Thursday, June 7, 2018

Philadelphia Developers See Cause For Optimism, But Challenges From City's Tax Structure

by Steve Lubetkin,
Commercial real estate development in Philadelphia’s burgeoning neighborhoods is facing a generally good economic climate, with only a few clouds on the horizon in the form of increasing labor costs, lack of skilled construction crews, and uncertainty about city tax policies, according to a panel of developers.

“There is an irrepressible march that is moving forward of improvement in the city,” says Bobby Fijan, a partner in Cross Properties. “Whether it’s restaurants and neighborhoods and creativity, and that sort of energy feels like it has just taken hold and it’s just going forward.”

“I think that the next 24 months look look strong for Philadelphia,” says Paul L. Badger Jr., president and CEO of The Badger Group. Badger thinks the city’s prospect of attracting the Amazon HQ2 development is good, but says regardless, “The city is positioning itself well to be receptive to new business, and that’s what’s really needed, jobs to help grow the tax base to help bring additional need for development, and continue to drive the demand.”

The “Meet the Developers” panel at the city’s Pyramid Club June 5 was organized by the Center City Proprietors’ Association, a networking chamber of commerce-style organization.

Rising construction costs in the market remain a major concern for developers, and could be playing a role in making outside investors hesitate about committing to projects here.

“Philadelphia has some of the highest construction costs of any city in this region but unfortunately we have rents that are commensurate with Baltimore and some of the more impoverished areas of the city,” says Badger. “So, without the proper incentives, it’s almost impossible to make a balance sheet work almost impossible to attract investment in the city and to raise capital. One of the biggest challenges that we have as a firm is getting outside investors to come into Philadelphia and invest in some of the projects that we are involved in.”

Tariffs on international shipments of lumber, in particular, are affecting the development business in Philadelphia, says Logan Kramer, CEO and founder of Design Pro Development, which is focused on development in the Brewerytown section of Philadelphia.

“My lumber costs gone up by about 12 to 14 percent,” Kramer says. “In terms of my pro formas for multifamily, I used to underwrite at like, $110, $115 dollars per square foot. I now have to underwrite it closer to $125 or $130 per square foot.”

One critical issue facing developers appears to be a lack of skilled construction workers, and the panelists called for improved training programs in collaboration with schools and local unions.

“I think there is a large amount of people in Philadelphia who are willing to work, but don’t have the skills to be anything more than a demolition contractor in distressed neighborhoods,” says Greg Reaves, principal and managing member of Mosaic Development Partners. “They have the ability to gain those skills, but I don’t think we have the labor education environment to basically take someone who’s currently unemployed, and in a year or two, they can be working on an electrical crew, or on a plumbing crew, and growing there.”

Despite these challenges, Philadelphia has significant strengths, the panelists agreed, with costs about 30 percent lower than other major cities.

“The market is super affordable,” says Kramer. “You also have a pretty good rate environment. The entry point  is really low in comparison to large cities.”

Better clarity in local tax policy would also help, says Post Brothers director of acquisitions Zak Klinvex.

“If there were a way to kind of make the taxes more predictable, even if it’s higher at first, but it gets you to the same place, and does it in a way that we can understand how to underwrite these deals to be a little more effective,” he says.

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