A recent demographics report shows that 80% of the U.S. population now lives in an urban area, a statistic that has been driven up significantly by the housing market collapse and falling appeal in suburban homeownership. The surge in urban growth has led developers back to cities that once suffered from stagnation. One example is the new Whole Foods that has been built in Midtown Detroit, a city where an upscale market would be unthinkable just a few years ago. Development of multifamily housing in urban centers is also booming as more people shed mortgages and move into rental properties. For more on this continue reading the following article from National Real Estate Investor.
When upscale grocery chain Whole Foods broke ground for its first store in Detroit this May, the move may have seemed like an aberration. While the Austin, Texas–based retailer has always had a presence in cities, it normally concentrated on more affluent neighborhoods and high-traffic mixed-use properties; for example, the Time Warner Center, across from Central Park in New York City.
Time Warner Center—with its mix of upscale shops, multimillion dollar condos and location in a tourist-filled corner of Manhattan with a major subway hub beneath it—has the ability to pull in both local residents and those New Yorkers from the outer boroughs who can fill their shopping carts on the way home from work. It’s a far cry from Midtown Detroit, a neighborhood with a much lower population density and household income that has been struggling for the past 25 years, according to Susan Mosey, president of Midtown Detroit Inc., a nonprofit planning and development organization devoted to Midtown’s revitalization.
Recently, however, Midtown Detroit’s face has been changing, which is why Whole Foods wants to open a store there. Prior to the Great Recession, Detroit was considered the prime example of urban decay. From 1950 to 2000, the city lost more than 48 percent of its residents, dropping to a population of less than a million, according to the Web site Demographia. But thanks to incentives ranging from a $2,500 rent allowance for employees of major local institutions who opt to move to the neighborhood to a planned 10-mile pedestrian and bicycle trail connecting Midtown and Downtown Detroit, the city is becoming a magnet for echo boomers, a generation born between the late 1970s and the early 2000s. Approximately 37 percent of people who come through its Live Midtown program are between the ages of 20 and 29, reports Midtown Detroit Inc.
“Many people are coming here because they find Detroit an interesting city,” says Mosey. “Young people want transportation options; they want interesting locally produced foods; they want job opportunities.”
What’s happening in Detroit is emblematic of a nationwide trend of the growing popularity of urban living, which has intensified in the wake of the housing crisis of the late 2000s, as owning a house in the suburbs has lost much of its appeal. According to the 2010 census, more than 80 percent of the country’s population now lives in urban areas. In June, the U.S. Census Bureau reported that during the 2010–11 period, population in 27 of the largest U.S. city centers grew faster than in the surrounding suburbs for the first time since the 1920s.
The echo boomers, who number approximately 80 million, are among the primary drivers for this trend. A recent study by commercial real estate services firm Jones Lang LaSalle found that people in their 20s are willing to spend up to 69 percent of their income on rent—more than 20 percent above the national average—in order to live in gateway cities, including Boston, New York, Los Angeles, San Francisco and San Diego. Thanks to greater affordability and redevelopment efforts like Midtown Detroit’s, they have also begun looking at smaller cities, ranging from Raleigh, N.C., to Des Moines, Iowa.
The commercial real estate industry is noticing a dichotomy between property fundamentals for commercial buildings in Central Business Districts (CBDs) and those in the suburbs. For example, rent growth for multifamily projects located in CBDs has outpaced rent growth for suburban projects by 3 percentage points, according to the CoStar Group, a Washington, D.C.–based research firm. Today, occupancy at CBD-based multifamily buildings averages a full percentage point higher than in the suburbs.
Similarly, in the third quarter of 2012, average rents for office buildings in CBDs nationwide stood at $30.10 per sq. ft.—a premium of more than $10 per sq. ft. over suburban office buildings. Vacancy at CBD office properties was also lower, at 0.1 percent, compared to 0.12 percent for suburban assets.
Commercial property developers and investors have experienced the shift firsthand. During the downturn, properties in urban markets proved more immune to recessionary forces than suburban projects because of higher barriers to entry and more resilient job markets, notes Ian Swiergol, managing director in the Phoenix office of Alliance Residential Co., a national apartment development, management and investment firm. Having built multifamily complexes in both urban and suburban areas in the mid-2000s, Alliance executives found that maintaining occupancy levels above 90 percent at suburban projects required offering renters anywhere from two to four months in rent concessions, equal to approximately a 33 percent discount on market rent.
At urban properties, on the other hand, only about a month and a half of concessions would suffice, limiting discounts to 14 percent at most. As a result, today Alliance is focusing on building multifamily complexes in urban locations, with easy access to transportation and established office, shopping and entertainment amenities, says Swiergol. A good example is Broadstone at Camelback, a 270-unit apartment community in Phoenix that will be located next to the Camelback Esplanade office complex, the Ritz Carlton Hotel and Biltmore Fashion Park, a 535,430-sq.-ft. mall anchored by Macy’s and Saks Fifth Avenue. Alliance expects that many of the residents at Broadstone at Camelback will be the office workers from Camelback Esplanade.
These are the kinds of properties where real estate investors and developers see the greatest potential for growth in the coming years, as Americans change the way they live.
