MARKET HIGHLIGHTS, AUGUST/SEPTEMBER 2012

PHILADELPHIA

Philadelphia Industrial

Bergen

The Regional Philadelphia industrial market is experiencing a slow, uneven recovery. At the end of 2011, we saw the highest level of absorption since 2007 and the lowest vacancy since 2008. But the recent flow of space back onto the market, along with more modest demand, has slowed what looked to be a solid recovery.

The overall industrial vacancy rate for the Philadelphia region at the end of the second quarter was 10.1 percent, which was down from 10.3 percent at the end of 2011.

Absorption was positive for the region as a whole, but lower than expected at 895,000 square feet. Strong absorption in the Lehigh Valley and the Southern I-81/I-83 corridor was offset by occupancy losses in the suburban Philadelphia counties and Southern New Jersey.

Bulk demand has contracted and some requirements are on hold or off, while the larger deals have opted for build-to-suits. There is also limited demand for the numerous large, older warehouse and manufacturing facilities that continue to come back onto the market, particularly in Southern New Jersey.

However there is a healthy pipeline of demand for quality warehouse and flex buildings in the 25,000- to 100,000-square-foot range.

Asking rents for warehouse space average between $2.95 and $4.95 per square foot, triple net, depending on size, quality and location; between $4.00 and $4.25 per square for bulk space and from $5.00 to $8.00 for flex space. Asking rents have remained flat, but some landlords are beginning to hold the line on rents for quality warehouse and flex buildings, offering less free rent and other concessions.

Property values have begun to rebound, but still vary according to building, type, age, location and occupancy. Pricing for net-leased, modern warehouse buildings has remained strong — above $50 per square foot. Quality, medium-size warehouse buildings have been selling in the $40 to $50 per square foot range. Larger, vacant buildings for user or value-add investor purchase, particularly those that have been on the market for an extended period, are trading below $30 per square foot.

At the end of the second quarter, there were 3 million square feet of build-to-suit space under way, along with 3.3 million square feet of spec construction. An additional three build-to-suits totaling 2.3 million square feet were announced, including Subaru America’s 524,000-square-foot build-to-suit lease in Florence, New Jersey.

The high level of build-to-suit construction is a positive indicator of the strength of the region, but many of these companies will be vacating other facilities, minimizing absorption. For instance, Crayola has committed to an 800,000-square-foot build-to-suit in the Lehigh Valley, but is likely to be vacating at least the same amount in multiple locations. Ocean Spray is building a new 315,000-square-foot bottling facility, also in the Lehigh Valley, but will be leaving 450,000 square feet in New Jersey. AirGas Safety is consolidating multiple regional locations into a new 250,000-square-foot building in Bristol, Pennsylvania.

— Larry Bergen, senior vice president, Industrial Group, with Colliers International’s Philadelphia office

Philadelphia Office

Leahy

Office market fundamentals improved in Philadelphia during the first two quarters of 2012. The vacancy rate decreased from 14.4 to 13.9 percent and year-to-date absorption was almost twice the total for the same period last year. A few submarkets had occupancy losses year-to-date, but these were minimal.

The average Class A rent for CBD Philadelphia increased to $26.50 full-service and to $24.50 for the suburban markets. Class B rents increased in CBD Philadelphia to an average of $22.09 per square foot, but decreased in the suburban markets to $20.58. So there has not been a significant overall change in face rents. Net effective rents are still deeply discounted. There will have to be strong, sustained absorption before there is a pullback in concessions.

Although fundamentals are beginning to improve, there is no clear trend for property values because there are still relatively few sales — and those sales that have closed have been a mix of investment grade properties, lender sales and user purchases.

REITs remain the most dominant landlords in both the CBD and suburban markets. However, as REITs continue to dispose of non-core assets, other locally based investors or joint ventures between local and out-of-town players have stepped up. Lender sales of distressed properties have also provided opportunities for buyers. For example, local developer Post Brothers recently purchased a 320,705-square-foot building at 260 South Broad Street from the lender for $86 per square, and at least a portion of the building will be converted to apartments. This is the second-largest CBD building purchased for apartment conversion this year.

