MARKET HIGHLIGHT, SEPTEMBER 2006

PHILADELPHIA MARKET HIGHLIGHT

Philadelphia Investment Market

Steady renter demand, moderate additions to supply and disappearing concessions have been more than enough to counteract rising utility costs in creating real NOI growth in the Philadelphia MSA apartment market.  Vacancy has been held in check in a narrow range of 3.4 percent on the low end and no more than 4.6 percent at the worst, since 2003.  Effective rents rose 74 percent in the 12 months ending the first quarter of 2006, versus the 1.9 percent gain in the preceding period.  This reliable operating performance helped fuel a 30 percent increase in the median price for apartments in 2005 plus additional gains this year.

Of course, there are differences depending on location and quality.  Class B and C properties posted the lowest vacancies and more rent growth than higher-end apartments as the region’s relatively affordable for-sale housing submarket had a larger impact on demand for Class A units, whether single-family or condominium.  Vacancy in Class A units climbed 80 basis points to 5.2 percent since the first quarter of 2005, including a 10 basis point rise in the first quarter of this year.  By contrast, vacancy in B/C apartments was up to just 4 percent in the first quarter and flat year-over-year.  Overall, accelerated job growth in the Philadelphia MSA should result in a 4.3 percent vacancy rate at year-end.

The median price per unit is up 8 percent this year to $73,000.  Average cap rates range from 7.9 percent to 8.7 percent, down about 50 basis points from a year ago, but properties pricing at $5 million and higher are between 7.4 percent and 8.0 percent, approximately 75 basis points lower than a year ago. 

Completions in 2006 will total 2,000 units, only a 1.1 percent increase in rental stock.  Last year, more than 2,700 units were delivered throughout the MSA.  This year’s projected completions are in line with growth forecast to arise from employment gains and creation of 5,800 new households.

Often overshadowed by flashier East Coast markets, such as New York and Washington, D.C., Philadelphia’s stable fundamentals and relatively low prices will continue to attract out-of-market investors looking for larger properties in the $5 million and up price range. Deals below $5 million experienced a 30 percent drop in transaction velocity during the past 12 months as more and more properties are being priced higher than $5 million.  Sales of properties with 200 and more units account for 16 percent of all transactions during the past 12 months, up from 7 percent in the preceding period.

— Jeff Algatt, regional manager, Marcus & Millichap in Philadelphia

Philadelphia Office Market

As the nation’s fifth-largest city, Philadelphia’s overall office vacancy rate currently hovers around 13.6 percent, nearly 2 percentage points higher than the average vacancy rate in the United States. It is no surprise then, to see Philadelphia’s office employment growth lag about 1 percent behind the rest of the country. The story, however, lies in the fact that the vacancy rate within city limits is on the rise, while the vacancy rate in suburban markets continues to decline. In the city, the vacancy rate over the past year has increased nearly 2 percentage points. Even in the city’s central business district, where more than 53 million rentable square feet lie, rates have flattened recently in the 12 percent range. Vacancy rates in the immediate suburbs over the same time frame have declined by nearly 2 percentage points, down to approximately 13.7 percent. This trend points to a healthy commercial real estate environment in Philadelphia’s suburbs.

Numerous new projects are underway in the suburbs, while just two — the recently-completed Cira Centre and the under-construction Comcast Center — are on tap for the city. And those represent the only office buildings constructed in Philadelphia since Two Commerce Square in 1992. The major factors driving workers out of the city and into the suburbs are neither secretive nor complicated — higher wage taxes, lingering 9/11 fears, crime and traffic.

Two suburban areas that are currently very attractive to tenants, which have escalated rental rates, are King of Prussia and Conshohocken. These two markets represent a combined total of 17,497,429 rentable square feet. King of Prussia, home to such companies as UGI and Universal Health Services, as well as the nation’s second-largest mall, has recovered from a multi-year highway construction project that devastated the area’s office occupancy. Since fourth quarter 2003, vacancy rates in the King of Prussia area have dropped in every single quarter, from 24.1 percent down to the current rate of 13.3 percent. Class A office rates are now pushing $25 per square foot, more than a $1 higher than the average high-rise rates in Center City Philadelphia for the same class product. King of Prussia is situated about 20 miles west of the city.

1000 Continental Drive, a 205,122-square-foot, six-story Class A office building that is being developed by BPG Properties, Ltd. and scheduled for delivery third quarter 2007, is an example of the state-of-the-art product becoming available in King of Prussia, explaining the decrease in vacancy and justifying the increase in rents.

Meanwhile, Conshohocken, about 5 miles closer to the city and a former industrial town that has seen an influx of modern low- and mid-rise office buildings in recent years, has seen its vacancy rate drop from 20.8 percent to 14 percent in the last three quarters alone. This drastic drop has contributed to rental rates for Class A office space of almost $30 per square foot. Further illustrating the attractiveness of the Conshohocken market was the sale of 300 Four Falls Corporate Center in December of 2005 — a 297,320-square-foot, seven-story Class A office building that was sold for the eye-popping price of over $340 per square foot, which also signals that new construction cannot be far behind.

