Behind Alterra Property Group's 'unrelenting' pursuit to buy 1701 Market

Alterra Property Group long identified the soon-to-be vacant Morgan Lewis office building at 1701 Market St. as the most ideal candidate in Philadelphia for an office-to-residential conversion.

As the deal was on, off, and on again — Alterra’s purchase of the building closed on Thursday — the Philadelphia development company that specializes in adaptive reuse remained committed to its vision.

In July, Alterra received city approval to convert the building into 325 apartments. Alterra Managing Partner Leo Addimando said plans now call for 299 units.

The developer’s determination persisted through economic headwinds even after costs increased so much that a previous contract agreement was terminated, as reported by the Philadelphia Business Journal in February. The property’s zoning, location, geometry and occupancy made it a favorable building to convert into 299 apartments, the largest planned in Center City since the start of the pandemic.

Addimando declined to disclose the price Alterra paid New York-based LXP Industrial Trust (NYSE: LXP) for the 305,170-square-foot, 18-story office building that has been the longtime Morgan Lewis & Bockius headquarters.

“There are only three things that matter in real estate development: The cost of the land, the total cost of development and the rents,” Addimando said. “Our forward-looking view on the rents hasn’t changed. Our total development cost sort of stayed the same. … The only variable that may or may not have changed is the purchase price.”

When the deal fell through over the winter, Addimando cited construction costs increasing 10% to 20% annually for the past five years and financing costs increasing from 3% to 8%. He said the math equation to make deals work was “basically broken.”

Seven months later, as the value of low occupancy office buildings continues to decline, Alterra closed a deal that Addimando said is now financially viable.

Addimando credited Alterra’s Director of Acquisitions Connor Burke and Senior Vice President of Development and Construction Mark Cartella for being “unrelenting” in their pursuit of the project, even after the previous deal fell through.

Addimando said Alterra stayed in touch with LXP to settle on a price point that ultimately made sense for both sides.

“As my wife tells our kids, ‘When everyone insists on getting what they want, nobody gets what they want,’” Addimando said.

Over the past two decades, Alterra has built its reputation converting buildings into apartments, including turning the the 220,000-square-foot One City office building at 1401 Arch St. into 323 apartments.

Prior experience gave Alterra the confidence to stick with 1701 Market St., believing the key factors of a successful project were largely in place.

The building is shaped as a rectangle rather than a square, making it significantly more conducive to residential use than other large nearby office buildings. The property is zoned CMX-5, meaning residential use is allowed. The location is highly desirable, in the core of Philadelphia’s central business district, three blocks from City Hall, with direct access to Suburban Station.

“We worked very closely, cooperatively with the seller even in the period of time when we were not under contract over the past 12 months,” Addimando said. “We continued to stay in touch with the seller and express that we were continuing to spend money and time on the project.”

Morgan Lewis is moving to the new 305,000-square-foot, 19-story tower at 2222 Market St. built by Parkway Corp. The entire office space at 1701 Market St. will be vacant when the law firm’s lease expires in January.

That played a big role in Alterra’s interest in the building.

“The only thing worse than an empty office building is a half-empty office building,” Addimando said.

With Morgan Lewis leaving, Alterra can move quickly rather than needing to buy out leases or wait for office tenants to leave. Addimando said construction is planned to begin in January and be completed by early or mid-2025, but Alterra has structured its deals so it’s not pressured to start by a certain time.

The 13 stories of office space are planned to be converted into 208 one-bedroom apartments and 91 two-bedroom apartments. A previous version of plans for the conversion would have included studios, but the developer reconsidered because Addimando said demand for studios has waned.

The four-level parking garage with about 180 spaces is planned to stay intact. Ground-floor retail tenants include Trumark Financial bank, an AT&T store and Drybar hair salon. Those are planned to remain while 8,000 square feet of vacant space at North 17th Street and John F. Kennedy Boulevard is planned to be leased to a restaurant or retail tenant. Amenities are planned to include a fitness center and rooftop terrace.

Addimando said the two biggest challenges for developers in Philadelphia right now are interest rates and the significant amount of new housing supply on track to deliver in 2025 that will serve as competition.

“So it takes some conviction and a long-term perspective to buy a building, potentially deliver it in ’25 when there will be a pretty good oversupply, I think, of Class A apartments in Center City,” he said. “But take a long-term perspective on optimism around the city’s continued revitalization. We’re optimistic about the new mayoral administration. All these things come together. Take a long-term view, we feel pretty good.”