Philly Multifamily: Supply and Demand Neck-in-Neck
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Will an influx of jobs mean enough renters in Center City to keep even with the influx of new units coming on line, maintaining the market’s strong occupancy (about 95%)? Probably, according to our panelists at Bisnow's fourth annual Philadelphia Multifamily Summit at the Ritz-Carlton. That’s because Center City’s a more desirable place to live than ever.
Class-A properties aren't the only ones benefiting from a strong market. LEM Capital principal David Lazarus says that his company remains bullish on multifamily supply and demand fundamentals, particularly in the Class-B value-add sector. The opportunity to create value by buying properties from dysfunctional owners, or where exterior and interior renovations can increase rents, remains compelling even as the market is increasingly competitive. “Flying under the radar" of larger investors with midsize deals helps them "penetrate" a niche of the market and avoid institutional competition, he says.
Korman Communities co-CEO Bradley Korman says that there will continue to be new investment deals coming online as capital flows into the market and yields continue to be strong. Institutional capital still sees Philadelphia as a relative bargain compared to New York and DC, even as cap rates start to slide below 5%. His concern is that the premium a developer once enjoyed for assuming the risks of new development is dwindling steadily. Where there used to be a 200-300 bps premium to develop versus acquire, that's shrunk to 125-150 bps. That might be fine as long as rates stay low, but how does that turn out when rates rise?
Morgan Properties principal Jonathan Morgan says that the most compelling buying opportunities are the large one-off transactions and portfolio deals in the Maryland-DC Corridor, which have better pricing execution given the limited competition. He notes that his company’s being priced out of deals in Philly since they are either too small or don't have enough of a value-add component. “I feel that the market is starting to get a bit frothy, so you need to be disciplined as an investor,” he says.
Alterra Property Group managing partner Leo Addimando says his company is building apartments targeted to urban families and empty nesters, which have dog- and kid-friendly amenities, and larger units. Pet owners as tenants tend to be very "sticky" and they're an ever-increasing percentage of the tenant population in urban settings. He adds that the old rent ceiling in Center City Philadelphia was $3/SF and is now $3.50/SF, and he expects that to trend toward $4/SF over the next five years.
PMC Property Group EVP Jonathan Stavin says PMC is bullish on Philadelphia, building slightly larger apartments than in the past, and including more two-bedroom units. He adds that the 10-year tax abatement program is essential to help offset the high construction costs relative to market rents. PMC is also active in Pittsburgh, Baltimore, Winston-Salem, NC, and Columbia, SC.
CBRE SVP Spencer Yablon says that interest rates will rise eventually, but when and why are critical questions. If the economy continues to improve, with more jobs and higher wages, interest rates will eventually rise. However, if they stay this low for too long, he says, we may see further equity and debt spreads compression, forcing investors and lenders to accept lower returns for the same risk. That would make it more difficult for the market to absorb future interest rate increases when they occur. Add to that the new supply, which will certainly temper NOI growth, and there’s additional risk for multifamily. Properties experiencing NOI growth from higher rents and occupancy would see that offset by higher interest rates, to a degree.
The speakers also stressed the importance of 20- to 30-year-olds who are renters by choice, unwilling to invest in a house and give up the flexibility that renting offers. This sector wants high-end finishes, WiFi everywhere, and amenities that they otherwise wouldn't get in any starter home. Also, they prefer to shop for their apartments online, often not seeing their actual units until the day of move-in. RD Jones principal Rebecca D Jones gave the opening remarks at the event, and the two moderators were Cozen O’Connor member Howard Grossman and McGladrey partner Beryl Simonson. Cushman & Wakefield senior director Karen Iman also spoke at the event.