Both King of Prussia and Conshohocken provide easy access to Philadelphia’s major roadways as well as public transportation, and are surrounded by numerous residential and retail opportunities. While Philadelphia is currently seeing a dramatic increase in condominium construction, we do not anticipate that the city will share in the commercial resurgence being enjoyed by suburban landlords throughout the area.

— Chris Graziano, marketing coordinator, Beacon Commercial Real Estate

Lehigh Valley Industrial Market

Lehigh Valley is one of the premier locations on the eastern seaboard for industrial development. Because of its location midway between Philadelphia and New York City, its close proximity to the Pocono Mountains and New Jersey, and access to major roadways, interstate systems, and bus, rail and air transportation, the region is a great place for distribution and manufacturing facilities. Local, regional and national developers are recognizing the benefits of doing business in an area that offers all of the amenities of major urban areas, but without the congestion and high cost of living.

In response to the influx of new business, officials in the region have been addressing road issues around the development hot spots. Currently improvements are being made to the Route 222 bypass near the Pennsylvania Turnpike, the Route I-78 interchange, and Route 412, which will allow for better access to Routes I-78 and 33.

The availability of land in Lehigh Valley is making it easy for owners of industrial parks to meet the varying needs of incoming industrial businesses. U.S. Cold Storage became the first tenant in LVIP VII, a 1,000-acre industrial park that is currently under development and owned by Lehigh Valley Industrial Park Inc. Receivable Management Systems also has an 80,000-square-foot, build-to-suit call center in the park. The Route 33 corridor, near the New Jersey border, continues to develop, with Prologis set to break ground on a 960,000-square-foot speculative distribution center at Routes 248 and 33. J.G. Petrucci Co., Inc. is developing a 120-acre rail-served tract in Forks Township, which will be one of only a few parks in the region with rail access.

Other major projects include the Olympus North American headquarters, Wakefern Foods’ 1 million-square-foot distribution center, and DHL’s new 350,000-square-foot regional logistics center.

Land acquisition activity throughout the Lehigh Valley remains strong, and land prices continue to rise. Lease rates range between $4.25 to $4.75 triple net lease and vacancy rates are in the range of 9 to 11 percent, which is the lowest in years.

Many companies are attracted to Lehigh Valley because of the skilled workforce and the outstanding array of colleges, universities and vocational schools. The Valley also enjoys affordable housing, low school and property taxes and an excellent quality of life. All of these factors give  Lehigh Valley the necessary infrastructure to support strong growth well into the future.

— Jim Vozar, J.G. Petrucci Co., Inc.

Philadelphia Multifamily Market

A shifting multifamily market is presenting opportunities for apartment owners as increasing interest rates limit the supply of renters who can purchase condominiums and single-family homes. While Philadelphia shares a number of trends with other major metropolitan areas, the region’s unique dynamics set it apart from other national markets. For instance, Center City Philadelphia is currently undergoing a housing boom, with 3,574 new residential units under development in the central business district. However, unlike other top tier markets such as Miami, Las Vegas, and Washington, D.C., Philadelphia’s condominium development is being driven mainly by buyers who will take occupancy of these homes within the next 24 months. Consequently, Philadelphia forecasts call for a soft landing for the Center City condominium market, with some projects being delayed or cancelled due to unrealized demand and others opening to strong sales. 

This positive condominium climate will affect the for-rent market in a number of ways. With few investors caught short in the Center City condo boom, there will be limited pressure for them to rent their properties and compete with multifamily rental projects. Also, as interest rates and housing prices continue to climb, potential buyers are likely to stay as renters for longer periods of time, fueling rental demand and setting the stage for rent increases, where appropriate. Consequently, the apartment markets in Philadelphia and the suburbs are seeing increased competition from potential apartment buyers, as occupancy and rental rates strengthen. For instance, in Downingtown, Pennsylvania, Meadowlake Apartments, a Class B apartment complex, built in1976, is enjoying a 96.4 percent occupancy rate, even as it undergoes a major renovation. Renovation is a major theme for many such complexes. Limited supply of land and increasing zoning restrictions, have severely limited new apartment development opportunities. In many areas, what can be built, has been built. Consequently, smart apartment buyers are acquiring properties with an eye for repositioning the properties to achieve the rent increases required for healthy returns. Current rental rates of $1 per square foot for well located, Class B properties are rising as high as $1.25 per square foot after renovations such as new roofs, siding, clubhouses, pools, fitness centers, kitchens and bathrooms. This has put downward pressure on cap rates even in the face of rising interest rates.

Overall, Philadelphia’s diverse economy, which is generating a substantial number of new jobs in the suburban markets, along with a real estate market that has not seen the highs of a true real estate bubble, continue to make Philadelphia and it environs an attractive investment.

— Gary Holloway Jr., president, GMH Capital Partners

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