New Projects Could Undercut Developers' Existing Ones

It’s a great time for commercial real estate developers, with multifamily one of the standout sectors. In buildings with five or more units, the number under construction is at a peak since 1973, according to Census Bureau and Department of Housing and Urban Development via the Saint Louis Federal Reserve FRED data site.

But there’s a downside in and around some areas, according to Brian Lawrence, vice president and relationship manager at Univest Bank and Trust Co. The success of new projects can mean a backward slide in existing ones.

“In the Philadelphia market we’ve been seeing a huge influx into our marketplace” with people moving south from New York, Lawrence says. “Rental rates have gone up over the last two years and one of those effects is new construction. With the new demand, there is also new construction that has gone on. Which is good for Philadelphia. You can see a boom in some tertiary neighborhoods.”

And yet, it’s not all good. The wave of people with more money looking for places to live puts gentrification pressure on existing communities. “Rental rates have gone up to a point where it’s bringing in a new type of tenant to the space, which is driving up the cost of houses,” Lawrence adds. “It’s one of the unfortunate things we’re seeing with the pandemic. You’re seeing a global economy where increases in price are happening and wages aren’t following. The city has combated that a little bit with affordable housing requirements, but it’s continuingly causing strain on that system.”

It’s a problem for communities and city governments, but also developers because of the local macroeconomic effects. There’s a feedback loop where newer buildings draw people from older ones, existing owners may have to upgrade to remain somewhat competitive but if not still will likely increase rents as valuations rise with the market, and more long-term residents don’t see wages rise accordingly, so have to look elsewhere for housing. Developers that also operate properties may find themselves putting pressure on other buildings they own.

“For developers, it’s a situation where they have to think thoughtfully about the projects they undertake,” says Lawrence. “It’s a delicate balance that the city has to deal with much more, but the developers are the people who have to deal with the neighborhood groups. There are some developers that develop, stabilize, and own and want to be a vibrant part of the community and they want to be a part of that community. Then you have your serial developers.” The latter depend on a business model of creating and then moving on. But as space gets scarcer around a city, the approach may not be sustainable for the builder, let alone residents or the city as a whole.

The city response then can become greater regulation and more restrictions on building sizes, heights, and other aspects.

“I think you’re going to find people maybe vilifying the developers with people pushed out of the area and no one wants to see that happen,” adds Lawrence. “But the developers are also faced with supply chain shortages, rising cost environments, and finding the proper subcontractors to do work. They’re facing it from all different angles, and you can’t blame them for raising the rates because they need to make the development profitable.”

But Lawrence notes, eventually prices can’t rise to meet what developers need or want. “You’re not going to be able to keep raising rents and housing at the rates of the last 18 months,” he says.