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What’s the Verdict on Urban vs. Suburban CRE Investment?

While there has been some major buzz in favor of suburbia, the truth is that the growth may not last.

In the recent past, it has been widely believed that urban markets triumphed over suburban ones to such a degree that many institutional investors avoided the suburbs altogether. Now, many are insisting suburbia is making its comeback and perhaps surpassing urban markets for investment opportunities.

This is understandable. Originally, it was predicted that the millennial generation would differ from their baby boomer parents and reside in large metropolitan areas in hip loft apartments, walking to the nearest farm-to-table eatery and eschewing cars altogether.

Chasing millennials

However, when the millennials began having children and were anticipated to be buying suburban homes with yards, investors began to rethink their urban-only strategies. Those investors, however, may have jumped the gun.

Here is the reality. First of all, today’s suburban interest is focused on close-in transit-oriented and highly-amenitized “first ring” suburban locations, as opposed to the more traditional, outlying suburban locales developed after WW II.

With regard to growth, there was a slight increase of 2.25 percent in millennial net migration to these suburbs from 2015-2016, causing many to believe millennials were deserting their urban roots.

While there may have been a shift of some millennials to the suburbs, the percentage of millennial net migration in 2017 has already declined by more than half, bringing it down to just 0.9 percent.

This generation’s suburban transition may indeed occur in the coming years, as it seems to be delayed. Millennials are getting married and settling down much later than previous generations, and they aren’t craving the suburban lifestyle just yet. When they do move, they are more likely to pursue suburban areas relatively close to the city, where they can still access the hottest sushi spots in town.

In addition, a shorter commute, both to work and to urban lifestyle options, is more desirable than a larger home deep in the suburbs, especially in those markets lacking easily accessible mass transit. This will likely mean that the jobs and, therefore strong office demand, should stay predominantly in the city core.

Chasing rent growth

Suburban appeal is certainly increasing due to strong current property fundamentals as a result of limited construction activity. Not only is the current rent growth greater in both multifamily and office than in urban areas, but it is also above its long-term average. While this has created some major buzz in favor of suburbia, the truth is that the growth may not last.

For one thing, this shift has only occurred quite recently and the recovery period for suburban office fundamentals is much later than its urban counterparts.

In addition, the more favorable numbers for the suburbs may not be a lasting change. Multifamily rent growth in the suburbs already appears to be moderating and we are expecting to see an increasing supply in the near future.

However, if property fundamentals in the suburban market continue to recover, both suburban multifamily and office supply will eventually increase, and this will have a negative impact on rent growth. Investors need to consider the long term before taking the plunge.

Suburban markets also tend to have lower constraints for new development, often delaying rent increases. This would need to change significantly for suburban markets to surpass urban markets in the long term.

Recent studies show that urban apartment supply is expected to plateau and then be reduced, causing a gradual escalation in urban multifamily rent growth, while suburban multi-family rent growth is decelerating, vacancy rates are increasing and NOI growth has weakened.

Chasing yield

So why are investors so insistent on a suburban comeback? They are in pursuit of higher yields and those yields are currently available in suburban assets—for the time being.

In the past, urban assets have outperformed suburban asset returns in both office and multifamily sectors. From 1996 to 2016, suburban multifamily fell behind its urban counterpart by 80 basis points, while the suburban office sector underperformed urban by 110 basis points.

The present spread between urban and suburban multifamily is consistent with its long-term average at 81 basis points, meaning there is currently no worthwhile advantage to investing in suburban assets when considering the long term.

All things in moderation

When it comes to investing, it is a matter of timing and balance. Regardless of whether millennials are choosing suburban over urban markets, investors should focus on balancing their assets for the long term. The market is continually changing and it’s not always smart to strike while the iron is hot. If investors aren’t ahead of the game, it’s likely they have already missed their opportunity.

Stanley Iezman serves as CEO and Chris Macke as managing director of research and strategy of American Realty Advisors, a provider of commercial real estate investment management services with more than $8.1 billion in assets under management.

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