaces and so many subleases that tenants are all negotiating very, very hard.”

New buildings now on the drawing board at the region's two biggest REITs could add to the problem. Malvern, Pa.-based Liberty Property Trust is getting ready to build One Pennsylvania Plaza, a $350 million, 52-story office building and an adjacent 16-story structure at 17th Street and John. F. Kennedy Boulevard.

At the same time, Brandywine Realty Trust of Plymouth Meeting has been named the developer of Cira Center, a planned 32-story, 800,000 sq. ft. office building on land owned by Amtrak near 30th Street Station, on the western side of the Schuylkill River.

But demand remains sluggish, particularly in the suburbs. Brandywine completed three suburban office buildings in 2002, and space was still available in two of them at year-end. They include the $41.4 million, 200,000 sq. ft. 402 Plymouth Road building in Plymouth Meeting, the $23.1 million, 125,000 sq. ft. 400 Berwyn Park in Berwyn, and the $19.2 million, 103,000 sq. ft. 935 First Ave. in King of Prussia.

Philadelphia-based Berwind Property Group is building two suburban projects, due to come on line in April. The $50 million 300 Four Falls in West Conshohocken will have 290,000 sq. ft. of offices. Berwind's 183,000 sq. ft., $27 million Highview at Providence is completely leased to Wyeth Laboratories.

Plans also call for the former Naval Air Warfare Center in Warminster to be converted into a $100 million office complex, to be called Franklin Corporate Center after its Blue Bell-based developer. Phase I, scheduled for completion this summer, includes a 60,000 sq. ft. office building and a 40,000 sq. ft. flex facility.

Due to the new construction and the sluggish economy, leasing is expected to remain slow through 2003 as tenants burn through Philly's overhang of sublease space, notes Monahan. “There's just no internal growth.”

Thomas Walsh and Peg Brickley are Philadelphia-based writers.

PHILADELPHIA - BY THE NUMBERS

POPULATION:
City: 1.5 million
Metro area: 6.2 million
Source: U.S. Census Bureau

UNEMPLOYMENT RATE: 7.7%

LARGEST EMPLOYERS:
1. University of Pennsylvania
18,400 employees
2. DuPont
13,000 employees
3. Verizon Communications
10,300 employees
Source: Greater Philadelphia Chamber of Commerce

VACANCY RATES (METRO AREA):
Office:
13.7%
, 3Q 2001
16.5%, 3Q 2002
Rent per sq. ft.: $23.92 3Q 2002
Source: Cushman & Wakefield

Multifamily:
2.2%
vacancy, 3Q 2001
2.7% vacancy, 3Q 2002
Rent per unit: $850 3Q 2002
Source: Marcus & Millichap

Retail:
8.3%
vacancy, 3Q 2001
8.8% vacancy, 3Q 2002
Rent per sq. ft: $16.75 3Q 2002
Source: Marcus & Millichap

Industrial:
6.9%
vacancy, 3Q 2001
10.5% vacancy, 3Q 2002
Rent per sq. ft.: $5.17 3Q 2002
Source: Cushman & Wakefield

HOTEL:
64.4%
occupancy, 3Q 2001
66.1% occupancy, 3Q 2002
Source: Smith Travel Research

MAJOR PROJECTS UNDER CONSTRUCTION:

Franklin Corporate Center, an 80-acre office and light industrial complex. Phase 1 includes single-story office buildings and flex space
Cost: $100 million
Owner: Franklin Realty Development Corp.
Completion: Phase 1, summer 2003

Penn's Port Pavilion, a 600,000 sq. ft. retail center anchored by Ikea, Lowe's Home Improvement, Best Buy and various restaurants
Cost: $60 million
Owner: The Goldenberg Group
Completion: Second-quarter 2004

300 Four Falls, a 7-story 290,000-sq. ft. office building
Cost: $50 million
Owner: Berwind Property Group
Completion: April 2003

Pitcairn Building, a 100-year old office building being converted into 77 loft-style apartments
Cost: $15 million
Owner: Miles & Generalis Inc.
Completion: Phase 1, Christmas 2003

National Constitution Center, a patriotic exhibit, meeting space and theater
Cost: $185 million
Owner: National Constitution Center, a non-profit group
Completion: July 4, 2003