Historically, the City of Philadelphia has been a hotbed for real estate investment. Due to its housing density, age of its housing stock, and demographics, there were unlimited opportunities. If you were a new construction developer, there were ample lots available to develop. Landlords were able to build large portfolios. Flippers were able to find distressed properties in almost every neighborhood. And today, those same opportunities still exist. However, what no longer exists is the same climate that has historically existed. And in addition, as of today, your investment dollars are safer, and will yield greater profits, in the Philly suburbs, outside of the City proper. What follows is our opinion as to what is wrong and what to expect from a real estate investors point of view.
From a macro standpoint, the shifting real estate market in the city was a forgone conclusion once interest rates started rising. It’s only common sense, rising interest rates equates to falling residential real estate prices as supply outpaces demand. This has been a truism since the dawn of time, but why are the Philly suburbs not experiencing this simple economic principle, yet the city is?
The simple answer is the city of Philadelphia is in trouble. Violent crime has never been higher. Poor governance has led to an eroding tax base. When people don’t feel safe and they can’t count on their local government for services, or worse, see their taxes go up significantly year over year while simultaneously seeing a drop in services, the decision is easy for those with the financial ability: leave. And where do they go? For most, to the city’s suburbs. So the flight from the city is fueling the demand in the suburbs.
So as the blog is being composed, there is significantly more supply than demand in the city. And when we state city, we mean every neighborhood. But is this temporary? Once interest rates stabilize and start to drip down will the city’s real estate market stabilize and supply and demand come back in balance? This writer thinks no, or to use that tired expression, the city has jumped the shark. Bold statement, but why?
Let’s start with absolute poor governance. Whether you voted for these clowns or not, let’s be honest, they’re clowns.
Despite what the Philly Inquirer will have you believe, the mayor, DA, city council, or judges, it’s a clown show.
Crime: Violent crime has never been higher. This isn’t some fabricated conservative talking point, violent crime has never been higher. Property crime has never been higher. In the city, police have stopped policing. Shoplifters run free and traffic violations are ignored.
Taxation: Another casualty of the pandemic is the city’s tax base has been eroded. A large percentage of workers who used to drive from the suburbs into the city five days a week now may only drive in two days a week, or none at all. The wage tax system is set up wherein the city can only tax a suburban resident, who works in the city, the days they are physically in the city. So wage tax revenue is way down. Everyone of those high rise commercial buildings that dot the city’s skyline has appealed their assessments, and that has further eroded the tax base. So what’s the solution? In Philly, the people in charge think it’s as simple as raising your property taxes every year. If you’re a landlord who owns Philly real estate, you know that for the last three years the city has increased your assessments. Just this week, the City announced that there will be no assessment hikes for year 2024. On the surface that seems like good news to all of us city landlords, but it’s not that simple. In 2024 when the city doesn’t have enough money to run the city, they can simply change the tax rate and increase your property taxes that way. Bottom line is that historically, one of the most attractive reasons to own rental properties in the city of Philadelphia was low property taxes, but that has changed and will continue to change.
Public schools: The city’s public school system is in shambles and the quality of education is far below suburban public school systems. This condition drives people to leave, which exacerbates the over supply of inventory.
City courts: In the city of Philadelphia, a real estate investor will find no one institution that has a more adverse effect on their real estate portfolio, than city judges. It is impossible to get treated fairly as a landlord in a city courtroom. This is not hyperbole. So until judges start adjudicating fairly, Philly landlords will always have higher losses due to unpaid rents than their suburban counterparts.
Basically, we have a city full of people who feel unsafe, over taxed, and underserved, so they are leaving, and will continue to leave.
Here’s another point worth looking at: in 2021, for the first time in the history of the city of Philadelphia, more of its residents were tenants than owner occupants. Let that sink in. As a rule, most real estate investors strive to procure rental properties in stable neighborhoods with low tenancy rates. But there is also that section 8 model where investors gobble up as much property as they can in low income neighborhoods, since the rents are greater than their monthly PITI, and as a result they can generate a positive cash flow, despite less equity growth. But is this model not in jeopardy as tenancy rates in these neighborhoods increases year over year and property taxes increase year over year?
At this point of the blog you must be scratching your head wondering what’s the point of all of this negativity in regard to the city of Philadelphia. Here’s the point: as a real estate investor you need to re-think how you allocate your dollars.
Flippers: As of today you should be prioritizing the suburbs over the city. First, in the suburbs, the forecasted ARV of your finished product will most likely be accurate; in the city, you should discount your forecasted ARV based on the expectation that when the product is finished and ready for market, prices may have depreciated. This means you need to buy your city flips deeper than you are accustomed. Also, beware of those historically hot neighborhoods like Point Breeze and Cobbs Creek, as those areas are depreciating at a much greater rate, due to large amount of investor owned properties, which equates to greater inventory, versus stable neighborhoods like Richmond or Roxborough or the like. Investors are quicker to drop prices than owner sellers. As an example, as of this date, there are exactly 131 active listings in the Point Breeze neighborhood as bounded by Washington Avenue to the north, Broad Street to the east, Mifflin Street to the south, and 25th Street to the west.
Landlords looking to grow their portfolios: For investors with deeper pockets, the easy answer is to start to buy rentals in the suburbs. You will need deeper pockets as you will need to leave money in these deals as otherwise you will not have a positive cash flow as monthly rents typically fall short of the monthly PITI. Therefore, for many of you, the city of Philly will be your only answer. For you city people, try to buy deeper than you ever have before. This is important because your expenses are going to continue to grow year over year due to increased property taxes and increased landlord license fees.
Landlords managing an existing portfolio: Take stock of your portfolio and if you have properties that are flirting with a negative cash flow, you may need to reorganize your financial vehicles, which may include selling off some assets that are already fully depreciated so that you can pay down some principals.
Here’s the main point we’re trying to make, as a real estate investor, whether a flipper or holder, you need to be more cautious when buying in the city and if possible, you should be setting up strategies, networking, and infrastructure to support moving your model from the city to the suburbs. The goal is to continue to build wealth, but for the numerous reasons addressed above, it’s getting much harder in the city of Philadelphia.