During the first 6 months of 2004, Philadelphia’s commercial real estate market has shown what flexibility and determination can achieve by overcoming recent economic bumps and forging ahead. The office market has shown nominal improvement so far, and once the economy levels off, will continue to recover in 2005. The investment market has remained active, with the low interest rates and uncertainty surrounding other capital markets driving activity. Also, during the past several months, multifamily development in and around Philadelphia has markedly improved, thanks to vacancy rates well below national averages. The industrial market has stood strong, benefiting from zoning ordinances and old-fashioned ingenuity.


The region’s office markets showed nominal improvement during the first 6 months of 2004. This will be a gradual recovery rather than a rapid bust-to-boom cycle. Conditions varied by submarket; the Pennsylvania suburban, Lehigh Valley and Delaware office markets improved, while southern New Jersey experienced a temporary increase in vacancy. Demand is still weak; but the supply of space coming onto the market has leveled off in most areas. So while absorption is minimal, vacancy rates have not increased in most area submarkets.

For the first time in more than a decade, there is more space under construction or pending in downtown Philadelphia than in the suburban markets. These projects have been the source of much debate regarding the awarding of tax-abated Keystone Opportunity Zone (KOZ) status to the new sites. Cira Center, being developed by Brandywine Realty Trust, is a 727,725-square-foot Cesar Pelli-designed office building. The project is adjacent to Amtrak’s 30th Street Station, at the bridge between the traditional central business district (CBD) and University City, and was awarded tax-free enterprise zone status. This tax abatement represents significant savings to possible tenants based on job creation. Two large law firms, currently located within the CBD, are the lead tenants signed to Cira Center.

Liberty Property Trust, the developer of the proposed One Pennsylvania Plaza, has also been seeking tax-abated status for the 1.3 million-square-foot building in order to help secure the intended anchor tenant. Owners of existing Center City buildings have vigorously opposed tax-free status because it puts their buildings at a disadvantage. Proponents of granting tax abatements feel it is a necessary policy to keep large tenants in the city of Philadelphia.

In addition to the new projects, several of the CBD’s largest tenants recently renewed or signed new leases for significantly less space. The full impact of this decrease in occupancy combined with new construction will not be felt until later in 2005 and 2006, with the vacancy rate increasing from the current 13.2 percent into the mid to high teens. While the trophy and upper-tier Class A buildings will be initially impacted, older Class A and B buildings will eventually suffer the windfall as tenants “trade-up” to better buildings.

During the last downturn in the market in the early to mid-1990s, owners considered mothballing vacant buildings. Many of these ended up being converted to other uses such as apartments, student housing and hotels. As the job market recovered, the CBD market was able to recover more quickly because there were ultimately less office buildings. Considering the strong residential market and continued demand to own rather than lease, some owners may convert Class B and C buildings into office condominiums or into a combination of low-floor office and high-floor residential condo units.

New construction has leveled off in the Pennsylvania suburbs of Philadelphia, giving the market time to absorb a significant supply of space — the vacancy rate at mid-year 2004 was 20.1 percent. In southern New Jersey, particularly Burlington County, new development has increased, but on a smaller scale. Opus Corporation, Brandywine Realty Trust and Liberty Property Trust have recently all been active.

The office market historically lags behind a general economic recovery by 12 months to 18 months. Companies that are hiring will reconfigure existing office space and fill underutilized space before expanding. Therefore, while we foresee a gradual decrease in the suburban vacancy rates during the next 6 months, there will not be significant improvement until well into 2005. The CBD is likely to have an upward trend in vacancy through 2006.

Asking rates are predicted to remain flat in the suburban markets. However, in the CBD, landlords are likely to start pre-emptively lowering rental rates in order to secure tenants before the large blocks of space hit the market during the next year.

Gregory J. West, Executive Vice President, Colliers Lanard & Axilbund


Philadelphia has lagged behind the rest of the country in multifamily construction during the last decade; however, new construction permits soared during 2003 as low vacancies, positive rental growth, the specter of higher mortgage rates and a decreasing supply of residential land provided the incentive for developers to start new projects. In addition, the Philadelphia area has had strong foreign immigration during the last 5 years, averaging more than 15,000 new residents annually, despite post-9/11 limitations.

The CBD currently has the highest level of new construction, with several luxury developments, both new and renovated underway. The most visible development is the 47-story St. James tower on Washington Square. Projects in the suburban markets will be highlighted by several conversion projects such as the Victor in Camden or new buildings in infill locations such as Millennium in Conshohocken.

The overall Philadelphia metropolitan statistical area vacancy rate is in the 4 percent to 5 percent range. Despite the trend toward owning, rental demand has remained strong, and Philadelphia is below the national vacancy rate, which is approaching 7 percent. The vacancy rate is likely to increase during the next 6 to 9 months with the delivery of new units.

Both the volume of transactions and new offerings are down year-to-date in 2004, reflecting the lack of properties on the market. Cap rates have decreased steadily over the last three years. However with an increase in the 10-year Treasury Notes and the impending interest rate hikes, cap rates are expected to increase shortly. Industry analysts currently have varying views on the impact of higher interest rates on cap rates and sale prices. Some experts feel that a rise in interest rates will drive capital to other investment markets, and cap rates will increase. Others believe that there is enough pent-up demand for real estate investments that an interest rate hike will not immediately impact cap rates.

