PENNSYLVANIA: An Introduction to Real Estate

PENNSYLVANIA: REAL ESTATE TRENDS, DEVELOPMENTS AND CONCERNS

Content:  

1. Overview  

2. Sector by Sector Analysis  

3. Tax Concerns Overshadow the Future  

1. Overview  

The real estate sectors that did well during COVID – particularly industrial real estate and single-family suburban residential – show no signs of slowing, with prices for existing product and developable land escalating at breakneck speeds. Businesses that were in semi-hibernation are emerging from their COVID slumber, and real estate is reacting to that.

Yet the re-opening may be coming too late for some. For a time, owners and tenants relied upon lenders’ forbearance, landlord’s good will or government moratoria to temporarily escape the sheriff’s knock at the door, but that time has run out. Landlords have resumed ejecting tenants, and lenders are taking back property.

Threatened tax changes loom large over decision-makers, who are trying to determine whether the Biden administration’s proposals will falter or take wing – and if the latter, when.

2. Sector by Sector Analysis. 

a. Industrial/Warehouse Real Estate 

COVID only accelerated the already torrid pace of industrial development and usage. With an insatiable appetite for this sector, e-commerce gobbled up industrial real estate faster than it could be developed. According to Jones Lang LaSalle’s Northeast Industrial Outlook Q1 2021, 2020 was a record-setting year for eastern and central Pennsylvania, but 2021 promises to outpace it. Close to 50 million square feet of tenant requirements remained unsatisfied at the first quarter’s end. With “only” 33 million square feet under construction and existing availability tight, there is nowhere near enough supply to satisfy demand. Urban industrial real estate was no exception, 1.8 million square feet leased in Philadelphia last year and 500,000 square feet leased this year. With inadequate supply of modern industrial space, JLL expects urban industrial space to continue to trade at a premium.

Tenants need to be prepared to pre-lease space under construction if they want to be sure they’ll have space when they need it.

b. Single-Family Dwellings 

The perfect storm of the large “baby-boom” echo population entering their prime home-buying years, historically low interest rates and COVID-19 led to an unparalleled rush of home purchases, pushing up housing market value nearly 8% in the Philadelphia area and 4% in Pittsburgh according to Zillow. Urban, suburban and rural areas all saw growth. The first quarter 2021 Bright Report reflected year over year price increases in double digits. Forbes noted that Pittsburgh median listing prices are up 23% while the number of sales is down nearly 36%, as the flood of buyers is being frustrated by a cohort of existing homeowners not ready to move. It certainly didn’t help that congregate living facilities, a natural landing spot for aging homeowners, could not attract many new occupants because of COVID risks in such settings.

Builder confidence levels are high, putting pressure on land prices in buildable areas.

No one expects this trend to diminish, as the large population of millennials want to buy, but their baby-boomer parents aren’t going anywhere. An increase in interest rates could allow pricing to level off, but for now rates are so low that the increase would have to be significant and sustained to offset the chasm between supply and demand.

The one negative sector has been urban condominium ownership, as the volume of sales nearly ground to a halt last year in Philadelphia, especially at the high end of the market. Observers have varying opinions about whether the re-opening up of restaurants and businesses will change this dynamic. Much will depend upon whether work-from-home continues (see Office section below), as high-end commuters may just stop commuting as opposed to buying homes where they work.

For those households in financial distress, the future is uncertain. Lenders, courts and the federal government gave those households a life-line that is coming to an end.

c. Multi-Family 

In 2020, apartment landlords fretted over their inability to do anything about expiring stimulus payments, tenant delinquencies, and the absence of college-aged tenants, who stayed home while attending school remotely. All those trends reversed themselves in 2021, as additional stimulus money and loosening of ejectment restrictions generate optimism that tenants will pay rent, and the expected resumption of in-person learning is creating an influx of new renters.

Landlords seem unconcerned about the 1,000 new apartment units per month coming online in Philadelphia, keeping rents unchanged or slightly up in Philadelphia. Pittsburgh rents are also largely unchanged.

In the future, spiraling construction costs and lack of availability of materials, together with fears of oversupply, may begin to constrain new construction, but so far that hasn’t happened.

d. Office 

COVID brought most office leasing activity to a screeching halt, as businesses tried to determine what the future would hold. Leases and building projects underway before COVID hit tended to be completed (in some cases, with re-negotiation), but otherwise whoever could extend their leases for a short term did so. That may be changing, as commercial brokers report an uptick in smaller tenants hunting for space. Most tenants are seeking space with low fit-out costs and short terms no more than five years. Most are reducing their office footprint.

Many tenants are considering how to reconfigure space for the post-COVID world, as everyone is struggling to determine just how much working from home will impact future needs. Some are considering “hoteling,” i.e., allocating no or limited space to individual employees and instead creating a “pool” of offices available to the employees that want to be in the office on a given day. Others plan to reduce office size in recognition that people will spend less time in the office.

e. Retail 

Traditional bricks-and-sticks retail remains stuck in the doldrums, as malls continue to reposition themselves, many by finding space for e-commerce. Likewise, small, isolated stores generally have had a hard time getting through COVID, especially if they were unable to pivot toward delivery and curbside services. On the other hand, shopping centers anchored by good supermarkets are generally holding on, as consumers working from home spent more at their local groceries than in previous years.

f. Hospitality 

After a decade of prosperity, hospitality took a nose dive last year, with room revenue in Philadelphia alone down nearly 75% over the previous year according to a report of local agencies. While leisure travel is expected to rebound in the latter half of the year, it remains unknown if business travel, the biggest driver of hotel use, will follow suit.

3. Tax Concerns Overshadow the Future 

Overshadowing nearly every decision made by real estate owners and investors is which tax changes, if any, the Biden administration will be able to push through, and when.

Potential increases in the capital gains rate, coupled with threatened elimination of the popular 1031 “like-kind” exchanges, are causing prospective real estate sellers to accelerate the pace of their transactions, banking that any tax changes will be prospective in nature.

The possible elimination of the “stepped-up basis on death” – which allows the inheritors of real estate to avoid the capital gains built-up during their predecessor owner’s lifetimes – may prompt older real estate owners to hasten to estate planning advisers to determine whether they should consider alternative arrangements to transfer wealth to the next generation.

Finally, the perennial tax reform target of the “carried interest” is being watched by fund managers and developers, who are hoping the lobbying tactics previously used will continue to allow them to thwart any change in the treatment of those interests.