Philadelphia, Pennsylvania
The City of Brotherly Love Faces an “Uncomfortable” 2023 Market
By Carole VanSickle Ellis
When a national expert like Moody’s Analytics chief economist Mark Zandi starts your market’s year off with the observation, “We’re in the bad times,” a lot of local homebuyers get chills — and not in a good way. For real estate investors, however, those chills are something like a silver lining, and Zandi only increased investor interest in the Philadelphia area when he continued his February analysis of that market by predicting that agents, first-time homebuyers, and single-family homebuilders will not feel “all that good” in Philadelphia this year.
“In 2022, potential buyers were desperate for more inventory,” recalled Axios Philadelphia analyst Mike D’Onofrio. He added, “Now, homes are hitting the market but people cannot afford them.” D’Onofrio blamed rising interest rates and a localized affordable housing crisis driving rents skyward for Philly’s looming real estate slump.
Since he published this analysis in late February of this year, new data shows that median selling prices have fallen by just under 4% year-over-year at the end of Q1 2023; housing inventory on the market is up by roughly 15% year-over-year, and the average time on market is up by more than two weeks year-over-year. Furthermore, at the end of the first quarter of 2023, more than half of all homes on the market in Philadelphia sold below asking price, and most of those transactions took place in what economist Kevin Gillen described as “the lower segment of the market.”
For real estate investors seeking metro-area investment opportunities, this confluence of factors could be just what the doctor ordered. With times on market nearing the two-month marker, Philadelphia sellers may feel more inclined to explore less conventional sales options in order to get deals done. As more and more homebuyers find they are no longer able to afford as much house or, in many cases, any house at all thanks to rising interest and rental rates that effectively diminish down payment savings while hiking monthly mortgage payments, the appeal of creative financing will also be on the rise.
For Bright MLS chief economist Lisa Sturtevant, 2023 in Philadelphia appears likely to be “about resetting what normal looks like,” including accepting 6% interest rates as something less than cataclysmic.
“The market is contracting on both sides,” Sturtevant explained. “[Fewer buyers and sellers in the market] makes for high competition within the market.” She went on to predict “the largest price correction will happen within the city” while “’second-tier’ suburbs may see a decline year-over-year in home prices [and] top-tier suburbs…continue to do well.”
Darkening Clouds on the Horizon … Maybe
For retail buyers in the Philadelphia area, things are looking bleak this spring, with Zandi describing the local market as being “about as weak as it gets” in May. He continued, “It is kind of consistent with the worst of sales during the peak of the pandemic when we were all shut in, or go back to the financial crisis in 08/09. It is those kinds of levels.”
The issue is a troubling combination of rising interest rates and an ongoing affordability problem that local analysts say is “stifling” the market. For individual real estate investors, this could lead to some difficulty finding homeowners willing to sell at any price point — much less at a discount — but desperate buyers in the area are likely to continue to push prices upward on available inventory.
For investors with access to viable deals, this will mean their properties are more in demand than ever if the current climate persists. However, it will be important to prioritize reaching potential buyers as well, since the Bright MLS Home Demand Index published in April indicates that many are giving up on the market and seeking other options. The report indicated that demand for luxury condos was the strongest this spring, followed by townhouses and single-family homes priced below $300,000. Luxury single-family homes trailed far behind the rest of the field with the lowest levels of demand. Researchers noted at time of publication that there was a 5.5-month supply of luxury condominium residences on the market and 1.4 months’ worth of mid-market single-family homes.
Rising activity from institutional homebuyers in the area may also affect future inventory and demand for homes for sale instead of rent. According to reports from housing advocacy group The Reinvestment Fund (RF), roughly 20% of homes in “distressed” neighborhoods in Philadelphia are currently being sold to institutional investors and converted to rental properties.
The fund’s research team defines “distressed” as areas in which there are below-average homeownership, “where both prospective buyers and current owners have struggled to access mortgage financing, [and]… in neighborhoods with low sale prices and high vacancy.”