Even if rates do rise, improving market fundamentals may offset the impact of higher cap rates on value for multifamily investors. Higher mortgage rates may benefit the rental market, resulting in higher occupancy and eventually rental increases.

Cary S. Tye, Esquire, Senior Vice President; Joel Flachs, Vice President; Mitchell Gold, Senior Associate, of Colliers Lanard & Axilbund


The Philadelphia industrial real estate market has seen the effects of two powerful forces: the Keystone Opportunity Zone (KOZ) and adaptive reuse. The KOZ, which is administered by the Philadelphia Industrial Development Corporation (PIDC), has had its greatest effect to date in the Eastwick section of the city. Adaptive reuse of older industrial buildings has produced the beginnings of what has become a remarkable transformation of several Philadelphia neighborhoods.

The advantage of the KOZ to the Eastwick section is simply another addition to the natural benefits of the location. Close to the Philadelphia International Airport, Interstates 76 and 95, as well as area bridges to New Jersey, the area has long been an attractive target for industries needing to be in this region. The high cost of construction was, most likely, the most important factor holding down new construction. Now, several new projects have begun, or are about to begin.

Construction of a 90,000-square-foot facility is underway for DHL/Airborne, which will include significant expansion capability. A build-to-suit project for the Brinks Company will add another 50,000-square-foot building to the area. Also, a 90,000-square-foot speculative project is to be divided into units as small as 8,000 square feet and sold as condominiums. The latter project is significant because there has been little speculative industrial construction activity anywhere in the Philadelphia region for several years.

Not far from the Eastwick section, the city and the state did everything it had to do to retain the Produce Market. The new market, approximately 900,000 square feet, will be built in south Philadelphia at the foot of the Walt Whitman Bridge.

While the build-to-suit activity continues, the sale of existing industrial properties keeps pace as well. The historically low interest rates have inspired entrepreneurs to purchase the manufacturing and distribution properties they occupy.

In south Philadelphia, conversion of old factory lofts to residential apartments and condominiums has been successful for some years. Now, that phenomenon has spread to the area north of Market Street, and along portions of the Interstate 95 corridor. Old buildings, once predominantly occupied by the needle trade, are now prime for conversion to exclusive residential use.

Philip Rothenberg, Broker/Vice President, NAI Mertz Corporation

Philadelphia’s Investment Market SHOWS STRENGTH

The regional investment market continues to be active, driven primarily by historically low interest rates, the continuing uncertainty of other capital markets and 1031 tax-deferred exchanges. Sales in most markets are limited only by lack of product. The office market also is limited by weak fundamentals. Institutional sales continue to lag due to lack of product to replace existing yields and the still significant difference between buy and ask. Credit remains the strongest element in institutional and quasi-institutional due diligence.

Overall, the picture remains nearly the same as it has been for the last 2 years, lots of capital carefully pursuing every available deal. The only difference is that 1031’s are less sensitive to yields due to tax savings.

Multifamily — Investor demand continues to exceed the supply of offerings. Cap rates range between 7.5 percent and 8.5 percent for Class A product and, despite the softness on rentals and continuing increases in operating costs, Class B product is not far behind. Sale prices per unit have hit all-time highs for Class A apartments with trades exceeding $140,000 per unit. Class B apartment properties are trading as high as $60,000 to $80,000 per unit. The low cost of capital will continue to fuel low cap rates and subsequently higher prices per unit.

Industrial — Sales volume was limited by a lack of institutional grade product during the first 6 months of 2004. The average sale price was $51 per square foot. Two Class A distribution buildings in Southern New Jersey, which were acquired in 2001, sold for an average of $53, an increase of 40 percent in 3 years.

Net-leased industrial continues to be the darling of the industry with long-term credit leases trading between 7.5 and 8.5 percent cap rates. Multi-tenant projects are also being purchased by non-institutional players at cap rates 50 to 100 basis point higher.

Office — Office remains the weakest sector of investment activity. However, the outlook is improving because of decreasing vacancy rates. The volume of sales is down from 2003, as many institutional sellers are holding property off the market due to high vacancy. However, despite the 20 percent suburban market vacancy rate, selling prices for the first 6 months of the year averaged over $162 per square foot, with one well-located building going for $266 per square foot. The average sale price in the CBD was $106 per square foot and there is at least one major sale pending. Equity Office has announced that it would be divesting its Philadelphia-area assets, which will likely generate a great deal of interest from investors.

The value of product made available has been negatively affected by continued vacancy and by difficult tenant-credit problems. Long-term net leases are the exception, with all available product being aggressively purchased. Cap rates for well-occupied buildings with reasonable credit tenants range from 9 to 9.5 percent.

Retail — The most competitive investment sector is well-anchored retail. Sale prices for fully leased, institutional grade neighborhood centers have averaged approximately $165 per square foot, while the prices for power centers have averaged approximately $170 per square foot. Cap rates have generally ranged between 7.75 percent and 8.0 percent. Credit single-tenant retail is the most sought after product type.

Cary S. Tye, Esquire, Senior Vice President; Joel Flachs, Vice President; Mitchell Gold, Senior Associate, of Colliers Lanard & Axilbund

©2004 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.

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