Commercial Real Estate: HOT AT THE CORE

In-house researchers at the global real estate giant Hines were crunching data on U.S. cities three years ago - incomes, ages, education levels - to decide which markets to invest in.

Their top two picks, Manhattan and Chicago's West Loop, were expected.

The third, not so much: Philadelphia's Center City.

"Were we surprised? Yes, a little bit," said Chuck Watters, Hines' senior managing director for Mid-Atlantic operations. "But when you kind of walk around the streets a little bit and see what's going on, it's less surprising."

Today, the Houston-based company is a partner in the 26-story luxury apartment tower rising near 12th and Walnut Streets, placing it among the increasing number of out-of-town developers working on big Center City projects.

But it's not just builders catching the Philly bug.

Out-of-town investors are driving commercial real estate prices to new highs, while companies from the Philadelphia suburbs and beyond expand into Center City office buildings. Trendy new retailers, meanwhile, are making an early splash in the city as they roll out their brands, and hoteliers are rushing to cash in on its newfound clout as a tourism destination.

"There's a real vitality here," Watters said. "There's a vibrancy."

Some strong headwinds do persist for Center City, such as the seemingly intractable poverty in many of Philadelphia's other neighborhoods and a high wage tax that wards off some businesses. Even as the employment picture brightens here, it continues to lag that of other big cities. And many doubt that the youthful new residents fueling much of the downtown resurgence will stay to start families.

But there's a palpable sense that Philadelphia is turning a corner after decades of stagnation, and out-of-town interests are taking notice.

That's important, said Paul Levy, president of the Center City District business association, because existing businesses aren't expanding at a fast enough clip to give the city the boost it needs to keep growing.

"The city is getting discovered," said Levy, whose organization is pushing for a legislative fix to the wage-tax issue, among other initiatives to capitalize on this brightening national profile. "The old urban-decline narrative is over."

Young and affluent

Philadelphia is benefiting from the tide that's lifting downtowns nationwide, as more Americans come to value dense, walkable living environments with ample places to shop and dine.

The result has been a growing population of young, well-educated, affluent residents in a city where it's still relatively cheap to build, rent office space, and open stores.

The population of what's known as Greater Center City rose more than 16 percent to about 183,000 in 2014, from below 158,000 in 2000, according to U.S. census data compiled by the Center City District.

Average income in that area - bounded by the Schuylkill to the west, Spring Garden Street to the north, the Delaware River to the east, and Tasker Street to the south - soared about 67 percent, to $98,000, in that time, the data show.

Philadelphia also had the fastest-growing population of millennials - the 20- to 34-year-olds considered a target market for new apartments - among the 10 U.S. biggest cities between 2006 and 2014, according to a comparison last year by the commercial real estate services firm JLL.

Apartment developers are rushing to build for that demographic.

A February tally by the Center City District found 23 major residential, primarily rental, projects due for completion by the end of 2018 across Greater Center City, accounting for 4,216 units, a surge over previous years' rates of construction.

Big opportunities

Seven of the 10 biggest projects are being completed by, or in partnership with, out-of-town developers - many new to Philadelphia. Among them: the East Market mixed-use project being built by the Washington-based National Real Estate Development on Market Street between 11th and 12th Streets, which is set to include 322 apartment units, with more planned.

National Real Estate decided to develop the complex - which also includes shops and offices - after dipping its toe into the Philadelphia market as a lender and investor on other residential projects, managing director Daniel Killinger said.

It saw firsthand Center City's rising rents and low vacancy rates, which promised solid gains when paired with development costs low in comparison with more established markets.

"There are opportunities to get returns in Philadelphia that the prices in San Francisco and New York make it difficult to get," Killinger said.

A similar sentiment is expressed by the real estate investors snapping up existing Center City office buildings in search of returns that have become elusive in other cities.

A bigger portion of Center City's office real estate went to out-of-town investors last year than at any time since 2007, a trend that appears to be continuing into 2016, according to an Inquirer analysis.

This year's first three $100 million-plus sales went to buyers from outside the region: the former 30th Street Post Office building at the western edge of Greater Center City, now known as Cira Square; the 1700 Market St. high-rise; and a package of Old City properties that include the historic Bourse Building.