Although institutional activity can be a good thing for neighborhoods where properties are stagnating and for long periods of time and also may ultimately create more housing opportunities for residents in a market, institutional investor participation in a market raises the stakes for individual investors also working to acquire these properties in order to flip to retail buyers or rent.
Zillow’s research team recently ranked the Philadelphia housing market 10th in the country for “hottest housing markets of 2023.” In that report, Zillow economic data analyst Anushna Prakash observed, “This year’s hottest markets will feel much chillier than they did a year ago,” adding, “The desire to move has not changed, but both buyers and sellers are frozen in place by higher mortgage rates, slowing the housing market to a crawl.”
Zillow placed Philadelphia in tenth place behind southeastern cities like Charlotte, Nashville, Jacksonville, Miami, and Atlanta, as well as a few midwestern markets. No city west of Dallas, Texas, appeared on the list at all.
In response to the ranking, local realtor Larry Flick, CEO of Berkshire Hathaway HomeServices Fox & Roach, Realtors, predicted that home prices would “remain stable” and “affordability will increase” over the course of 2023. So far, home prices have actually continued to climb while inventory volumes persistently decline. Even showings were falling, with Bright MLS reporting a 26.6% decline in March 2023.
Flick is not the only optimistic party when it comes to Philadelphia’s market in the latter half of 2023, however. Brett Rosenthal, a local realtor with Compass group Revolve Philly, insisted affordability is improving. “A first-time homebuyer could purchase a home under $200,000 in Philadelphia in many areas which are move-in ready,” he said. Yahoo! Finance recently dubbed Philadelphia one of the most affordable markets for Gen Z homebuyers investing in real estate. Rosenthal enthusiastically agreed, citing the city’s “strong job market, proximity to major cities like Washington, D.C., and New York City, and countless attractions, including visiting historic sites and partaking in delicious food.” He believes the city will remain especially attractive to Gen Z buyers, many of whom are beginning to think about purchasing their first home.
Meanwhile, Philadelphia’s Office Sector Continues to Contract
While demand remains strong for most residential sectors of the industry, Philadelphia’s commercial real estate market stands on shaky ground. Office occupancy, in particular, is falling, and ongoing employer dedication to hybrid- and remote-work models is making the situation even more tenuous. According to CBRE, office occupancy in Greater Philadelphia is down by 10 million square feet since pre-pandemic numbers reported in 2019. It currently seems unlikely that this section of the market will fully recover simply because COVID-era remote-work practices have created a “new normal” in which workers do not necessarily need to report to an on-site location to do their jobs.
Nick Gersbach, senior vice president at the CBRE Philadelphia offices, explained, “We are in a three-to-five-year window from stabilizing and experiencing a slow recovery. People are not going back into offices.”
Gersbach’s colleague, Joe Gibson, an associate director of research at CBRE, noted that deals are still being done mainly on high-end buildings. He cited companies’ goals of getting people back into the office as the impetus for these trophy deals. “[Companies] are looking to amenities and quality space to get people back,” Gibson explained.
In the meantime, Philadelphia is still attractive to new residents, which could represent another avenue of recovery for the commercial sector if office buildings are repurposed into other types of venues. “There is this weird phenomenon of…people wanting to live in the city, wanting to play in the city, wanting to dine in the city as restaurants and retail are reemerging,” Gersbach said, adding, “But for whatever reason, [people are] not wanting to go into an office in the city.”
Investors considering other commercial-sector assets should evaluate each project carefully. Local developer Bill Glazer, owner of Keystone Development + Investment, recently warned locals that commercial real estate is facing a “triple threat” of “unprecedented” interest rate increases, declining lending and capital availability, and recession and revenue pressures. He conceded that the “unprecedented” interest-rate hikes are relative in nature, rising more than five percentage points in a year.
