Fueled by low interest rates, an abundance of available debt capital, and superb fundamentals, the demand for multifamily assets in the U.S. has exploded over the past few years. This increased demand has led to fierce competition between capital in the multifamily sector, and consequently, a dramatic compression of going-in cash yields.
With rents in “top-tier” cities at peak levels, these markets look prohibitively expensive. As a result, foreign capital is beginning to explore new markets to find more attractive yields.
Long considered a second-tier U.S. city by global capital, Philadelphia has historically been overlooked in favor of cities such as New York City, Washington D.C., Boston, Chicago, San Francisco, and Los Angeles. When evaluating Philadelphia in comparison to other major metropolitan regions, the slow and steady growth of the Philadelphia MSA did not differentiate it enough to attract the foreign investor. Instead, those capital sources targeted cities with higher population growth, job growth, and rent growth.
In good times, that calculation paid off with higher yields and greater appreciation. However, today most investors conclude that we are in the late stages of this real estate bull market. Yet, they still have capital which needs to be deployed. Those divergent factors set up a delicate balancing act of risk versus reward.
How do you invest your capital, protect your downside, and earn an attractive return on investment when the economy is slowing and there is the looming possibility of a recession? As foreign investors are now focusing on risk management and capital preservation in addition to yield, Philadelphia is looking more attractive.
Capital Increase
Through the third quarter of 2018, Philadelphia saw a 516 percent increase in capital flows from foreign investors year-over-year, placing it first among all U.S. cities with more than $100 million in foreign investment. With this recent distinction, it’s clear that foreign investors are no longer looking past Philadelphia.
A prime example of such activity in the multifamily sector can be seen with the sale of University City’s EVO at Cira Center South, the nation’s tallest student housing property. The 33-story, 347-unit student housing tower near 30th Street Station sold in January 2018 for $197.5 million to Mapletree Investments, a subsidiary of Temasek, the real estate investment arm of the Government of Singapore.
Another example is Christina Mill Apartments in Newark, Delaware, which was recently acquired by Buligo Capital Partners out of Israel. We’ve also seen Korea Investment Management and Oaktree Capital Management of South Korea, Zurich Insurance Group of Switzerland, and Wafra of Kuwait enter the Philadelphia market in the past two years. In addition, The Meritus Group, a Canadian, family-owned real estate company, recently developed the city’s largest nightclub and has additional plans to develop office space and/or multifamily.
Stable Fundamentals
So why are foreign investors suddenly focusing on Philadelphia? Foreign capital may have finally discovered a few characteristics of Philadelphia that were hiding in plain sight all along.
Philadelphia has always been defined by its stability. In raging bull markets, property values in Philadelphia have increased at a healthy pace, but still well below the pace seen in top-tier cities. The characteristics of Philadelphia that support slow and steady growth also serve to ensure resilience in tough times.
In bear markets, Philadelphia apartment fundamentals have held up far better than most other cities. During the eighteen months of the Great Recession between December of 2007 and June of 2009, multifamily occupancy fell approximately 5 percent into the low ninety-percent range and rents flattened. While the conditions were not ideal, the environment was far worse in comparable metros that were simultaneously dealing with significant oversupply. Development cycles in Philadelphia aren’t as robust as those cities.
Philadelphia delivers about 4,000 to 5,000 new residential units at peak. While these figures seem like a lot to local investors, they pale in comparison to the 20,000 to 30,000 new units brought online in other similarly sized metros. Consequently, Philadelphia rarely has prolonged periods of citywide occupancy struggles.
Philadelphia’s stability is due in large part to the employment base. Top employers in Philadelphia have always been anchored in education and healthcare. The healthcare sector recently surpassed manufacturing and retail as the largest source of jobs in the U.S. Additionally, healthcare is the only employment sector that grows every year regardless of the state of the economy. With world class hospitals including Thomas Jefferson University Hospital, The Hospital of the University of Pennsylvania, and Children’s Hospital of Pennsylvania (CHOP), patients from all over the world come to Philadelphia for care.
Changing Narrative
Some of the finest colleges and universities in the world call Philadelphia home, including the University of Pennsylvania, Drexel University, Villanova, and Temple University. In years past, the city experienced what was referred to as the “brain drain.” Students would receive an excellent education in Philadelphia and then take their skills to other cities like Boston, San Francisco or New York.
Those days are over, as Philadelphia now retains a greater percentage of our students than Boston. According to Pew Charitable Trust, Philadelphia experienced the highest percentage increase of 20 to 34-year-olds among the 30 largest U.S. cities between 2006 and 2012.
They are staying for several reasons. First, Philadelphia is an affordable city where one can live well, have expendable income and save money. Second, over the past decade, Philadelphia has experienced a renaissance of award-winning restaurants, luxury retail and exciting nightlife. In short, the city has regained its “cool factor”. Third, Philadelphia is experiencing an influx of new jobs.
In 2008, Liberty Property Trust completed the development of the tallest building in Philadelphia at the time, a high-rise office building for Comcast’s new headquarters, aptly named The Comcast Center. They didn’t stop there. In 2014, Liberty Property Trust broke ground on a second office tower for Comcast called The Comcast Technology Center. Capped by a Four Seasons Hotel, the second high-rise stands at 1,121 feet and is the tallest building on the east coast outside of New York City. The two towers will house approximately 9,000 employees.
Across the Schuylkill River, University City has evolved into one of the leading innovation districts in the country. Drexel University and Brandywine Realty Trust just kicked off a $3.5 billion master-planned development called Schuylkill Yards, designed to further solidify University City as a leading hub of innovation. Wexford Science and Technology is developing uCity Square, a 14-acre, 2.5 million square foot mixed-use community anchored by the University City Science Center. The dynamics in University City have led to a burgeoning sector of new jobs in technology, biotech and venture capital startups.
In November 2015, Philadelphia was named a full member of the Organization of World Heritage Cities (OWHC), the first World Heritage City in the United States. That moment corroborated what many people who live and work in the city already knew: Philadelphia is a world-class city. Recent real estate investments from foreign capital providers indicate that the rest of the world agrees.