The commercial real estate market has enjoyed a seven-year bull run. Is it coming to an end? Nationally, in many major U.S. markets, real estate values returned to pre-recession peaks, recovering 28%-30% over the past decade.
Demand in Philadelphia’s multifamily sector is expected to remain strong for the foreseeable future across all submarkets; however, there is considerable supply risk looming on the horizon. Due to the fundamental demand growth in this submarket and, until recently, the relative lull in new construction (with only 500 units delivered in 2015), landlords are able to command very robust increases in rental rates with vacancy rates in 2014 and 2015 trending down to low levels. However, the Center City submarket will deliver just over 2,000 new units in 2016 (which is roughly 11% of existing supply) and another 2,000 units in 2017. Vacancy rates will rise over the next two years as this new supply is absorbed.
The single-family story stands in contrast to the oversupply worries of the commercial multifamily market. While healthy sales are reported in the residential sector, concerns revolve around inventory shortages with scarce labor resulting in rising construction costs. The ongoing, relatively tight mortgage underwriting standards continue to dampen sales in this subsector.
Partly contributing to tight underwriting standards, current interest rate levels present an unfavorable climate for single-family residential mortgage lenders.
In Philadelphia’s retail submarket, new construction is increasing. However, the new supply is meeting demand and we do not foresee oversupply in the Philadelphia retail market. The suburban community, neighborhood centers, and well-anchored centers have strong underlying market fundamentals, as vacancy is trending downward while rental rates are increasing. The extended Center City residential base has been growing rapidly and is projected to increase dramatically for the foreseeable future, spurring CBD retail.
Foreign capital made a major splash into Philadelphia office investment in 2016. We anticipate growing investor demand in the CBD office segment for class A core assets. In the suburbs, the market fundamentals are improving overall and are anticipated to moderately improve for the foreseeable future. The Philadelphia region, inclusive of Lehigh Valley, Southern New Jersey, and Central Pennsylvania industrial submarkets, remains a highly desirable market for both investors and space users going into the second half of 2016. Although the year-to-date transactional volume has decreased compared to 2015, we see a burst of recent assets hitting the market or coming under contract. Our findings, mentioned above, are depicted in the accompanying tables, which illustrate the fundamentals of each mentioned Philadelphia submarket.
Joseph D. Pasquarella, MAI, CRE, FRICS is the senior managing director of IRR-Philadelphia.