Taxes, Schools Are Biggest Challenges To Philadelphia Market, Say CRE Industry Leaders

by Steve Lubetkin, Globest.com
Commercial real estate developers around the Northeast are more interested in Philadelphia because of its lower cost of living and the ability to earn money from projects here, according to industry leaders on the opening panel at yesterday’s RealShare Philadelphia conference, produced by GlobeSt.com’s parent ALM Real Estate Media, at the Union League Club in Center City.

This interest comes despite challenges facing the city in terms of its struggling public school system and a tax structure disliked by most of the business community, panelists say.

“I think there is a new energy in the city, and all of you guys are doing some incredible development work,” says Anne Fadullon, director of planning and development for the City of Philadelphia. “The city is ready and willing to assist you to try to move that ball forward, and we realize that we have some significant challenges as well, but we have great people in the administration and we have great partners in all of you.”

Noting that she has only been in her job five weeks, Fadullon joked that “I have my head totally around it and I know exactly what I’m doing.”

The city is seeing growth that it hasn’t seen in a number of years, said Fadullon, citing 38 major projects underway, representing about $4.7 billion in combined public and private investment. By 2018, she says, $6.7 billion in completed projects in Center City is expected, including 6,700 residential units, 2,000 hotel rooms, two million square feet of new commercial mixed-used development, and more than 2.3 million square feet of new retail space.

The Navy Yard and University City submarkets continue to grow as well, Fadullon says, with more than seven million square feet of commercial space occupied at the Navy Yard and more than ten million square feet under construction or recently completed in University City.

“In spite of what we hear about all this luxury housing being built, we still have a relatively affordable cost of living,” she said. “We’re about 80 percent of that in New York City, and our median home prices are still about 50 percent less than Boston, New York, or Washington.”

Charles McGrath, managing director of Washington-based MRP Realty, says his firm was attracted to invest in Philadelphia by several factors, including cap rates, the city size, and job growth trends.

“You can buy office at a seven [cap rate] here, in DC it’s six on average, and in New York it’s five,” he says, noting that average residential cap rates for the three cities are five, four, and three, respectively.  As previously reported by GlobeSt.com, MRP recently acquired four office buildings from Kaiserman Company in the Market East submarket, including the landmark Bourse Building on Independence Mall.

“Philadelphia is the second biggest city on the East Coast, and the eighth biggest job market in the US,” he says. “If you really start peeling back what that means to us, it means job growth, and I wouldn’t be here if it wasn’t for job growth.”

In the office market, the arrival of Shorenstein Properties and other outside capital is a positive sign for development growth.

“Historically, a good year was maybe $800 million to $1 billion in total office trades,” says Walters. “In 2016, we feel very confident that we will do at least $1.5 billion in office trades, and perhaps even as much as $1.7 billion.”
Millennial “hipsters” and Baby Boomer empty-nesters both continue to play a key role in growth of multifamily development, but it isn’t a new trend, according to Carl Dranoff, president and CEO, Dranoff Properties, who recalled his earliest multifamily development in 1982, a project called the Wire Works, at 3rd and Race Streets.

Dranoff’s Left Bank development in University City has 282 apartments and 260 parking spaces. When the project was completed in 2004, Dranoff says, every parking space was rented, but today, half go unleased because Millennials aren’t driving cars. Whether they stay in the city depends on the quality of life.

“The City will have a big say, with the school system, with parks and recreation, with fundamental clean and safe services,” Dranoff says. “I think we have a real opportunity to keep the Millennials, and keep driving new development, driving the retail economy, new apartment buildings, and new office workers who also want to be urban.”

Panelists agreed that a major challenge facing further development in the city is the condition of the city’s public school system.

“No city in the Northeast other than New York has solved for good neighborhood public schools,” warned Matt Pestronk, president, Post Brothers, which is redeveloping several trophy properties in the region. “How is the business community going to become engaged, since government has heretofore not solved the issue of public schooling. That’s really what’s going to drive office buildings to be worth $500 a foot, when people can draw a large, educated employment base from within the city, and it’s what’s going to cause our residential rents to grow everywhere. That’s what will stabilize the neighborhoods.”

Panelists also said the current tax structure is slowing investment.

“The tax structure is still an issue,” says Chip Walters, chief investment officer, Keystone Property Group. “I’m an office guy, so to me, the tax structure presents a challenge to the continued growth and an opportunity to accelerate it.”

“The tax structure is what discourages job growth in the city,” says Dranoff. “If we ever change it, we will attract so much capacity in job creation, our heads will spin.”

More than 300 market participants attended the conference. Check back for coverage of the other panels at RealShare Philadelphia later this week.
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