Finding Value in Philadelphia’s Multifamily Market

Dalzell Capital Partners' founder & managing partner shares his knowledge about Philadelphia's multifamily business climate and what to expect in a late-cycle economy.
Christian Dalzell, Founder & Managing Partner, Dalzell Capital Partners
Christian Dalzell, Founder & Managing Partner, Dalzell Capital Partners

Philadelphia has had a good year in terms of multifamily investment activity. The sustained growth in population is only one of the reasons that drive demand up, especially in downtown submarkets such as Center City and University City.

Multi-Housing News reached out to Christian Dalzell, founder & managing partner of Dalzell Capital Partners, who sheds more light on the particulars of Philadelphia’s value-add market and expectations for 2019.

Philadelphia entered 2019 on a strong footing, with a good multifamily business climate and decreasing unemployment rates. How do you expect the market to continue performing so late in the cycle?

Dalzell: Philadelphia’s downtown housing market is currently strong. Bolstered by macro-economic, cultural and demographic factors that are favoring live-work, transit-oriented and walkable areas like Center City and University City, the overall affordability of the city, its density of jobs, cultural and retail amenities, and an extraordinary array of family friendly activities and parks, should promote additional, if not accelerated, in-migration patterns that have outstripped historical trends.

While accounting for only 5.7 percent and 2.4 percent of the total land mass of the Philadelphia MSA, Greater Center City and University City account for 42 percent and 11 percent—approximately 310,000 and 80,000, respectively—of all jobs across the 11-county MSA. Since 2008, the number of jobs in Philadelphia grew by 63,200. About 51,000 of those positions are in Greater Center City or University City.

Unfortunately, this data tells half of the story. Philadelphia’s job growth is the slowest among the 25 largest cities in the U.S., and its corresponding rate of housing growth has been quite modest, ranking Philadelphia County 62nd among counties nationally, in units permitted since 2010. There remain challenges associated with the local school system and local taxes regime, both of which have depressed job growth historically and weakened the real estate tax base required to support the city’s public schools.

To avoid the potential for too much supply downtown, Philadelphia’s leaders must put into action public policies that facilitate job growth throughout all neighborhoods across the city and not just in Greater Center City or in University. Otherwise, the inconsistency of the growth will tether the city’s future continued job growth.

Since its founding, Dalzell Capital Partners has roughly had a value-add strategy across the metro. What makes Philadelphia such a good value-add market?

Dalzell: Philadelphia’s affordability, compared to most cities in the Northeast and Mid-Atlantic, make it a “good value” market. With apartment rents in 2018 averaging $2.18 per square foot across Greater Center City, Philadelphia stands out as an increasingly affordable option compared to such CBDs like NYC ($5.32), Boston ($3.69) and Washington, D.C. ($3.07).

Due to the nature of the job growth in Greater Center City and University City, these two submarkets are more insulated from downturns in the economy, compared to most cities in the U.S., due to the increasingly large Education and Health Care job sectors that remain the keystone of Philadelphia’s economy. Since 2010, approximately 69 percent of the new jobs created in Philadelphia were in these industries.

Both Center City and University City have many natural barriers to entry. Most notably, approximately 70 percent of all rooftops are small rowhouses that line so many of Philadelphia’s streets. In Center City and University City, it has become prohibitively expensive and very risky to attempt to assemble the necessary amount of land needed to build a large multifamily or mixed-use property. Since there has been a tremendous amount of construction across all industries in Philadelphia, there remains few large undeveloped tracts in the city. To create the necessary scale to build large assets in this market, one has to contend with materially higher land and construction costs as well as a highly protective neighborhood groups are generally skeptical of new developments.

Of the many markets that we researched before diving into deals located in Philly, we found it encouraging that so many of the largest local stakeholders from Philadelphia were investing vast sums in a number of massive developments across the city. Comcast opening its $1.3 billion Comcast Tech Center in late 2018; Brandywine and Drexel announcing and kicking off the development of Schuylkill Yards—6.9 million square feet of public-private development just north of the 30th Street station; University of Pennsylvania’s 1.5 million-square-foot Medical Pavilion Extension that will cost $1.5 billion; the Children’s Hospital of Philadelphia’s brand new 23-story,  $500 million research headquarters delivered in the summer of 2017, which is slated to be phase one of a four-phase complex; Pennovation; the Naval Yard; Penn’s Landing; the 1.4 million-square-foot Fashion Gallery—PREIT and Macerich-owned mall that is scheduled to open on East Market in September 2019; and many more.

