It's 'Pencils Down' For Philly Multifamily Development Amid Booming Supply, Fallow Financing

In the Philadelphia area, the prevailing attitude toward new multifamily development is the same as it is in most markets nationwide: don’t.

The construction boom precipitated by rock-bottom interest rates in 2021 is now in its late stages, with 2023 shaping up to be a massive year for new deliveries. Conversely, construction starts have plummeted in the past few months, thanks to spiking interest rates and insecurity among regional banks, panelists said at Bisnow’s Greater Philadelphia Multifamily Annual Conference at Xfinity Live! on May 11.

Rental supply still has a long way to go before it catches up with demand, but absorption is still expected to lag behind the rate seen in 2021 and early last year, panelists said. Stabilized apartment buildings can’t push rents the way they had in the past couple of years, and new buildings aren’t leasing up as quickly. 

“We were getting 20, 25 leases per month maybe a year ago for new product,” Hankin Apartments President and Chief Operating Officer Michael Hankin said at the event. “Now, we got 14 last month, and I was happy about that. So it's a little bit of a struggle on the lease-up side.”

Within Philly city limits, multifamily construction was driven by more than macroeconomic factors. The 10-year tax abatement for new construction was replaced at the end of 2021 by one worth half as much, a long-gestating change that prompted anyone remotely interested in development to file building permits before 2022, resulting in a bonanza of development proposals. 

The area’s construction industry lacked the capacity to build all of those proposed projects, but the city’s apartment pipeline still swelled to historic levels. But for developers with plans in hand that couldn’t close on their loans and land purchases to break ground by last fall, the decision before them may now be between waiting until next year and punting on parcels altogether.

“The name of the game is if you're going for a construction loan, try to delay it for a little bit,” Whiterock AI founder and CEO Jordan Girard said. “Because things are going to look brighter over the next three to six months. If you can wait three to six months, it might be worth saving a couple hundred [basis points] on that construction loan.”

Smaller, cash-poor developers may already have exhausted their capacity to wait for a construction loan to materialize, especially in an environment where the few regional banks willing to make any construction loans at all are heavily prioritizing sponsors with whom they have longstanding relationships, Hankin and Bozzuto Development Co. Senior Vice President Pete Sikora said.

Investors with deep cash reserves like real estate income trusts and family wealth offices are focusing on swooping in on development plots where a developer has failed to close on land acquisitions or, if they already own the land, can no longer stomach carrying costs, said Chris Luo, managing director of her family’s office, Willton Investment Group.

“There’s a lot of developers able to do some land banking with higher-risk land purchases,” Luo said.

Because of how uniquely difficult construction loans are to underwrite now, even debt sources prefer financing pure land acquisition deals, anticipating at least a year before starting the development process in earnest, if not more, Stonehill Strategic Capital President Daniel Siegel said.

“I like lending within that [land banking] sector,” he said. “There's not really a good supply nationally of developable lots. And I think we can all agree that actual housing demand is sort of artificially deflated by interest rates right now. And so as soon as those start to tick back down, I think you're going to see a lot of increase in terms of demand for housing stock. So we don't mind getting a little bit swelled with that type of inventory right now.”

One particular difficulty in obtaining construction financing is how much more expensive construction has become since the beginning of the pandemic, panelists said. Part of what makes that issue feel so acute now is that in 2021, rents rose so quickly that they kept pace with the upward spiral of construction input prices.

“For the next year, I would suggest that all developers just put pencils down so construction costs can drop,” Sikora said. “The capital will come back. It's just that other factors have to help out. And we can't just keep raising rents to solve the issue. And unfortunately, that's been the solution over the last few years. But the music stopped on that.”

Even though housing inflation is still rising — and despite the Federal Reserve continuing to raise interest rates — optimism was prevalent among panelists that fundamentals will recover enough to justify new construction in the next year. Finding enough short-term debt at the right basis for an early investment exit may be another story.

“What you're not going to see is three-year flips anymore; at least I don't think so,” Hankin said. “In the past five years, if you built it, you were going to be successful, and then you were going to be able to sell it in three years. And I don't think that model exists anymore, at least in the short term.”

Even if developers may never recapture the heady times of 2021, no panelist expressed concern that the resulting construction boom would have any lasting negative effects for the industry.

“There's only one criteria that determines whether a developer is going to build a project, and it's not market demand or anything like that,” Post Brothers CEO Mike Pestronk said. “It’s whether somebody will give them the money.”