Philly Multifamily's Price Problem And 4 Other Things We Learned At The 2018 Forecast Event

The panelists looking ahead at Bisnow's 2018 Philadelphia Forecast event covered a diverse range of topics as specific as Schuylkill Yards and as broad as the national debt market, so we have compiled the biggest takeaways in an easily digestible list for you. Consider it an early Christmas present.

Multifamily supply boom hitting top of market hardest

Though some are resistant to using the term “oversupply” to describe the ongoing influx of apartments in Philadelphia, it is no secret that construction costs restrict all new-construction apartments to charging rents at or near the top of the market.

One of Philadelphia’s biggest advantages in drawing millennials — it is second in the country in terms of millennial growth, according to Longfellow Real Estate Partners Managing Director Jessica Brock — is its affordability compared to New York and Washington, D.C. But newly built apartments in Philly are targeting rents at an average of $3.50/SF, according to JLL Research Director Lauren Gilchrist, or $3,500/month for a 1K SF apartment. For most Philly renters, that is an astronomical figure.

“You can go to tons of places in nice areas that are considerably cheaper than that, so I’m not sure who will be paying those rents besides professionals landing in Philadelphia for the first time or empty nesters coming into the city,” Gilchrist said.

The lease-up numbers bear that out. Available apartments costing $3.50/SF are about 60% occupied, according to Gilchrist, compared to 80% of apartments between $3 and $3.50/SF. Apartments that rent between $2 and $3/SF are over 90% occupied.

The continuing difficulty of buying a house, even for those making a decent wage, means that millennials are likely to stay in the renting market for longer, as their wages figure to increase eventually. Because of that, and landlords’ willingness to offer generous concessions, Gilchrist has no long-term concerns about multifamily absorption in the city.

Schuylkill Yards will feature life science heavily

When Drexel University and Brandywine Realty Trust broke ground on Schuylkill Yards, the partnership announced it would bring in Longfellow Real Estate Partners as co-developer on the new office buildings planned for the site. Because of Longfellow’s specialty in life science, the office component of those planned developments after the renovation of 3001 Market St. will have a focus on companies in that industry.

“What makes [University City] a successful life science area is the mix of small, medium and large companies — the institutions, the startups and the key element of the mid-size companies that grow out of the startup space,” Brock said.

The first phase of Schuylkill Yards will be a 1.5M SF mix of office, residential and retail, Brock said, but life science will be its main draw. Longfellow has completed projects in “knowledge clusters” like Boston and the Research Triangle in North Carolina and views Philadelphia as a market with similar potential.

“The size of the life science market right now is already 11M SF, but 9M SF is in the suburbs, so Philly will continue to be a strong life science market,” Brock said.

Brandywine, Drexel and Longfellow are all betting that Schuylkill Yards is attractive enough for its design and proximity to University City’s "Eds and Meds" that it can draw some of those life science companies inside city limits. They are also hoping to grow some of their own.

Suburban office is perhaps the toughest investment asset class

All across the country, it seems that one asset class has become the least attractive for investment dollars: suburban office. Precious few buildings are close enough to mixed-use assets or public transit to take advantage of the demographic trend toward urban living and away from car dependence, and the result is a market out of favor with the deep pool of investors looking to deploy capital.

“Two-thirds of job growth in America is in the major cities,” Steinbridge Group CEO Tawan Davis said. “From 2010 on, populations have been growing faster in cities than in rural and suburban areas for the first time in a century. So I think that’s enough to say this is a long-term trend, which is why you have a tougher time selling suburban office buildings.”

This could be of particular concern to the Greater Philadelphia market, which has a high concentration of its office product in the suburbs. Challenging business taxes in Philadelphia remain a deterrent to potential office tenants, which puts the market as a whole in a bind.

For years, developers and investors in commercial real estate have been calling for a change in the tax structure to be more friendly to businesses. With the new federal tax bill having passed Congress and due to be implemented at the start of the new year, it remains to be seen what impact it will have on local tax structure.

Beside any tax changes, Brandywine Realty Trust Chief Investment Officer George Hasenecz recommended improving the commute out of the city to rejuvenate the office market. Widening Interstate 76 does not seem to be in the cards, so improving and expanding the SEPTA regional system seems like a no-brainer.

“Despite all the vibrancy [in the city], we still have the majority of people that live here commute to jobs in the suburbs, so if people can take the train rather than driving and sitting in traffic, that’s a real positive,” Hasenecz said.

The debt market is "white-hot"

A common refrain among the capital markets crowd is that a deep pool of investors sits ready to deploy capital, but there are not enough deals to be done. That has contributed to the debt market seeing a host of new entrants.

Banks remain among the most reliable sources of debt, but life companies and private funds have also increased activity. CMBS loans have been making a comeback as well, according to Rubenstein Partners head of finance Scott Whittle.

All of that amounts to white-hot competition in the loan market, Whittle said. According to RAIT Financial Trust Senior Managing Director Gregory Marks, that should be cause for concern.

“There are way too many capital sources in the market,” Marks said. “As the most cynical lender up here, I liken this to the end of 2006 where a lot of groups saw the returns being realized by debt funds and the CMBS market. There were a lot of new entries, and many of those aren’t around today.”

Marks predicted 2018 would see the apex of this cycle’s lending activity, in part because the difficulty in the investment market could lead to increased interest in refinancing among building owners. The downturn would begin in 2019, Marks said.

Some of that concern is due to the increase in debt funds over the last few years from players that wish to capitalize on the hot market. According to Whittle, the number of funds in the market has grown from 60 to 100 in the past two years alone. Life companies with similarly deep pockets are also putting pressure on banks and other established debt sources.

“We’re competing against players that we have no business competing against, like life companies blowing us out of the water with rates we can’t match,” Marks said.

Construction loans remain difficult

Even with so many players in the debt market and sky-high amounts of liquidity to be played with, most debt sources have been relatively reluctant to lend for construction — another reason refinancing looks like a solid bet in 2018. Banks have been especially cautious regarding construction, due to the amount of time they would have to wait before seeing any return.

“Coming from the banks, there may be a few more strings attached [with new construction] than with an existing asset,” Equus Capital Partners Director of Capital Markets Laura Brestelli said. “It seems to be very much sponsor-driven, where they save their dollars for their best customers. So borrowers may need to look farther, and the price may be higher than for existing assets.”

Even debt funds, aggressive in the refinancing, mezzanine and acquisition loan areas, are given pause by construction loans in today’s market. That may be especially true of Philadelphia, where construction prices rival those in New York but returns do not.

“Ground-up construction is harder for debt funds, and your total universe of available lenders shrinks dramatically from redevelopment deals,” Whittle said. “If you don’t have a specific amount of pre-leasing, it becomes more difficult and you need more recourse.”