As Global Indicators Cause Concern, Philly Banks On Its Slow-And-Steady History

After a protracted recovery from the Great Recession, it appears that the national and global real estate market is beginning to wobble.

Rising interest rates, a declining stock market and geopolitical uncertainty have combined to make some concerned that a recession could be on the horizon for 2019, but speakers at Bisnow's 2019 Forecast event at Yards Brewery were more optimistic on a local level.

“We’re all quite aware of what’s happening to the stock market and in our government, but we’ve had a very calm eight or nine years, so 2019 might just be a little more interesting,” Hunt Real Estate Capital Managing Director Harris Heller said at the event. “That might benefit Philadelphia more than others, because we’re a pretty steady market and lower debt cost would keep transactional activity moving forward.”

Philadelphia has long had a reputation as a market not as prone to booms or busts. While it did not enjoy the explosive growth that some cities in the Southeast and Texas have experienced since the recession, it also does not seem to have exposed itself to much of a crash either.

“We really resisted overbuilding in this cycle," Keystone Property Group Regional Director Todd Monahan said. "The main new [office] construction was just the FMC Tower, Comcast Technology Center and 2400 Market St., and all of those are pretty much full.”

Though some multifamily construction will likely continue, the bulk of development in that market has also run its course. The top of the rental market will likely take 2019 to stabilize from its current period of slow absorption and concessions, but asset classes below the trophy level remain as strong as ever, Hunt said.

Most of the large movement among office tenants has already taken place, which will likely portend a decline in leasing activity, HFF Senior Managing Director Doug Rodio said. But the stabilization of buildings that have landed such tenants should mean an increase in investment sales.

“I expect to see the largest Central Business District [building] trade in Philadelphia history occur in Q1, and there’s a gigantic office trade slated to close in Q1 in the suburbs,” Rodio said.

Though rising interest rates affect deals at every level of real estate, Rodio and Wells Fargo Managing Director Mike Petrizzi both believe that they are still low enough relative to expected yield in Philadelphia to make lending for acquisitions and bridge financing attractive.

In terms of making investment more attractive, nothing has driven more conversation than the Qualified Opportunity Zones policy enacted as part of the Tax Cuts and Jobs Act of late 2017. Although Philadelphia Director of Planning and Development Anne Fadullon and Mayor Jim Kenney echoed concerns that the policy could be a gentrification tool, they also pledged to fight against that risk on the citywide level.

“In a city like ours where we’re seeing strong growth and more than a quarter of our residents living in poverty at the same time, it’s our responsibility to bring in more investments, business and new housing," Kenney said during his keynote address. "But we have to make sure our growth benefits our existing residents and businesses and does not lead to displacement.”

The Department of Planning and Development and PIDC are both working to ensure that social impact is considered in opportunity zone investment not through restrictions, but by offering incentives that would come with additional local funding if met. As Alliance Partners HSP Managing Partner Richard Previdi and CLA principal George Kotridis cautioned, an opportunity zone tax break would not make a bad deal into a good one, but its incremental benefits are worth studying.

Mosaic Development Partners has long operated in disinvested areas, many of which are now designated as opportunity zones. While the bulk of investment activity has so far focused on areas that were already seeing significant development, like North Broad Street, Mosaic co-founder Leslie Smallwood-Lewis noted that more investors have sniffed around her company's projects.

“It has just brought more potential investors to our deals," Smallwood-Lewis said. "The challenging part that we’re seeing is that our current deal is worth around $7.5M. It’s a nice deal for us, but not big enough to attract institutional investors.”

The concerns surrounding opportunity zones largely focus on the lack of restrictions for investment, which define more traditional social impact projects like affordable housing. For developers like Mosaic that already operate in that space, opportunity zones add another potential funding source in opportunity funds to the complex capital stacks on which those projects depend.

Outside of affordable housing, another example for how opportunity zones can work as intended is Alliance's Arsenal project in the Bridesburg neighborhood of the city.

In November 2017, the company purchased 210K SF of former warehouse and factory space that housed munitions operations until the mid-20th century. Alliance has already begun the process of converting the buildings into creative office and light industrial space, but the project's location in an opportunity zone has cast it in a new light.

“With the opportunity zones, there’s a good chance that we’re going to be able to revitalize that and provide jobs and development that otherwise would not have existed,” Alliance Director of Acquisitions and Leasing Matt Handel told Bisnow after the event. “[Opportunity zones] do make projects economically desirable and feasible that would not be at a marginal level.”

Initially, Alliance planned to redevelop the Arsenal and flip it once it had stabilized to a degree, but the company is now considering a more long-term hold to take advantage of the capital gains deferment offered by the program. Alliance is also in conversation to bring in a Qualified Opportunity Fund as an investor.

A large portion of opportunity funds have so far focused on zones within the biggest markets like New York and Washington, D.C. But if Philadelphia maintains its relatively safe position as a downturn hits, opportunity zones will likely also benefit Philadelphia as a target for outside capital.

"Philadelphia has always been viewed as a place where you can get enhanced yield, and that’s what drives investors," Rodio said.