Philly's Stability Continues As Trump-Based Uncertainty Has Waned For Investors
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A year ago, investors in commercial real estate looking ahead to 2017 had no idea what to expect. Donald Trump had just been elected as president, with no policy background to speak of and a campaign full of erratic behavior and incendiary rhetoric.
Ten months into his presidency, investors feel more confident that they know what to expect from Trump, and the end of 2017 has so far not seen the pause that the previous year’s fourth quarter experienced. According to Equus Capital Partners Director of Investments Kyle Turner, there is less uncertainty overall heading into 2018.
“At our leverage levels, which are generally pretty conservative, we’re able to secure multiple forms of debt financing for our projects,” Turner said. “People are generating good market returns without taking huge risk positions.”
Even early this year, many were uncertain about how the new administration would affect the federal interest rate, causing a slowdown in lending. Though nothing is set in stone, an actionable picture has begun to form. Equus Director of Capital Markets Laura Brestelli predicts the rate to rise three times in 2018.
“I think there is not a great deal of uncertainty over what will happen to short-term interest rates in 2018,” Brestelli said. “It’s beyond 2018 when you need to determine whether you [should] have a conservative approach.”
HFF Senior Managing Director Doug Rodio agrees, though he cautioned, “If we’ve learned anything during this presidency, it’s that it’s next to impossible to predict what comes next.”
“Interest rates are still at historically low levels, first and foremost, and we don’t see any real signs for why that should change in the near term,” Rodio said.
Rodio went one step further and claimed that the uncertainty following last year’s election was less tied to the unpredictability of the president-elect than it was a pause that happens after every new president is elected as the finance community sizes up the incoming leader. Brestelli said Trump simply is not as transformative a president regarding the business world as he made himself out to be.
“I don’t think [the Trump administration] will be as effective on sweeping change as they promise themselves to be, so don’t think there will be major changes as a result of administrative policy,” Brestelli said.
In Philadelphia, more diverse capital and debt sources are in the pool than ever before, and in greater numbers due to increased confidence and its higher yields than most comparable markets. The biggest limiting factor is the number of potential investments out there, and it has produced an incredibly competitive environment, making it difficult to find deals at acceptable returns.
In a strange twist, the competition has likely slowed deal-making, or as Turner put it, “Everyone is sticking to their knitting.”
“That’s the predicament we’re all in right now,” Turner said. “We have to be understanding that returns are going to drop, and we have to either be more aggressive in driving value, or accept a lower return in exchange for stability of capital.”
The most popular, and thus most competitive, assets in the region as 2017 draws to a close are value-add multifamily developments in the suburbs and industrial real estate, especially in New Jersey and the Lehigh Valley. Both have their own barriers to entry — multifamily buildings positioned well enough to add significant value are in short supply, and industrial buildings more than a few years old are becoming obsolete faster than ever as the demands of tenants change rapidly, leaving the ones that are well-suited prohibitively expensive.
“It’s cheaper to build industrial than buy it,” Turner said.
Office properties in Philly’s central business district have some divided. Turner and Brestelli believe this investment cycle has mostly run its course, pointing to large transactions like Centre Square and the Duane Morris building as some of the last major deals available in the city. Rodio, on the other hand, believes the path is clear for more, smaller deals in the coming year.
“After the sizable Centre Square transaction, it’s tough to say that there will be more investment dollars spent in 2018 than there were in 2017, but I’d expect that there would be more transactions in the midmarket as the top has cleared,” Rodio said.
Equus and HFF’s differing opinions on office are borne out in their recent moves. While Equus is departing Center City for its Ellis Preserve development in Newtown Square, HFF moved from Conshohocken to 1700 Market St. on Monday. Brestelli referenced the City of Philadelphia’s “cumbersome” business climate as a reason for the move, and noted that the quality-of-life differences are shrinking between the city and certain suburbs.
“There are some very strong submarkets that have a focus on building a live-work-play environment with some aspects of an urban lifestyle,” Brestelli said. “People feel like they don’t have to get in their car to get everywhere, without having to deal with the city.”
Turner said suburban office is also drawing investor interest, noting that capital and debt sources want to put their money "where the people are." His position stands in contrast to indicators like Workspace Property Trust's delayed initial public offering, which was due to investor interest not matching its anticipations.
Rodio said that for the young talent that HFF targets, location in the city is a big factor in attracting and retaining it.
Across properties, the wide availability of debt and capital and the relative paucity of investment opportunities could lead to property owners creating new ones, such as office occupants leveraging buildings they own for revenue infusions.
“Owners that we’ve talked to have considered monetization either through a sale or a refinance,” Rodio said. "Not only will there be increased sales, we think the amount of refinancing will also go up in 2018."
Contributing to the eagerness of businesses and investors to tap into Philly’s capital markets is its stability. It is all but a truism that Philadelphia does not do “boom and bust” on the scale that other cities, particularly across the Southeast and Southwest, experience. Part of that is due to the city's business environment.
“It protects against the boom, and without the boom, you’re never going to have a bust,” Turner said.
Despite his frustration with the relative lack of job and office rent growth, Turner said the stability has its benefits.
“You feel pretty protected that your investment environment will be secure, and the question becomes how significantly you can grow revenue and harvest value,” Turner said.
Come discuss the investment future of Philadelphia among other topics at Bisnow's Philadelphia 2018 Forecast event Dec. 13.