Outside investors target tertiary markets for better yields
Local investors beware: Central Pennsylvania is on the map for outside groups looking for higher returns.
Last month, The Solomon Organization, a New Jersey-based operator of multifamily properties, closed on a $25.7 million purchase of the newly built Ivy Ridge Apartments in Swatara Township. That price — $117,913 per unit — is the highest in the Harrisburg market this year.
It also marked the company's first foray into the Harrisburg area after landing in Lancaster County six years ago. It owns six communities in Lancaster County and more than 1,200 units.
"Two years ago, you said 'Harrisburg' and people would just hang up the phone," said Zachary Pierce, director of the National Multi Housing Group in Philadelphia for Marcus & Millichap Real Estate Investment Services.
Outside investors were interested only in primary markets such as New York City and Washington, D.C., and maybe Philadelphia, he said. But as prices have shot up in those prime areas, the tertiary markets offer a cash-on-cash return that is 100 to 200 basis points better.
More are willing to make the drive to the midstate to take a look, Pierce said, citing three competitive offers from outside groups on Ivy Ridge. Interest is out there from large portfolios based in New Jersey, New York and Washington, D.C.
'Our primary markets'
Located behind the Harrisburg Mall, Ivy Ridge is a 218-unit complex made up of mostly two-bedroom, two-bath apartments. It was built by Lower Paxton Township-based Triple Crown Corp.
"Generally, you will see higher returns," said Marshall Rosen, managing director of The Solomon Organization. "Cap rates in secondary and tertiary markets are typically higher than primary markets. And the product will sell for less."
The Solomon Organization doesn't normally go after new construction, because it's not readily available, Rosen said. With more than 10,000 units in Connecticut, New Jersey, New York and Pennsylvania, it typically looks for value-added opportunities in suburban markets, meaning an older complex of garden-style apartments that need to be updated.
"You don't have the level of competition from institutional buyers — the pension funds and publicly traded REITs — because they are focused on primary markets," Rosen said, the latter referring to real estate investment trusts.
Those groups can accept lower returns on their investments because they have to focus on the things people immediately identify with, which is the larger metropolitan areas. If they do venture out into secondary markets, it's going to be for new construction at a low price.
"For us, the secondary or tertiary markets are our primary markets," Rosen said.
The Solomon Organization started more than 35 years ago with developments almost entirely in New Jersey as residents sought affordable alternatives to New York City. By 2003, it ended up in Pennsylvania with two deals — one in the Bethlehem area and another in Sinking Spring, which is outside Reading.
"We knew we liked the Bethlehem market. It's just over the Jersey border," Rosen said. "A lot of New Jersey commuters."
In Sinking Spring, the company found an area that was reasonably vibrant and attracting residents. The jobs had changed. There was some light industry mixed with service and health care. It was a model the company had seen in New York and Connecticut, Rosen said.
"They have become hubs for some high-tech activity and a health care boom," he said. "It's brought another level, a different kind of worker. There are higher-paid employees that want nicer things we try to provide when we buy assets."
That led to Lancaster County.
The Solomon Organization normally focuses on kitchen and bathroom updates, modernizing or adding clubhouses and fitness centers. At Ivy Ridge, the plan is to undertake an extensive landscaping project to improve curb appeal, as well as adding new signage throughout the complex and shutters on all windows.
"Our opportunity is we're going to operate and over the next few years increase rents," Rosen said, which will move Ivy Ridge more in line with market averages for new construction.
Rosen said there is interest to further expanding its midstate presence.
"The York market is a market we do like," he said.
There is a misconception that Harrisburg is a risky investment because of the city's financial challenges, Pierce said. The reality is that there is a lot of stability here with a diverse mix of industry and large employers. And this area is close to the Lehigh Valley, Baltimore and other metros.
The investment market, at least on the rental side, is less competitive than prime markets, because there is less density, he said.
Brokers need to do a better job of educating the market, Pierce said.
Last December, a net-leased medical office built for PinnacleHealth System in 2006 was sold for $4.26 million at a capitalization rate of just above 7 percent.
The Lower Paxton Township office set a sales record for Central Pennsylvania at $326 per square foot, according to California-based Marcus & Millichap Real Estate Investment Services.
Recently, an office built for the Internal Revenue Service and Social Security Administration in Springettsbury Township sold for more than $6.6 million, or $345 per square foot. The buyer was an Israel-based pension fund.
"Like the PinnacleHealth deal, quality real estate, credit and term is attracting a lot of capital," said Ben Appel, a net-lease specialist in the Philadelphia office of Marcus & Millichap's National Office and Industrial Properties Group. "High-net worth is not just regional but from around the world."
Tier two and three markets have been more attractive to outside investors because of smaller yields in top-tier markets, he said. In this York County case, the deal was attractive because of the government tenants.
"It's not the specific location. They are looking nationally for single-tenant government lease properties for 10 to 15 years," Appel said.
Because there has been very little new construction in the greater Harrisburg area over the last five years, it's becoming more of a landlord's market, said Erik Gainor, director of the National Office and Industrial Properties Group.
Rental appreciation is driving more outside dollars into the market, he said.
"In order to sell at a profit, rents have to be high enough," he said. "That's driving income and what the buyer is going to cap."
The Solomon Organization LLC bought the Ivy Ridge Apartments in Swatara Township for $25.7 million based on what it thinks it can raise rents to in the coming years.
An analysis of two-bedroom apartment rents in the Harrisburg area had the new construction average at $1,247 per month, according to Marcus & Millichap Real Estate Investment Services, the firm that brokered the deal.
Ivy Ridge’s initial lease-up rates were $875. The firm indicated that pro forma rents should be about $1,200.
The average rent on older apartments was $839 per month, according to Marcus & Millichap.
New construction properties, average two-bedroom rents
• Madison Hamilton Park (303 Hamilton Circle, Harrisburg): $1,400
• The Overlook (150 Erford Road, Camp Hill): $1,318
• Magnolia Terrace (2300 Magnolia Terrace Drive, Harrisburg): $1,239
• The Encore at Laurel Ridge (137 Ringneck Drive, Harrisburg): $1,208
• Graham Hill Apartments (1515 English Drive, Mechanicsburg): $1,190
• The Terraces at Springford (830 N. Highlands Drive, Harrisburg): $1,128
• Ivy Ridge Apartments (589 Yale St., Harrisburg): $875
Older vintage properties, average two-bedroom rents
• High Pointe Club (1500 High Pointe Drive, Harrisburg): $953
• Twelve Trees Apartments & Townhomes (1136 Summerwood Drive, Harrisburg): $860
• East Park Gardens Apartments (199 Francis L. Cadden Parkway, Harrisburg): $825
• Twin Lakes Manor Apartments (4405-A Union Deposit Road, Harrisburg): $825
• Pennswood Apartments & Townhomes (4913 Wynnewood Road, Harrisburg): $821
• Aspen Hill Apartments (5069 Stacey Drive East, Harrisburg): $819
• Eagle’s Crest Apartments (1008 Eaglescrest Court, Harrisburg): $774