By: Tim Witt, chief investment officer at Concorde Investment Services
The COVID-19 pandemic has generated significant transitions and migrations. Business travel and office work has transitioned to Zoom, e-commerce and the accompanying need for warehouse space has exploded. People are leaving states, such as California, New York and New Jersey, with a high cost of living and high taxes and moving to places such as Austin, Boise, Denver, Nashville and Florida. A migration from the urban core to suburbs and smaller town is under way. Vacation travel has become more local – within driving distance. The lowering of interest rates by the Fed has led to cap rate compression for multifamily and net lease.
The key challenge for real estate investors in 2021 is determining which 2020 trends are temporary and which ones have longer legs. While each of these transitions is worthy of an in-depth analysis, this article will focus on the migration to the suburbs.
The burbs are back, and not only as a result of pandemic-induced moves. This shift was in the making prior to COVID-19 and may continue for years.
A key driver of urban core revival has been the millennial generation which highly values mobility, freedom and flexibility. They are not loyal to employers and will readily jump ship for a better opportunity. The unique attributes of this generation and their living and spending preferences have influenced real estate investing in recent years, but that is changing.
For the next decade, there is one overarching millennial trend that will impact real estate investing: the delay of marriage. While it is widely known that rates of marriage have been declining in our country, many millennials will still tie the knot. However, instead of getting married in their 20s as previous generations, they often delay marriage until their 30s. As a result, many are also delaying having children well into their 30s.
While city life has its perks—access to diverse cultural experiences, proximity to museums and landmarks, convenient access to dining and retail, and the like—the three major drawbacks to raising children in the city are the three S’s: space, schools and safety.
The compact urban apartment or condo quickly goes from cozy to cramped as a family grows. The cost of moving up to a two- or three-bedroom apartment/condo, plus the cost of childcare, can be prohibitive. Many families will desire a backyard for the simple pleasures of throwing a ball or hosting a barbeque. The suburban home, with a lower cost per square foot and lower property taxes, will seem like a bargain compared to city real estate.
When the first child is two to four years of age, the focus on schools intensifies. Urban millennials are well-educated, and they desire the same for their children. Many urban public schools may not meet their requirements, and private-school tuition in the city is high. The cost of education, coupled with the cost of housing, will provide only the highest earning millennial families the ability to maintain an urban lifestyle.
In short, the baby will drive the millennials back to the burbs. The events of 2020—the pandemic, protests/riots, rising crime, and efforts to defund the police—have accelerated this trend. Having a family heightens the need for and awareness of personal health and safety. Even for those who are not married, safety and security will cause many to question the choice to live in the city. The pandemic, at least in the short term, has lowered enthusiasm for other aspects of city living, including public transportation and congested, high-density multifamily developments and office space.
All these factors will—and already are—impacting the real estate investment landscape. Here are a few investment trends to consider.
Lifestyle and Location
Many millennials with heavy debt (especially student loans) or little saving will be renters for some period. When considering a migration, they will be attracted to suburbs with high-performing public schools, a variety of local dining options, and healthy grocery stores. Desirable suburbs may have artificial barriers to entry for new multifamily competition—the Not In My Back Yard (NIMBY) phenomenon. Residents of these suburbs often take a dim view of traditional apartments since they can be a strain on public resources, and apartment tenants are viewed as transitory and not invested in the community.
As such, Class A- and B apartments that can be upgraded with more modern, attractive finishes may be the best options for investors. They may allow more affordable rent compared to new construction for tenants who are burdened by debt and/or want to save for a down payment on a future home. These older communities are usually lower-density and have ample green space compared to newer apartment communities that typically offer little beyond buildings and asphalt. With increasing demand and limited new supply in many submarkets, rent growth should outpace urban areas, especially those urban submarkets that have seen significant apartment deliveries.
Distressed Office Space
Investors should consider suburban office properties with high vacancy that can be purchased at a substantial discount to replacement cost. Having a low basis is critical as these buildings will need costly improvements to finishes, amenities and air quality systems. Millennials value workspace that is healthy and inspiring. The goal is to have an all-in basis meaningfully below replacement costs to be competitive on rents compared to newer office properties.
While tenants may not move completely to the suburbs from the central business districts, they are far more likely to open satellite offices to follow a workforce that is relocating to the suburbs. Millennials still value flexibility and a fulfilling work-life balance. Splitting their lives between the suburbs and the city, along with the time, cost, and environmental impact of commuting, will not be desirable. The events of 2020 may also drive a larger trend toward satellite offices as employees and businesses alike look for less congested options—both in their own spaces and in the office buildings they occupy.
The past year has been an inflection point for work from home, either full-time or a few days a week, which presents a major opportunity for homebuilders. Millennials, along with other generations, will be attracted to homes with well thought-out remote office space. Most builders locate home offices either right next to the main entrance or upstairs mixed among the bedrooms. These are less than ideal unless only the remote worker is home during working hours.
Remote workers need separation from other family members and barking dogs. The space should be situated with ample windows for mental health and a suitable background to provide a professional appearance on video calls. Good access to a bathroom is helpful. At least one production homebuilder is offering a floor plan with a small cottage in front of the main house. Home office layout and placement is ripe for creativity, and builders who meet this need will have a competitive advantage.
All is not complete doom and gloom for urban areas. The generation following millennials is large, and they may eventually backfill many of the apartments and office spaces left behind for space in the suburbs. Empty nesters may hold off on moving to the city but could reconsider when some societal normalcy returns. Office tenants may retain a presence in the urban core for various business reasons. However, for investors seeking to profit from trends, the millennial migration from the city to the suburbs should provide an opportunity for well-located suburban real estate to outperform over the next decade.
Tim Witt serves as the chief investment officer for Concorde Investment Services, a national securities broker-dealer registered with FINRA to solicit securities products in all 50 states and several territories.
Headquartered in Michigan, Concorde Holdings, Inc. is the parent company of Concorde Investment Services, LLC., a national securities broker-dealer registered with FINRA to solicit securities products in all 50 states and several territories. Concorde Asset Management, LLC, an SEC registered investment adviser and Concorde Insurance Agency, Inc., which is insurance licensed to solicit insurance products in over 30 states, are also subsidiaries of Concorde Holdings, Inc.
This is for informational purposes only. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Past performance is not indicative of future results. Forecasts are inherently limited and should not be relied upon as an indicator of future results.
The views and opinions expressed in the preceding article are those of the author and do not necessarily reflect the views of The DI Wire.