CBD Philadelphia will be the market to watch over the year, both in terms of activity and a potential spike in vacancy. On the negative side, GlaxoSmithKline will be vacating two buildings, potentially 800,000 square feet, when the company moves to the Navy Yard in late 2012 and early 2013. Another potential setback is the recent increase in the Philadelphia Use & Occupancy Tax, which will raise occupancy costs for tenants in the city.

On the positive side, there has been an increase in tenants moving to or opening expansion offices in CBD Philadelphia, mainly to attract a younger talent pool. Exton-based Bentley Systems recently subleased 12,000 square feet. Fiberlink, from Blue Bell, will be leasing 30,000 square feet and IHS Global will be moving from Delaware County into 22,538 square feet.

CBD Philadelphia has also had the highest volume of large leases. The majority of the downtown deals were renewals, but most tenants maintained their occupancy levels. A few firms leased more space, including law firm Cozen O’Connor. Southern New Jersey also gained ground. Companies such as Title Resource Group and Comcast expanded. Burlington Coat Factory will remain in New Jersey and build a new 180,000-square-foot headquarters. The Northern Delaware market outlook is better than it was a year ago. Law firms and financial sector firms have been active.

— Brendan Leahy, senior vice president with Colliers International’s Philadelphia office

Philadelphia Multifamily

Yablon

Demand for rentals will remain firm in Philadelphia, while rising rents will prompt builders to advance projects put on hold during the recession. After construction came to a crawl over the past few years, operations recorded significant improvements in that time as fundamentals caught up. In fact, through the second quarter of this year, vacancy has fallen nearly 300 basis points from its peak in early 2010 due to multiple factors, including an uptick in home foreclosures as well as stringent underwriting for home mortgages. As a result, the median price of a single-family residence has dropped to a five-year low, while the homeownership rate has fallen to a level last seen in the late ’80s. A large portion of the newly employed will turn to rentals and target communities near entertainment and employment hubs in Philadelphia County and surrounding areas where solid rent growth and tight vacancy will jump-start construction. In the suburbs, developers are purchasing land once zoned for commercial use and building large, Class A complexes instead. If all of the new supply comes online, operators will face greater competition as early as next year.

As the economy continues to improve, developers are moving forward with plans to deliver additional rental units to the Philadelphia MSA. On an annual basis through June, construction output reached 645 new units, increasing inventory by 0.3 percent. The 230-unit Jefferson at West Goshen came online in the Central Chester submarket, boosting stock by 2.6 percent. Approximately 1,700 units are under construction in Philadelphia, which is equivalent to 0.8 percent of total inventory. More than 600 apartments will land in the Burlington submarket by 2014, inflating supply in the area by 5.5 percent. More than 5,600 units remain on the drawing board, with 700 apartments proposed for the Upper/Lower Merion submarket, while Center City could receive 830 units of the planned inventory if all the projects are completed.

Firm tenant demand during the last year supported a 110-basis point decline in vacancy, including an improvement of 70 basis points in the first half of 2012. Vacancy of 3.6 percent at midyear marks the lowest vacancy level since 2003. Robust job gains in the financial services industry as well as the professional and business services sector ignited demand for Class A apartments in the last year. Tenants occupied more than 1,600 top-tier units during this stretch, tightening vacancy 110 basis points to 4.1 percent. Limited new supply and employment-generated demand underpinned an 80-basis point improvement in the Class B/C vacancy rate in the first half of the year to 3.1 percent. In the previous six months, vacancy compressed 40 basis points.

In the first six months of this year, operators lifted asking rent 0.4 percent to $1,048 per month, which is a modest slowdown from the prior two quarters, when rents increased 1.1 percent. A similar trend unfolded with effective rents, which rose 0.9 percent so far this year to $1,007 per month, after recording growth of 1.2 percent in the second half of 2011. Class A asking rents increased in nearly every submarket during the past 12 months, bolstering an overall improvement of 1.7 percent to $1,252 per month. Class B/C asking rents ended the second quarter at $854 per month, representing growth of 1.1 percent from a year earlier. Along the Main Line in Delaware County, asking rents rose 3.6 percent from a year ago to $1,202 per month, while Center City recorded the highest rents of $1,667 per month, annual growth of 1.3 percent.

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

©2012 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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