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Performance prospects for the Philadelphia apartment sector remain positive. At mid-year, vacancy was in the low five percent range despite only modest job growth in the first two quarters. Since then, a steady flow of residents moving into apartments has enabled owners to reduce or maintain vacancy and improve asset values.
By the end of the year, rental property completions will have risen after several years of limited construction. The current upswing in development will minimally affect market-wide vacancy and rents, and the impact of the new units will be contained to local areas. In Center City, for example, minor vacancy swings and more frequent concession use will occur as new projects are leased up.
Generally, strong conditions in the market are encouraging developers and building will progress at a steady pace in the next two years. Nonetheless, the new construction cycle hardly looks forbidding, as the units permitted over the past year would expand multifamily stock only 1.1 percent if all those projects were built.
Year to date, 879 new rental units have been placed in service in Philadelphia and it looks like developers will complete 2,600 apartments in 2013, which is up 1,238 units over last year, but will expand rental stock by just 0.7 percent.
Significant market-rate completions so far this year include the 74-unit Avery Townhome complex in Burlington County, and 319 rental units in the 2116 Chestnut Street high-rise in downtown Philadelphia.
Steady demand growth will surpass the increase in rental housing and vacancy will decline 30 basis points to 4.9 percent, the lowest year-end level in six years. Last year, Philadelphia’s vacancy rate was unchanged. This year, strong spring leasing and move-ins lowered vacancy 20 basis points during the second quarter to 5.2 percent. Currently, overall vacancy is unchanged year to date, but is 50 basis points higher than one year ago due to a soft fourth quarter last year.
Average effective rents advanced 0.5 percent in the second quarter to $1,122 per month. With the increase, average effective rents are up 1.3 percent year to date. Concessions in the metro averaged 7.9 percent of asking rents at mid-year, the equivalent of less than one month of free rent and a decline from 8.7 percent of asking rents one year ago. A greater number of property owners are wielding more pricing power, as only 5.3 percent of units currently offer leasing incentives, a post-recession low.
In the local investment market, an insufficient number of properties are listed for sale to fulfill investor demand, leading to highly competitive bidding and upward pressure on prices. Properties priced to capture returns commensurate with risk will find motivated buyers. In the Class C segment, this means cap rates starting at approximately 8 percent, which translates to double-digit cash-on-cash returns. At the upper end of the market, Class A properties in primary locations, such as Center City or Main Line communities, often command cap rates in the mid-5 percent range. The rise in long-term interest rates in the second quarter, however, may place a floor beneath cap rates for upper-tier properties and hasten the migration to Class B assets, which were already receiving more attention from investors.
To date, local and regional banks have held rates steady, perhaps waiting to see how other lenders adjust pricing. Acquisition financing is available from an array of sources. Refinancing is also a viable option for many borrowers while interest rates are well below long-term trends.
— Spencer Yablon, vice president and regional manager of the Philadelphia office of Marcus & Millichap