Table of Contents
A freeze has descended upon real estate development in Philadelphia, even as cranes dot the sky in Northern Liberties, University City, and parts of downtown.
On July 26, the Federal Reserve raised interest rates to their highest level in 22 years. More hikes are possible this year, as policymakers keep a wary eye on inflation.
At the local level, that means many of the ambitious developments unveiled over the last year are paused, if not outright canceled. The combination of 16 months of tightening monetary policy — which makes borrowing more expensive — and the still elevated costs of construction materials have made many developers reconsider their plans.
At 42nd and Market Streets, in University City, Alterra Property Group has scrapped plans for a 352-unit modular apartment building.
“42nd and Market is not moving forward,” said Leo Addimando, managing partner with Alterra, based in Philadelphia. “The combination of land cost, construction costs, interest rates, scarcity [of] debt capital for development, and rents don’t make for a viable project.”
Alterra isn’t alone. None of the projects The Inquirer spotlighted last summer, such as the Goldenberg Group’s 468-unit proposed tower at Broad and Lombard Streets, have broken ground yet. (The developer did not respond to a request for comment on the project, which is being opposed at the zoning board by neighbors.)
The projects that can be seen going up across the central city were mostly financed and planned before the surge in interest rates and today’s more challenging lending environment.
The increasing difficulty of development doesn’t mean nothing new will be built. But many projects may never leave the “soft costs” stage: Permits have been pulled and architectural renderings drawn up, but a foundation won’t necessarily be laid.
“We’re definitely seeing the pullback in private spending,” said Lyndsey Christofer, head of real estate with the Philadelphia-based insurance giant Chubb. “We’ve seen more projects be delayed before the shovels have gone into the ground. We will see more of that.”
Many banks retreat from real estate
Regional bankers say that at first the rising interest rates didn’t have that much effect, but by the end of 2022 their clients began to get more conservative. Developers such as the New York-based Durst Organization announced a “pause” on major plans in Philadelphia. As 2023 progressed, developers found themselves having to put more money upfront into their projects than planned. In many cases, proposals that made sense in the first half of 2022 don’t look as solid a year later.
Even as developers moved through the approval process, behind the scenes they would admit that the renderings community groups and city planners were analyzing had little chance of becoming reality in the near future.
To complicate matters further, many monetary policy watchers have been betting that a recession is on the way, which they believed would force the Federal Reserve to cut interest rates. As a result, some developers have been pausing projects in hopes that borrowing could soon become cheaper again.
In Philadelphia, there’s been a huge burst of multifamily building, too, so developers might not be able to charge the rents they need to cover their loans and turn a profit.
“I haven’t seen a new request for a construction project in a couple months,” said Brad Fouss, senior vice president for the Greater Philadelphia area at OceanFirst bank. “Projects are more expensive because of rates, and if you’re going into a market where there’s a lot [of housing] coming online, it’s a good time to pause and review your numbers.”
At the same time, many banks have dramatically scaled back their real estate lending, fearing that they will soon take losses — especially from commercial developer clients who may not be able to pay off their loans in the current context of declining office and mall properties.
As a result, banks with exposure to commercial real estate have been increasing their reserves to cover their potential losses and pulling back from offering capital.
“I don’t think the majority of lenders will be back in the market until this time next year,” said Bill Hankowsky, former CEO of Liberty Property Trust, a legendary Philadelphia-based commercial developer that was sold in 2019. “Rates went up, construction costs went up, and it’s now very difficult, if not impossible, to start a new project. It could be another year, easy.”
What’s still being built
Some local lenders say there are sub-markets that are still hot in the city, and especially in the suburbs, where development will continue at a slower pace.
The so-called Riverwards neighborhoods of Northern Liberties, Fishtown, and parts of Kensington have seen so much new development that lenders such as Fouss at OceanFirst are concerned that new apartments won’t be able to command the rents that would allow them to profit and pay their loans back.
But the smaller scale townhouse market is strong enough to sustain new projects, especially as the supply of single-family homes for sale remains constricted by the same surge in interest rates — which have caused families to resist moving in the face of more expensive mortgages.
“If you asked me this on Jan. 1, I would have been wrong because we have not seen a slowdown in loan requests,” said Charles Crawford, chief executive of Northern Liberties-based Hyperion Bank, which backs a lot of townhouse development in the Riverwards.
“We had the largest loan growth in the first six months that we’ve ever had,” Crawford said. “Our forecast for the second half of the year certainly is slower, but there still remains a low inventory of housing.”
If many large residential projects in the city are stalled, lenders say they are still seeing some movement in big multifamily residential projects in the suburbs. Philadelphia itself has enjoyed a lot of multifamily development, but the suburbs have not kept up even as demand soared.
If developers can get regulatory permission and land to move forward in desirable parts of the collar counties, they can still turn a profit, said Mike Keim, president of Souderton-based Univest Bank.
“In our area, the lack of residential housing supply spurs on borrowers to move forward even though rates are higher,” said Keim. “[We’re seeing] residential developments in the suburbs. Housing prices are holding up, so they’re still viable.”
Regional bankers and developers say that much depends on whether the Federal Reserve decides to keep increasing rates. The real estate industry craves certainty. Interest rates are not anywhere near historic highs, but all the players in the system got used to extremely cheap borrowing.
Now they are adjusting to a new reality, but are held back because they don’t know where things will stand in six months.
Many developers insist that this adverse context doesn’t mean their projects are canceled, just that they will start later than they’d originally planned — maybe much later.
In the booming Garden Court neighborhood, West Philadelphia developer Kfir Binnfeld has been successfully adding hundreds of new apartments to the local housing stock for years. At 4900 Spruce, he’s recently finished a 150-unit rental building.
But just down the street, at 4746-48 Spruce, a proposal for a 170-unit building is as close to reality as when The Inquirer first reported on it last summer.
“We are hoping to start around March 2024,” said Binnfeld. “[It’s] not easy to build with 10% rate on construction loans.”