How will the record-breaking construction activity affect the value-add market?

Dalzell: The new supply that has come online over the past couple of years has impacted the market’s performance. In particular, the new supply led to what felt like two distinct parts to 2018—the first two quarters, when supply was stronger and rents weaker, and a materially stronger second half, when we saw rents rebound significantly. What was unusual was the pronounced uptick in demand and rent growth in the late May to early June. For the year, we experienced rent growth of 3 to 4 percent—3.7 percent average—across our seven properties in Greater Center City.

The market is becoming more sophisticated and the new product has led to many older properties being renovated in order to become more competitive. If your properties are not competitive or suffer from physical or locational obsolescence, it will be tough competing in the future as new, more contemporary, units come online. We find ourselves constantly thinking of ways to improve the experience for our residents. Whether that means improving the look of the lobby and exterior or installing new unit amenities, like Nest thermostats and keyless entries. Whatever the flavor of the day, we find it increasingly important to continuously search for ways to differentiate our product from that of our closest competitors.

I look at the new construction as an opportunity for anyone willing to continue to invest in their property. Most owners don’t spend a great deal of time worrying about trying to compete with the newer product coming online. As a result, there will be separation between the performance of the properties that make investing offensive capex a priority and those who don’t. Ultimately, it is not our decision where a tenant chooses to live. We can only attempt to compel a tenant to choose one of our communities by continuously investing in our properties and units so that rents continue to grow at or above the level of rent growth in our submarkets.

What was the most challenging project Dalzell Capital Partners has worked on in Philadelphia? Tell us more about it.

Dalzell: Our most challenging project to date hasn’t been challenging due to any unforeseen surprises, but rather it is challenging due to the complexity and comprehensive nature of the repositioning of Waverly Court, our 62-unit mixed-use property located at 13th and Pine. The renovation includes a comprehensive rebuilding of 27 of the property’s 61 multifamily units, a comprehensive renovation of all common elements, and the creation of a façade that bears little resemblance to the current façade.

Expanded from 28 units to 62 units in 2017, Waverly Court suffered from a lack of a uniform façade, unrenovated common areas, and 27 units that were left unrenovated. We are focused on creating a significantly improved physical plan to match the quality of the location and the immediate demographics. We expect the renovated property will have little resemblance to the property we purchased on June 27, 2018, which should increase the appeal of the property.

If done correctly, the renovation will transform the asset. If not, we could leave a lot of upside on the table, which makes the planning and staging of the $1.1 million renovation of the fully occupied building challenging. One of the things we found most helpful was being upfront and forthright with our tenants with respect to the planned scope of work so that they were not surprised when we started the renovation. We’re confident we’re taking all the right steps to ensure the success of this important project.

By developing open lines of communication with our tenants, we began to notice their elevated interest in the work we were doing and, in most cases, a genuine willingness to work with us by giving us access to their unit so that we could upgrade the unrenovated apartments before we got to the next rollover. So much of the success of a value-add project lies in the planning and how the process is approached. If a landlord communicates very little to the tenants about a planned renovation, in almost all cases, that renovation will likely be much more difficult to complete on time or within budget. Alternatively, a landlord can make their renovations much smoother by oversharing information, provided they are final plans.

What are some foreseeable challenges for 2019 in Philadelphia’s multifamily market?

Dalzell: Jobs, jobs and jobs. Philadelphia lost jobs from 1970 to 2000. Since 2000, Philadelphia has enjoyed employment gains every year except for 2009. Like all U.S. cities, Philadelphia is also benefiting from the expanding preference for urban areas from the nation’s two largest age cohorts, Millennials and empty nesters, with 46 percent of core Center City’s population now aged 20 to 34. Lastly, since 2000, 115,000 immigrants have moved to Philadelphia.

As a result of the new development of housing units and bevy of new commercial developments around the city, residents began to “find” Philadelphia again after many years. In fact, people started to realize that Philadelphia has a lot more to offer than previously thought. In 2017, 67 percent of all university seniors said that their preference is to remain in Philadelphia post-graduation. This rate is 6 percent higher than in 2016 and is far higher than both Boston and New York.

Philadelphia’s natural advantages—transportation, location, enjoyable and interesting live-work environment, an abundance of cultural, entertainment, and retail options—has led to significant local job growth and household formation.

My biggest concern with Philadelphia is two-fold—continued job growth, and maintaining viable and flexible housing supply that is generally consistent with the changes in Philadelphia’s evolving job market.

Image courtesy of Dalzell Capital Partners