Redevelopments Are Better Suited To Thrive Through A Downturn Than New Construction
Philly is riding a development wave in multifamily, but the market’s best bet going forward might the same thing that kicked off its 21st century revival.
Philadelphia continues to deliver apartments at an unprecedented rate, and the vast majority of new construction units charge rents at or near the top of the market.
No one seems to be suffering too badly from slow lease-ups or concession issues, but panelists at Bisnow’s Philly Multifamily Summit on Oct. 2 agreed that there is some softness in the market that could be compounded in a downturn.
“There has been a lot of construction going on, plenty of multifamily stock getting added, which may have led to longer lease-up time frames, some concessions, and maybe a little uptick in vacancy,” Hunt Real Estate Capital Managing Director Harris Heller said.
When Philadelphia began its rise from the ashes of the latter half of the 20th century, much of the housing stock added early on came from the redevelopment of obsolete office buildings and historic former industrial buildings. Such projects may have been seen more favorably by lending sources, but definitely were more appealing to potential tenants, multiple panelists said.
Robust multifamily pipelines have driven tight market conditions for landlords in Center City and its inner neighborhoods, as well as the most popular suburbs like King of Prussia and Exton. In the most central areas, expensive units pushed up in price by high construction costs remain subject to the amenities arms race.
“It’s not so much about what [amenities] we have, it’s about having the best version of what we have,” Post Brothers Vice President of Design Rebecca Frisch said. “Our child play areas have full treehouses in some of our properties, our dog park is so much more than just a small strip of Astroturf, and we don’t just have a pool — we have a whole dining and lounge area integrated [with the pool area].”
But as job, population and wage growth in the Philly area continue at a slow and steady pace, the size of the demographic willing and able to pay around $2K or more for a one-bedroom apartment is painfully finite. A large portion of those are empty nesters who rent by choice, Morgan Properties principal Jason Morgan said.
One-bedroom apartments charging $1K to $1,400 per month and two-bedroom units charging $2K can access the deepest pool of renters right now, according to MMPartners founder David Waxman and Red Rocks Group Managing Director Ethan Fellheimer.
That price range is where you will find the urbane millennial that seeks community, spends money on experiences and doesn’t have the savings for a down payment on a house — exactly the archetype that has fueled Philly’s ascent into the national cultural consciousness. That type of person also is unlikely to select an apartment for its amenity package, except as a trade-off for smaller units, Fellheimer said.
“We try to put as little amenity space in our buildings as possible, with the idea that these are areas in close proximity to where people want to live and we want to give them dynamite living spaces,” HOW Properties Managing Partner Gary Jonas said.
Neighborhood success stories like Northern Liberties (where HOW recently completed a multifamily building with Starbucks and Giant Heirloom Market as ground-floor tenants), Fishtown and Brewerytown have been driven by adaptive reuse projects and strong, neighborhood-scale retail scenes, not necessarily amenity-rich fortresses amid dormant streetscapes.
Those areas’ growth was not driven by their relative affordability. Construction costs being what they are, adding units at scale in the next-in-line neighborhoods might require a pre-existing building to renovate and have a creative approach to raising capital.
“We spend a lot of time on the front end figuring how we can back into the construction costs that justify the middle-market rents we want to hit,” Waxman said. “Reusing buildings helps, historic tax credits help, PIDC has been extraordinarily helpful in fitting out retail spaces, and the state tax credit system, while small, still helps.”
Current federal policy might be more favorable to financing redevelopment as well. Opportunity zones are now a potential part of that fundraising equation, Waxman said, noting that he has already completed one deal using the much-discussed federal tax break and is in negotiations for several others.
As federal interest rates have declined in recent months, securing loans might be easier in the short term, especially when compared to new construction, Morgan said. The more developers focus on affordability when choosing where and how to build, the more likely they are to have Fannie Mae and Freddie Mac support their projects by buying their loans.
“The capital markets are as strong as we’ve seen them,” Morgan said. “We’ve been able to get pricing as good as we possibly can, because we’re not doing Class-A units.”
Being safe with one’s lending terms might be of greater importance now than at any point in the past 10 years, with the entire market waiting for a downturn to begin. When it does, the fundamentals at top of the market will be tested, while less ambitious projects could be sitting pretty.