Rahil Raza has built homes to rent and sell in lower North Philadelphia for a decade.
Like almost everyone else, his business is frozen right now. The new office his company is building for its small staff will remain a blueprint for the immediate future. Their infill single-family homes are frozen at various stages of completion on quiet residential blocks. Home sales have slowed and the contractors he employs are out of work.
But like many professionals active in Philadelphia’s real estate sector, Raza says that his faith in the industry’s future remains strong.
“I think development will pick up right where it left off,” Raza said. “I’m not going to say ‘these things happen’ — nothing like this has ever happened — but there are always hiccups in the economy. I think we’ll get back on track.”
Raza said that he is planning for a six-month hit to the for-sale market. On the rental side, he thinks that his company may have to lower rents to attract clients who could be more financially conservative in the pandemic’s wake.
“I bought these properties for a low amount and so if I have to drop the rent a couple hundred dollars, I’ll do that,” said Raza. “It’s not gonna break my bank.”
‘Planning for the recovery’
For now, most construction in the city is halted. Layoffs have hit architecture firms, real estate companies and contractors. The Philadelphia Building Trades Council reports a 60% unemployment rate for its members. Project managers who managed to secure waivers from state authorities report difficulties finding workers, as some subcontractors laid off their work forces en masse after last Friday’s end-of-construction deadline.
Still, the developers say the acute pain will be temporary. Most of the real estate professionals interviewed for this story predict that the economic downturn caused by the coronavirus pandemic would affect their industry less dramatically than the Great Recession.
But that’s not saying much. Mortgage foreclosures and the collapse of the real estate-backed financial industry caused the 2008 economic crisis and quickly, credit ceased flowing. It was clear to many observers that getting a loan for a project would be difficult, if not impossible, for years to come.
“Lenders completely ran for the hills,” said Carl Primavera, a real estate and finance attorney with many major Philadelphia developers as clients. “The economy was structurally impaired and it wasn’t going to be a short-term dislocation. It was an overall failure that really put people on the sidelines and the amount of activity slowed tremendously.”
Primavera and other industry players who were operating in 2008 and its aftermath say they haven’t yet seen similar kinds of reactions from the various corners of the real estate industry.
“[Unlike 2008], people that I’m talking to are not pessimistic or thinking that it’ll be a recession or depression,” said Primavera. “We’re still seeing a tremendous amount of interest from our clients in moving forward with pre-development approvals and planning for the recovery.”
Affordability crisis could be worsened
The industry optimism is not without caveats. Moody’s Analytics is predicting a sharp decline in residential sector lending activity in the second quarter of this year, followed by a sharp rebound afterwards. But the company believes credit markets remain tighter into 2021, contributing to a downturn in home construction that will worsen affordability for potential homebuyers, aggravating an existing affordability crisis.
Developers, meanwhile, will experience the economic pain differently, depending on where they are in the process. A smaller operator like Raza, with capital spread among a handful of single- family homes under construction, will probably be less exposed to risk than a larger developer who’s sunk much of their capital into a partially completed major project in Center City.
Those risks can be exacerbated by the length of the development process, especially for larger projects. By the time physical construction starts, developers have often been investing in and working on a prospective building for years, which leaves a lot of time for things to go wrong. Because of the high risk, especially on big multi-family or commercial buildings, construction loans have high-interest rates that create a substantial burden if you are holding one and can’t actually build.
“During the Great Recession, there were a lot of these half-built projects that had to stop because the money got cut off,” said Jenny Schuetz, fellow at the Metropolitan Policy Program at Brookings Institution, a think tank. “In the meantime, you’re not earning any revenues on it, you can’t rent out space, and the developers are still paying carrying costs on it. So that’s really expensive not to be able to push forward and finish it.”
Many developers who stuck with those half built projects through the 2008 recession were eventually driven out of business, contributing to the mass unemployment in the field. Nationwide the industry never really recovered from the fall out, Schuetz said.
But Philadelphia never saw the turbo-charged heights of the pre-2008 years and it didn’t fall as hard. Industry experts hope that the city will be able to weather the coronavirus pain better than some of its peers again, especially because of its reliance on educational and medical industries.
“2008 was this whole mess that needed to be unraveled, that took years to unravel,” said Matt McClure, head of Ballard Spahr’s zoning and land use team. “We’re not in that situation. It’s still scary, but it’s more acute and less complicated. And I’m bullish on anything to do with logistics, health care and biotech, which sounds pretty damn good for Philadelphia.”
Even if McClure, Primavera, and other real estate development players in Philadelphia have confidence in the industry’s medium- to long-term future, they also note that no one in business today has ever seen anything quite like a nation-stopping pandemic before.
It all depends on how long the economic freeze lasts. A couple month lag in construction would be painful, but many companies have cash reserves. Longer than that, however, could start causing serious damage. Meanwhile the inability of tenants, both commercial and residential, to pay rent could hurt cash flow for the many companies — like Raza’s or OCF Realty — that both develop and own properties. The overall effect of stimulus and assistance from all levels of government is a huge unknown.
For now, many in the industry will just have to wait and see. Some developers have won waivers from the state to keep building, at least on some of their projects, but Raza is not one of them. His company has enough reserves to cover three months of operations, but they’ve still had to lay off three employees. But he hopes that, with government assistance, they can rehire them in June and business will rebound.
After all, the things that he liked about Francisville and the other near North Philadelphia neighborhoods where he is building will still be true after all this is over, he says. Raza doesn’t believe the pandemic, or its fallout, will drive people away from walkable, transit-oriented parts of Philadelphia in the long term.
“It is a very scary time,” said Raza. “But I think it’s a momentary pause. After we’re over this, I think the area will continue to grow and prosper.”