Value-Add Multifamily Investing Is Getting So Competitive, Buying New Is Growing More Appealing

There is still a deep well of potential investors looking for places to put capital in Philadelphia, as has been the case for years now. But finding deals keeps getting harder.

The unprecedented rate of multifamily deliveries is predicted to finally slow down dramatically in 2019, giving all those new buildings — nearly all of which are Class-A — time to absorb and stabilize. 

At the same time, the pool of available capital isn't just getting deeper. It is also becoming filled with more diverse investors, such as institutional and pension funds and international groups. All of those players are less likely to take on ambitious redevelopment projects, which have become fewer and farther between.

“Gut renovation deals really don’t exist at this point in the cycle if they aren’t super overpriced," Post Brothers Director of Acquisitions Zak Klinvex said. 

Klinvex will be speaking at Bisnow's Philadelphia Multifamily Boom event Sep. 13, which will also tackle such topics as the potential impacts of a 1% construction tax and the new opportunity zones created by the recent federal tax law. He and other players in the city are still on the hunt for the few value-add deals left, including unique ones such as the Piazza in Northern Liberties that Post Brothers acquired in May.

The Piazza has few analogues in Philadelphia as a well-known, Class-A development that was seriously mismanaged by out-of-town owner Kushner Cos., leading to disappointing performance. Post Brothers will be doing some renovations to the units and common spaces, but believes it can add value simply by being more present and responsive, Klinvex said.

For plenty of investors, especially the out-of-towners, value-add might have become so competitive that newer, stabilized buildings have gained in appeal. Southern Land Co.'s sale of 3601 Market St. in University City, a project which was only completed in 2016, to a San Francisco-based investor serves as an example.

“Because [value-add multifamily] is so highly coveted as an asset class, the returns have been pushed down dramatically," CBRE Senior Vice President Spencer Yablon said. "You have to execute so perfectly to hit your yield targets that it might make more sense to just buy a newer asset.”

Concerns about the current development wave creating too much supply seem to have died down as people have become accustomed to the idea that many new building owners will simply need to be patient with their absorption numbers. Though the newest buildings are fighting over the most affluent renters in the city, a recent report by CBRE found that job growth has been better in Philly than in any other major eastern U.S. city over the past two years.

Philly being in first place in East Coast job growth over a two-year period is unprecedented in the past 28 years, according to CBRE Research Director Ian Anderson. The city's unprecedented run of strength, as well as its resistance to busts, has been the driving factor in attracting new sources of capital in both the debt and equity markets.

Post Brothers has experienced the effects of the current market, which overwhelmingly favors borrowers. Klinvex said the company has been able to start bidding wars between potential lenders in some deals. 

“I think the competition is a very real thing," Klinvex said. "We’ve had a few financings we’ve done where we’ve basically been telling people to turn around and try again with better terms, and 10 [capital] sources will come back two or three more times with better deals because they know others are [doing the same thing].”

All this new money in town looks likely to change investment dynamics over the long term, but one factor that could potentially drive them off is the inconsistency of property assessments — part of the uncertainty in Philly's tax structure that is driving real estate professionals mad.

“The lack of clarity on where assessments, and thus real estate taxes, might go on a property is an issue," Yablon said. "If I’m buying a property worth $100M at an assessment of $20M, and the city reassesses me at $100M, my taxes go up fivefold and I can’t even pay off my debt.”

But the growing presence of institutional investors in the city has a compounding effect, as more players notice where their competitors are placing their money and follow suit.

“Philly has always been a bit of a parochial marketplace, with wealthy families that have owned property here for generations," Yablon said. "And only in the last 15 years has it become more of an institutional market. Institutional owners are more likely than private guys to sell after a five-year hold, so though our velocity is picking up, it’s still below comparable metros.”

Yablon predicts that deal velocity will continue to increase at an accelerating pace as long as the assessment question doesn't become too thorny. If outside capital does not get scared off, it is likely that a solid number of the city's newest apartment buildings will trade hands in the coming years.

Discuss the constantly changing multifamily market with Klinvex, Yablon and all the other panelists at Bisnow's Philadelphia Multifamily Boom event at the Philadelphia 201 Hotel on Sep. 13.