“We are seeing universally that capital availability is being pulled back for every class,” Glazer said, noting that major retail closures like that of Bed Bath & Beyond are hurting both retail spaces and warehouses. He predicted that commercial developers would soon begin a “flight to quality,” meaning that as lenders begin to face stressors, they will only make commercial loans available to projects that look like the surest bets. Glazer also pointed out in Philadelphia, in particular, “most new, ground-up projects are being shelved, paused, or sidelined.”
He explained, “The contractors are still finishing up jobs in their pipeline, but it’s coming. The Fed, in tamping down inflation, is adding so much pressure to the [borrowing] costs of new construction there will be far fewer new-construction starts.” He also pointed to an assortment of canceled condominium projects and other stalled developments in the area where the projects were started, demolitions completed, but then building did not begin.
The Bioscience Sector Question is Not Going Away
One bright spot for Philadelphia’s commercial investors will likely be the bioscience industry, which has, Glazer said, “a burning need” to access labs and specialized science space in order to “get their science into the marketplace.” However, even the bioscience industry is currently on shaky ground thanks to pressures associated with the difficulties of raising capital. The city is home to one of the biggest bioscience “clusters” in the United States and ranks eighth in U.S. life sciences employment. The availability of bioscience funding in the latter half of 2023 and beyond will have an outsized effect on Philadelphia’s employment numbers and both residential and commercial real estate development.
CBRE warned that a “notable pullback in life sciences venture capital investment and initial public stock offerings” is already underway in 2023, but National Institutes of Health (NIH) funding has remained consistent. In 2022, Philadelphia bioscience companies received about $1.3 billion in venture capital funding, and it was ranked 8th for its receipt of NIH funding as well. Between 2019 and 2022, Philadelphia’s bioscience sector’s NIH funding rose 1%. However, Philadelphia’s vacancy rate for research and development (R&D)/life sciences laboratory space is over 10%, compared to 3% in top-ranked Boston. The city also ranked 8th for biomanufacturing capacity with 20 facilities in the area.
Investors should note that many of these statistics are subject to dramatic change due to the secretive nature of bioscience R&D. For example, one local company had been operating in almost complete secrecy until April of this year. During 2022, it built a facility boasting more than 22,000 square feet of laboratory and manufacturing space in which to work on gene therapies. This was done in what CBRE researchers described as “stealth mode;” that company’s employees and the economic opportunities associated with that new facility were essentially invisible in bioscience metrics for the Philadelphia metro until the cloak-and-dagger phase was over.
Plenty of Opportunities for Tuned-In, Creative Investors
At first, the Philadelphia real estate market might appear to be a private club with locked doors thanks to high demand, low volumes of inventory, and an uncertain development environment. However, there are certainly plenty of opportunities for investors willing to look “off the beaten path” and think creatively about the current market’s unusual challenges. In particular, the city is known for being ahead of the curve when it comes to converting buildings to residential or lab space from office or factory space. Glazer noted that there are many historic buildings in the area that qualify for tax credits in exchange for conversion from offices to apartments.
Philadelphia faces an unpredictable year or two ahead, but the city is known for maintaining an even keel even when the rest of the country is experiencing extreme volatility. If this holds true in 2023 and beyond, then there will be plenty of opportunities for creative investors willing to invest their own time and resources into the process of identifying good deals and then making them happen.
SIDEBAR
By the Numbers
13 — Number of Fortune 500 companies headquartered in Philadelphia and the surrounding area
» AmerisourceBergen
» Comcast Corp.
» DuPont
» Lincoln National Corp
» Corteva
» Aramark
» Crown Holdings
» Universal Health Services
» Campbell Soup Company
» Toll Brothers
» UGI Corp
» Avantor
» Burlington Stores
6 — Yahoo!finance ranked Philadelphia in its “6 Cities with the Most Affordable Homes for Gen Z” (2023)
10th — Philadelphia’s rank on Zillow’s “10 Hottest Housing Markets of 2023”
1% — Amount that median sales prices in Philadelphia are predicted to rise in 2023 over 2022 (Bright MLS)
6.5% — Amount that median sales prices in Philadelphia rose from November 2021 to November 2022