Competition among the enlarged pool of office-property buyers is helping to drive purchase prices to previously unseen highs - up 71 percent, to $173.70 per square foot, during the three months ended June 30 compared with the same period in 2012, according to the commercial real estate firm CBRE.

"There are new players that haven't been here before, and they're willing to pay above what were previous benchmarks in pricing," said Bill Luff, founder of the commercial real estate consultancy CRE Visions. "They're willing to be more aggressive."

Justifying those rising purchase prices are the increasing rents that office landlords are able to charge for Center City space. Here again, the impact of out-of-towners is evident, since they account for many of the city's biggest new leases.

Last year saw companies from outside Philadelphia sign leases in Greater Center City for a record-breaking 450,000 square feet of office space - an area bigger than the Dow building on Market Street - according to the real estate services firm Newmark Grubb Knight Frank.

"What was typically a very mediocre-to-weak market in the office sector is now underpinned by an element we've never had," Wayne Fisher, an NGKF managing director in Philadelphia, said of the new entrants.

Leases signed in 2015 included those of the American Bible Society, which moved its headquarters from New York into 100,000 square feet at 401 Market St., and Independence Blue Cross, which is shifting staff from two suburban offices into 228,000 square feet at 1900 Market.

DiD Agency, an Ambler-based advertising firm focused on health and wellness brands, opened a 7,900-square-foot office in the Graham Building at 30 S. 15th St. earlier this year. It wanted to get closer to Center City's creative young workforce so it could recruit from among its members more easily, said Peter Kenney, a DiD partner.

"Our ability to grow was a little bit hampered by the slow pace we had of bringing on people," Kenney said. "People who weren't coming to us - who were talented - had a desire to work closer to home, and a lot of them were younger people who lived in the city."

That growing population of increasingly affluent residents also has been noticed by big national retail and restaurant chains, helping Center City slowly join the likes of Boston, Washington, and San Francisco as a relatively early stop for national retailers as they expand through the country, said Tom Londres, president of the retail brokerage Metro Commercial Real Estate Inc.

"They're kind of saying, 'Hey, people are moving to these cities, so let's go chase our customers there,' " he said. "Philly is part of that."

Among the recent arrivals is New York-based Bonobos, a formerly online-only men's clothing retailer that opened a store at 1519 Walnut St. Friday, hot on the heels of locations in more likely cities like Los Angeles, San Francisco, and Chicago.

Bonobos was drawn by what its research said was a rich vein of sophisticated shoppers, and by the vibrancy of the area's existing retail environment, said chief revenue officer Erin Ersenkal.

"For us, going to Philadelphia was a no-brainer," he said. "We've been looking at Philly since the beginning."

New stores like Bonobos are adding to the growing retail buzz around Philadelphia that led Condé Nast Traveler magazine to name it the No. 2 shopping city in the world last year.

Hotel demand

Center City's shops and boutiques are combining with its homegrown restaurant scene and cultural draws to lure ever-greater numbers of visitors, stoking demand for hotels.

Fourteen hotel projects now in the planning stage or under construction in and around Center City would bump up the number of rooms by nearly 2,765, or 19 percent, from about 11,600, the sharpest increase since the surge that surrounded the Republican National Convention in 2000, according to Peter Tyson, a managing director at CBRE Hotels in Philadelphia.

Among those projects are the two hotels planned on South Broad Street by the Los Angeles-based hospitality mogul Sam Nazarian's SBE Entertainment Group: the 152-guest-room SLS Lux Philadelphia Hotel & Residences and the 76-room Hyde.

SBE, which has until now mostly associated itself with prominent destinations like Beverly Hills and New York, is coming to Philadelphia to serve what it sees as unmet demand for trendy high-end lodgings in an increasingly cosmopolitan city.

"We are definitely bringing a level of sophistication and a level of guest experience that would challenge any cosmopolitan opportunity in the United States," said Arash Azarbarzin, president of SBE's hotel group. "We will be another catalyst, another ingredient in this big recipe of what Philadelphia is becoming."

Source: Philly.com