MARKET HIGHLIGHT, MAY 2012

PHILADELPHIA

Philadelphia Multifamily

Yablon

The recent performance of the Philadelphia apartment market offers evidence that a sustainable recovery is taking hold. Vacancy returned to a normal level, while property owners continue to realize greater success in raising rents. Newly employed residents and recent graduates of local colleges and universities will further stoke tenant demand in the quarters ahead. As would be expected following several quarters of solid performance, the recovery is initiating a new construction cycle, as heralded by the start of construction in the first quarter on a 319-unit rental in Center City. The pipeline of planned projects has also increased, but the potential impact on property operations will likely be modest as these projects represent 3 percent of existing stock. In addition, developers appear to be focused on adding rentals in areas where tenant demand is the greatest, placing a large concentration of their projects in Center City and Main Line submarkets, including Bala Cynwyd.

Minimal additions to market-rate stock have moderated vacancies. During the 12 months ending in the first quarter, only the 97-unit 600 on Broad in Center City came online. Developers are becoming more confident, as 6,500 market-rate units are planned, an increase from 4,100 rentals 6 months ago. Only a few projects are advancing, as roughly 1,700 units of for-sale and rental multifamily housing were permitted in the past 12 months, a decrease of 8 percent from the preceding year. Additions to the pipeline of planned projects include the 612-unit Renaissance Walk in Pennsauken and 159 units in the Bordentown Transit Village project in Burlington County.

At 4.3 percent, metrowide vacancy was unchanged in the first quarter, but the rate is 70 basis points less than that recorded in the first 3 months of 2011. Since vacancy peaked at the end of 2009, resurgent demand and limited additions to stock have driven the vacancy rate down 220 basis points. The Class B/C rate has declined 80 basis points over the past 12 months to 3.8 percent, including a 10-basis-point drop in the first 3 months this year. Strong demand for in-city residences pushed down the vacancy rate 40 basis points over the past year in Center City to 4.1 percent, the lowest rate in 7 years. Among the South Jersey submarkets, vacancy in Cherry Hill/Evesham/Medford ticked down 20 basis points in the first quarter and 90 basis points in the past year, to 8.5 percent.

Average asking rents rose 0.7 percent in first quarter to $1,051 per month, while effective rents surged 0.8 percent to $1,006 per month. Since the first quarter of last year, asking and effective rents have climbed 2.3 percent and 2.6 percent, respectively. With a vacancy rate of less than 4 percent, Class B/C asking rents also continue to rise, posting a 0.5 percent increase in the first quarter to $855 per month. Year over year, asking rents in the lower tier have advanced 1.6 percent.

Encouraged by the steady improvement in property operations and the availability of low-cost debt, investors remain intensely active across the metro, with many current owners seeking to expand portfolios. Overall, a modest shortage of assets listed for sale persists, but property owners are increasingly acting to take advantage of strong investor demand and compressing cap rates, triggering a gradual rise in listings. Areas of interest include high-density locations in the Pennsylvania counties and prime locations in Camden County, New Jersey, that offer relatively easy access to Center City. Generally, Class A properties trade at less than 6 percent, but cap rates on stabilized Class B product have compressed slightly to the mid-6 to 7 percent range, depending on property size, and usually draw numerous bids. Distressed properties also remain a target for many investors, though to a lesser degree than 1 year ago. Investors that once focused intently on troubled assets are instead increasingly diverting their attention to stabilized properties for more immediate cash flows and appreciation potential.

— Spencer Yablon is vice president and regional manager of the Philadelphia office of Marcus & Millichap Real Estate Investment Services.

Greater Philadelphia Office

Overall, the first quarter of 2012 brought improving market trends to the office sector in Philadelphia and Delaware. The number of tenants in the market has increased, although this has not translated into a significant increase in occupancy. Some tenants are growing, but it is still common for companies to make lateral space moves or take smaller, more efficient offices.

In CBD Philadelphia, occupancy decreased slightly during the first quarter from 88.6 percent to 88.4 percent. The main reason for the loss in occupancy during the first quarter was due to banking sector tenants Citizens and Wells Fargo consolidating space in the Market East submarket. The Lehigh Valley also had a decrease in occupancy, mainly due to the closing of a 100,000-square-foot T-Mobile call center. On the other hand, the Pennsylvania suburbs, Southern New Jersey and Northern Delaware all registered low, but positive absorption for the first quarter.

