Investor Appetite for Center City Apartments Reaffirmed in Q3

As Philadelphia gradually shook off the damage of the 2008 - 2009 financial crisis, affluent millennials and empty nesters began to converge on Center City's rental market. A boom in apartment acquisitions by major investors such as JPMorgan Chase and BlackRock quickly followed.

By 2015, Center City's annual apartment acquisitions had surged to an all-time high of more than $470 million, more than double the sales volume that was recorded during even the best years of the economic high of 2005 - 2007.

The boom in Center City apartment sales has lost some steam, and investments have slowed noticeably in recent quarters. While more than 1,600 apartment units changed hands in 2015, sales dropped by more than 70% in 2016, and less than 400 units have traded during the first three quarters of 2017.

There are a few reasons why investors hit the pause button on Center City apartment transactions. With booming development activity increasing Center City's stock of multifamily units by more than 5% per year, newly-completed apartment towers are increasingly offering one - or in some cases even two - free months of rent in order to lease up on schedule. Furthermore, at the end of 2016, Philadelphia's City Council voted to close loopholes that had previously allowed many large real estate investors to circumvent the city's hefty 3.1% realty transfer tax.

After the drop off in Center City apartment sales activity and the elimination of tax loopholes, some market participants are wondering, do prices need to decline significantly for apartment sales to pick back up again?

The September 2017 sale of the Pepper Building at 1830 Lombard deserves a close look from Philadelphia apartment investors. It was the first Center City apartment deal with a price over $50 million that has closed in more than 18 months. The Pepper Building, built in 1927 but renovated in 2009, sold for $53.3 million. The 4.75% cap rate on the deal reflects robust investor demand for the asset. Furthermore, the per-unit price tag, at $288,000, came closely in line with the price of $294,000 per unit that 1930 Chestnut and 400 Walnut traded for during 2015. Like the Pepper Building, both of these properties were originally built in the 1920's but offer a modern amenity set.

The Pepper Building's sale did reveal some signs that investor demand for Center City apartment has moderated in recent years. This same building sold in 2011, and when the Pepper Building changed hands in that transaction, it spent only two months on the market before selling.

This time around, the building spent about three months on market, and another two months in escrow while the buyer arranged financing. Nonetheless the sale was a largely positive sign for the market. As the first large Center City apartment sale to close in several quarters, the deal reaffirmed investors' willingness to acquire large center city apartment assets at sub-5% cap rates.
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