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Philly Office Market Rings Bells
By Johnathan Berke - The Daily Deal
September 16, 2002 - Philadelphia's office market has always been a 'tweener. In recent years, for example, large real estate investors have opted to build or buy office towers in New York and Washington, D.C., instead of in the city between the both of them.
Indeed, while Philly office buildings boast a solid roster of financial services firms for tenants, New York still has Wall Street and is the financial capital of the world. Washington and Boston, meanwhile, are the dominant locales for the technology and telecommunications industries on the East Coast.
But look which city has had the third-most real estate deals for the first half of this year. The 11 real estate deals worth $798 million put Philadelphia behind just New York and Los Angeles in that time frame and ahead of Washington. And now national investors such as Douglas Shorenstein and Thomas Properties Group, which own several million square feet of office space between them, are cutting deals of their own in the City of Brotherly Love.
Why? Besides a stable lease outlook, no new inventory is coming on line and prices of the existing stock are low.
"[Philly] may not have peaks, but it does not have many valleys either," said Robert Walters, a senior managing director at CB Richard Ellis.
Shorenstein's privately held real estate investment company, Shorenstein Co., has never shied away from opportunity, and it may have found one in June when it purchased Two Liberty Place on Philadelphia's Chestnut Street.
Shorenstein officials didn't disclose a value for the deal, but most media reports put the price at $167 per square foot, or about $200 million.
The property is entirely leased to global insurer ACE Ltd. right now, but that lease is up in 2006. Shorenstein could then re-lease the building and create value, according to Gentry Hoit, an executive vice president with Shorenstein.
"We've liked downtown Philly for years and always wanted to own a top building," said Hoit, adding that Shorenstein may pursue other opportunities there.
Right now, there is plenty of space for tenants to move to.
The vacancy rate of 13.15% for the city's central business district is the highest since 1997, according to Northbrook, Ill.-based broker Grubb & Ellis Co.
"Philadelphia's long-term structural impediments as a regional head office market have made it susceptible to downsizing through corporate mergers/acquisitions and a weak economy," according to a recent research report from Merrill Lynch & Co.
But that softness in office vacancies may actually work in landlords' favor. No major new construction is under way in Philadelphia, so while tenants may have choice now, they're not likely to in the near future.
That's no small consideration, considering that the city's downtown area is small relative to other cities. To stay within Philadelphia's core won't be easy.
Economically, this is apparent in office rents which, despite the double-digit vacancy rate, averaged $23.79 per square foot in the central business district for the second quarter of 2002, according to Grubb & Ellis.
Naturally, if companies with offices in Philadelphia continue to downsize, the value plays that Shorenstein is making will turn into real gambles.
One prime example of such a situation involves Centre Square, a Class A office building in Westside, which is Philadelphia's main downtown section. The property could witness tenant problems sooner than later.
To be sure, the 1.9 million-square-foot Centre Square is considered risky because three-quarters of its tenant base will have to deal with their leases expiring within the next two years. That's far sooner than what Shorenstein faces with Two Liberty Place.
Nevertheless, Centre Square is reportedly attracting interest. Speculation has it that HRPT Properties Trust, a Newton, Mass.-based real estate investment trust, is in the final stages of acquiring the 43-story tower from Metropolitan Life for $190 million.
One Philadelphia-area broker familiar with the property noted that global management consultant Towers Perrin has options to renew its lease in the building at what is believed to be below market prices and is likely to renew its contract for the 500,000-square-foot space it now has.
(Towers Perrin, which occupies more than 25% of the total commercial office space in the building, isn't the only one in Centre Square with a lease due to expire. Comcast Corp and Wachovia Corp. are in the same boat.)
HRPT didn't return calls seeking comment, but buying a trophy property within the Philadelphia office market wouldn't be out of left field.
To be sure, HRPT isn't a typical REIT. Unlike Shorenstein and other REITs, HRPT's properties are managed outside the company. In addition, HRPT is as intent on buying stakes in real estate companies as it is individual properties. For instance, it holds or has held stakes in a hotelier, Hospitality Properties Trust, and a senior living company, Senior Housing Properties Trust, which it spun off.
But the quirky REIT already derives 22% of its office building revenue from the Philadelphia area. And if HRPT does make a deal involving Centre Square, area brokers believe HRPT will become the city's biggest office landlord.
Of course, an anonymous REIT being the largest office-space owner in Philadelphia would be particularly fitting, since the city is already under the radar for many real estate investors.
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