Numerous large tenants are looking in the market. However, many of these leases are likely to be renewals or moves without significant additional occupancy. With the exception of a rumored 145,000-square-foot Capital One lease in Wilmington, Delaware, which is a new requirement, none of the deals in the market are anticipated to have a major positive or negative impact on the market at this point.

The major REITs continue to be the most dominant landlords in terms of size and competition for tenants. Liberty Property Trust and Brandywine Realty Trust set the bar for rent and concession trends.

Asking rents have remained unchanged, and one month of free rent per year of term and generous tenant improvement allowances are still common. Landlords are expected to begin to “reel in” concessions as the year progresses if the leasing market remains active.

Asking rents in CBD Philadelphia are $28-plus for trophy class buildings, $23 to $27 per square foot for Class A space, and in the high teens to low $20 range for Class B space. In the Pennsylvania suburbs, asking rents average $25.07 full-service for Class A space and $21.07 full-service for Class B space. In Southern New Jersey, the average Class A asking rent is $20.97 full-service and $19.67 for Class B space. In New Castle County, Class A rents average $27.75 in Downtown Wilmington and $22.18 in the suburban markets. Class B rents average $17.73 downtown and $21.57 in the suburbs. Lehigh Valley rents average $20.95 for Class A and $16.78 for full-service Class B space.

In terms of investment sales, it has been difficult to establish a pricing trend because of the limited number of sales in submarkets such as CBD Philadelphia and the number of lender sales in the suburban markets.

Private investors, particularly private-equity funds, have become more active over the last 18 months, and have been able to take advantage of distressed property offerings and non-core REIT asset sales to expand their market holdings. Currently, an undisclosed buyer is under contract to purchase the 502,531-square-foot Two Penn Center in CBD Philadelphia from Crown Properties. MIM-Hayden closed on the 228,056-square-foot Five Tower Bridge in Conshohocken at the beginning of the year. Brandywine Realty purchased a 154,000-square-foot, former user building in Plymouth Meeting. Rubenstein Partners acquired the 107,742-square-foot 1150 Northbrook Drive in Trevose (Bucks County) from the lender. In addition, Liberty Property Trust finalized the sale of a multi-state portfolio, which included four buildings in Southern New Jersey

The three most significant developments are build-to-suits for tenants relocating from other buildings in the market. GlaxoSmithKline will be moving into its new 205,000-square-foot building at a new $81 million development by Liberty Property Trust at the Philadelphia Navy Yard at the end of the year, vacating over 800,000 square feet in two CBD Philadelphia buildings. Endo Pharmaceutical has a 320,000-square-foot building underway at Atwater Corporate Center in Malvern. Endo will be vacating three buildings totaling more than 160,000 square feet in Chadds Ford, Delaware County when they relocate to in December. West Company will also be moving within Chester County with a new 170,000-square-foot building in Exton.

Occupancy growth will continue to be sluggish over the next 12 months, driven primarily by three factors that will continue throughout the year: there have been very few net new users to the region of meaningful size to impact occupancy; sluggish job creation has put limited pressure on existing space requirements; and, the trend to creative and more efficient workplace solutions will continue to enable companies to maintain if not contract their office footprints.

— Joseph Fetterman is executive vice president of Strategic Initiatives with the Philadelphia office of Colliers.

Philadelphia Retail

The landscape of the supermarket business in Philadelphia is changing at a dramatic rate. Larger store formats, such as Wegmans, Target and Walmart are having serious impact on smaller supermarket chains. Two other very tough competitors, Giant of Carlisle, Pennsylvania, and ShopRite, are also reshaping the market share of food dollars spent in the Philadelphia area.

Recently Safeway purchased the Genuardi’s chain and sold off almost all the stores. Super Fresh and Pathmark closed many formerly high-producing stores with this new wave of competition. ACME Market, the former market share leader, has seen comp sales decrease dramatically. The newest entry to the market, Bottom Dollar, a discount grocer, hit Philadelphia with an onslaught of 20 new stores and is still growing.

Divaris Development’s Village at Valley Forge, in Valley Forge, Pennsylvania, is one of the newer developments that has been on the boards for a while. The Wegmans there is getting ready to open, although additional retail has not been built at this time. Not far away, in Malvern, Uptown Worthington Center by O’Neill Properties is on track leasing a new lifestyle center, going after quality tenants to take advantage of the strong demographics of the Main Line and Chester County areas.

In northeast Philadelphia, the Shopping Center at the Arsenal is one of the few new projects being planned. Arsenal Associates is developing the 500,000-square-foot power center that will dominate the entire lower northeast section of the city.

The Metro Development Center on Route 611 in Warrington (Bucks County) will feature a Walmart and regional restaurants.

