By Carlo L. Batts, MAI, Rittenhouse Appraisals
As we close out 2022… are the good times gone? Economists are predicting a downturn during 2023. Cost of living increases, slowing global growth, Russia’s invasion of Ukraine, and the still present effects of the pandemic are all cited as causes. In the third quarter 2022 survey of Professional Forecasters by the Federal Reserve Bank of Philadelphia, the panel lowered growth expectations for the next three quarters.
Naturally there is speculation about what will happen to real estate development. Global, national, and Philadelphia specific forces will be the influencers impacting the industry in the City during the next 12 months, of which we see the following.
At the beginning of the month the Federal Reserve raised the baseline interest rate for the sixth time this year. The expectation is this is not the final adjustment with another increase likely happening by the end of the calendar year. The higher interest rates will lead to less investment in new construction projects and decreased demand for new development which will impact profitability.
While increases in interest rates typically make developers reassess spending and investment plans, Philadelphia’s new tax abatement program is an important multiplier being added to the local equation. Based upon our work in 2021 versus 2022, the mixture of rates and the new tax program is slowing real estate activity in the City.
As the new abatement program is a stepped one there will be reduced returns to developers and some projects will be teetering on feasibility. The increase in interest rates will further squeeze developers as they are forced to shelve plans for new projects that are more expensive to finance. If the new abatement program had not taken place, the interest rate changes would have a minor impact on the real estate market in the City.
Another influencer is the pressure created by a challenged economy riding side-by-side with housing cost increases. According to the US Census Bureau Philadelphia’s 2021 population dropped by 1.7% in one year, after reaching 1.6 million in 2020, the first decline since 2006.
Despite this population decline in the city we predict housing prices and rents will continue to increase through the first three quarters of 2023, although not at the exponential rate we saw in 2021. Furthermore the affordability crisis is also exacerbated in Philadelphia because of overall low incomes for residents when compared to other big cities.
There are some bright spots beyond this predicted slowdown of real estate development. While the noted influencers impact many sectors that mirror economic cycles, the scope of their negative impact on real estate development is mitigated by type of project, location, and market conditions. Philadelphia continues to be a whirlwind of life sciences and research development, which largely operates beyond economic cycles. This bright spot is a welcome affirmation for the city’s real estate and ancillary industries.
After the seemingly break-neck speed at which development in Philadelphia has endured over the past few years, we anticipate a slower development pace due to a low-yield environment to extend through 2023 changing in Q4 of 2023, as owners, developers, and lending institutions adjust to the changed influencers.
Carlo L. Batts, MAI is principal of Rittenhouse Appraisals.