Real estate development in Philly likely to slow this year given interest rate uncertainty

The story came a few days before Christmas, a punctuation mark on a year that began favorably for the city’s development industry but was ending on an uncertain note.

A New York mega-developer that had decided to build in Philadelphia during the pandemic called time on a 360-unit building into which it had already sunk $42 million of its own money.

“The Durst Organization is pausing on construction of the mixed-use project at 300 N. Columbus Boulevard,” read a statement from the company’s Philadelphia spokesperson Anthony Campisi. “This decision is the result of unexpected rising construction costs and a challenging financing market.”

Interest rates are at their highest level in 15 years, making borrowing more expensive. The Federal Reserve is strongly signaling that more rate hikes are coming in 2023, because it doesn’t think inflation has yet been tamed.

Some developers in Philadelphia are pumping the brakes on projects where construction isn’t well underway, though few are doing it as dramatically as Durst. More common is that projects still on the drawing boards will stay that way, although development industry watchers say more dramatic shifts could arise by the middle of the year.

“There are definitely people I know who penciled out deals, and then when everything went on these past nine months, they decided to pause those projects until things calmed down,” said David Segal, senior vice president with TriState Capital Bank. “They didn’t want a roller-coaster ride in terms of materials, labor and now, obviously, borrowing costs.”

This new conservatism is evident across every sector: retail, housing, industrial, and office (although new construction in that last sector isn’t seeing any action at all because of remote work). Even warehousing, which was such a safe bet in recent years, is seeing some cautious notes as companies such as Amazon retreat from the peak of their pandemic-era investments.

Some bankers said they are hearing from developers that the only commercial projects they are approaching with urgency are those that are pre-leased. Speculative development, for now, is out of fashion.

“Anything that’s speculative is a challenge, and by that I mean it probably doesn’t get done,” said Bernie Shields, regional president for Philadelphia and South Jersey with M&T Bank.

“In normal times, if something is more risky, you may just require extra equity going in,” Shields said. “Right now, I don’t know that any amount of equity would get a lender interested in doing a commercial deal that doesn’t have substantial pre-lease.”

That doesn’t mean nothing is getting built. The $93 million cold storage warehouse recently locked in for Port Richmond is an example of an industrial project that met those requirements.

Multifamily housing developments in hot market areas are still seen as a safe investment in 2023, too. But there is concern that some companies may have to cut their asking rents in the competition for tenants due to the sheer scale of construction in recent years.

“There’s so much coming on in the Northern Liberties, Fishtown, Kensington area that we may see some concessions to fill that inventory,” said Susanne Svizeny, regional president of OceanFirst Bank. “It’s still a strong market, there’s still strong demand, but there’s been a lot of building.”

Regional banks say that they aren’t seeing big differences in how the interest rate environment is affecting lending in the region’s different submarkets. Philadelphia, its collar counties, Delaware, and South Jersey are seeing similar patterns.

They also say that the slowdown isn’t as painful in the Philadelphia region because the heights of the construction boom were not as extreme as they were in many Southern and Southwestern metropolitan areas. As occurred during the aftermath of the Great Recession, the Philadelphia region’s highs aren’t as spectacular, but its lows aren’t as devastating, either.

There is some hope that even if the Federal Reserve continues to increase the cost of borrowing, it will slow the hikes. Eventually, perhaps, it will just keep them at a sustained level.

That’s not as bad as it sounds. Part of what has been spooking developers and lenders is that they don’t know where interest rates will wind up. Once a new normal emerges, even if borrowing costs remain elevated in comparison to the last couple decades, development will likely pick up again.

“There’s uncertainty about when rate increases will slow down or stop,” said David Ross, senior vice president at Citizens Bank. “Until there’s a clear line of sight on that, the whole financing community is being selective in how they deploy their capital. If there’s a relationship with an existing client, we will look at it. But if somebody who we don’t know comes in: no.”