North of Philadelphia, the Lehigh Valley has become a strong standard metropolitan statistical area with nearly 1 million people. In Trexlertown, just west of Allentown, Goldenberg Group and Tim Harrison created a joint venture to develop a new power center with a discount department store, wholesale club and food market.

In Southern New Jersey, the rapidly growing Gloucester County area has Richwood Marketplace, a Madison Marquette development at Route 322 and 55 in Harrison Township, with Walmart and other boxes. At Route 322 and the New Jersey Turnpike in Woolwich Township, another large power center with Walmart is being developed by Wolfson Properties. In Burlington County, an 800,000-square-foot center near Burlington Mall is in the planning stages.

PREIT, one of the Philadelphia area’s largest owners, has done an amazing transformation of the former Echelon Mall by tearing down part of the mall and building a lifestyle center, the Voorhees Town Center.

Costco, the third largest retailer in the country, continues to gain market share and recently opened new stores on Route 422 in Sanatoga (Montgomery County) and Warminster (Bucks County) and the company is under construction in Concordville (Delaware County), Pennsylvania.

Recently Kohl’s has become very active opening stores on Route 1 in Upper Darby, and in submarkets of Stroudsburg, Hazleton and Pottsville.

Center City Philadelphia has experienced major residential growth with new construction as well as conversions of former office space. There are numerous retail projects and an incredible restaurant renaissance following this growth. In southern New Jersey, the new state-of-the-art Virtua Hospital is a catalyst for the same type of retail, residential and restaurant growth.

— James DePetris is CEO of Legend Properties, Inc./TCN Worldwide

Philadelphia Industrial

The Philadelphia regional industrial market extends outward as the Pennsylvania Distribution Corridor, encompassing the Lehigh Valley, Harrisburg, Wilkes-Barre, and Scranton. This corridor is generally seeing an increase in activity in most categories, especially logistics. That is particularly the case for the largest industrial transactions — those of half-million square feet or more.

For example, recent major leases have included Unilever’s 1.3 million-square-foot warehouse/distribution lease completed by Cushman & Wakefield in Newville, just south of Carlisle. Additionally, Crayola Crayons recently announced that it will be going into a new 800,000-square-foot facility to be constructed in the Bethlehem Commerce Center.

A corresponding trend, fueled by the demand for big-box warehousing/distribution space, is construction of speculative developments of significant size. Five projects are already under construction: Liberty Property Trust is developing a 1.2 million-square-foot building within the Bethlehem Commerce Center in Bethlehem and a 972,000-square-foot facility in Carlisle; Trammell Crow and USAA formed a joint venture to develop a 700,000-square-foot facility in Mountain Creek Distribution Center in Carlisle; Griffin Lane is developing the 228,000-square-foot Lehigh Valley Tradeport in Lower Nazareth Township; and Exeter Property Group is building a 280,000-square-foot building in Palmer.

There is more to come in the near-term. At least two more speculative projects have been proposed in Allentown by ProLogis and Panattoni.

Property values are strong currently. Rents, for the most part, have totally recovered in this post-recession economy. There are some exceptions: Some spaces in certain sizes and submarkets that have been vacant for some time are seeing strong competition to find tenants, so those rents have not recovered.

But overall, rents have recovered wherever there is a degree of supply shortage, as indicated by the amount of speculative development we’re seeing. Asking rents are now between $4.15 and $4.40 per square foot, which is as high as they have ever been.

At the same time, overall vacancy rates have been consistently trending downward to the point where the rate is 7.9 percent in the Lehigh Valley right now, and 9.6 percent for the entire Pennsylvania Distribution Corridor. As a yardstick, 5 percent to 6 percent vacancy is classified as a “shortage.” In some categories of space, we do have a shortage, and in general we are trending toward short supply right now.

The dominant industry continues to be logistics, driven by Pennsylvania’s geographic location. (The Distribution Corridor is a one-day truck drive to approximately 35 to 40 percent of the population of the United States.) At the same time, corporations continue to shift their logistics toward more super-regional distribution centers, taking a million-square-foot building, for example, to service the entire Northeast/Mid-Atlantic region of the U.S., and replicating that in other regions of the country.

Pennsylvania competes very favorably with New Jersey, Maryland and other states because of its geographic location for warehousing/distribution. The metrics to locate in Pennsylvania, if a company has a broad distribution pattern, are very favorable, and that will continue to drive the regional industrial market.

— Stephen Cooper is a senior director with Cushman & Wakefield, Inc.

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