“On a global basis, you are clearly seeing significant urbanization because the cities are where the jobs and opportunities are,” says Robert O’Brien, vice chairman and real estate sector leader with global consultancy firm Deloitte. “I think what we are going to see here is this trend continuing for the foreseeable future, driven by the high cost of gasoline and traffic patterns. You are going to see people moving closer to their jobs, transit systems becoming even more important than they are and companies out in the suburbs looking to move closer to the cities.”
Part of this shift is the result of the housing crisis, says O’Brien. Previous generations, including the baby boomers, saw a house of their own as an always-appreciating investment and couldn’t wait to buy a place with a yard, miles away from urban crime and pollution. But as housing values fell 34.4 percent over the past six years from their 2006 peak, according to the S&P/Case-Shiller home price index, home ownership came to look like a much riskier bet than previously thought.
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Meanwhile, the echo boomers have been graduating from college carrying thousands of dollars in debt in student loans and facing limited job prospects, notes Ella Shaw Neyland, president of Steadfast Income REIT, an Irvine, Calif.–based multifamily investment and management company. Jones Lang LaSalle estimates that year-to-date in 2012, home purchasing activity for people under 44 is down 60.1 percent compared to 2008. Not only can they not afford homeownership, they view renting as offering greater flexibility if they end up getting a job offer that requires relocation.
For the echo boomers, the choice to live in urban areas rather than in the far-flung suburbs also comes down to quality of life, Neyland says. She notes that her three children would rather have time during the week to indulge in activities they like than spend hours commuting to and from work and worrying about things like fixing household appliances. In many instances, renting instead of buying also results in more income left over for discretionary purchases.
“When I started out, an apartment was a transitory shift; you were waiting to buy a house,” Neyland notes. “That’s not true anymore.”
Other factors have also played a role. As baby boomers get older, they no longer feel as safe and comfortable driving an hour or longer into the city for work or entertainment, notes O’Brien. That’s happening at the same time as the commutes to the suburbs have become plagued by endless traffic jams and as cities have been investing millions of dollars to create safe, vibrant downtown districts. As a result, many boomers are moving to the cities as well, after their children leave home.
Walter Page, director of research for the office sector with the CoStar Group, is a typical example. While his kids were young, Page and his wife maintained a big house in the suburbs of Chicago, and every morning he spent an hour and a half commuting to work. But after the kids went to college, the Pages moved to Cambridge, Mass., because they wanted to be in an urban environment, close to all amenities.
“I can now walk to work, bike to work or take public transportation to work,” Page says. “I never drive.”
Major employers are taking note. In July, Motorola Mobility Inc. announced it would be moving its headquarters and 3,000 employees from Libertyville, Ill., to a 600,000-sq.-ft. office at Merchandise Mart in Downtown Chicago, representing the largest influx of new employees to the city in decades. The move will cost Motorola an estimated $300 million.
Aircraft manufacturer Boeing Co. reclaimed space in Downtown Seattle this year, moving about 80 employees, including top executives, to Russell Investment Centers from Renton, Wash. Boeing was founded in Seattle but moved outside the city in 2001.
Even Detroit has seen an uptick in new businesses recently. In 2011, healthcare IT company GalaxE Solutions moved about 500 employees to 1001 Woodward in the Downtown district. Last April, Chrysler announced that it will establish an office at the Dime Building, bringing with it 70 employees. In Midtown, up to 40 small businesses have recently opened, notes Mosey.
At the peak of the recession, in July 2009, the unemployment rate in metro Detroit averaged 16.9 percent. By September of this year, the unemployment rate was down to 10.7 percent, according to the Michigan Department of Labor and Economic Growth—still roughly 3 percentage points above the national average of 7.8 percent, but a vast improvement given Detroit’s history.
Marcus & Millichap Real Estate Investment Services, a Calabasas, Calif.–based brokerage firm, projects that the city will see 400,000 sq. ft. of new retail space enter the market this year, with more to come in 2013. Multifamily developers will receive permits for 630 new apartment units, a 61 percent increase from 2011. There is also 1.7 million sq. ft. of new office space on the drawing board.
“Downtowns have just been getting more and more popular with tenants, commercial and residential,” notes Robert Bach, national director for market analytics with real estate services firm Newmark Knight Grubb Frank. “The large cities have good transit and employers can draw from a wider geographic range than in the suburbs. And it’s not just in the 24-hour downtowns; it’s happening in a lot of mid-market downtowns.”
Among the second-tier cities that have been experiencing job and population growth the researchers name the three major Texas cities; Atlanta; Denver, Colo.; Charlotte and Raleigh, N.C., and even Birmingham, Ala. In fact, in 2013, population growth should register the highest increases in secondary markets, including Phoenix, Raleigh and Orlando, Fla., notes Chuck DiRocco, director of real estate research with professional services firm PwC.
For commercial real estate investors and developers today, the decision to build in cities is a no-brainer.
“[The city] is where you have mass transportation, it’s where people live,” says Robert K. Futterman, chairman and CEO of RKF, a retail leasing and investment sales brokerage firm. “Land costs are going to be higher, but if all of the metrics work, you will see this trend continue.”
Chain retailers, finely attuned to demographic changes, have been among the first to take note. For example, Whole Foods executives indicated plans to open more stores in areas similar to Midtown Detroit, including in Newark, N.J., and on Chicago’s South Side. Big-box operators that have traditionally focused on locations in power centers in suburban areas, including Wal-Mart Stores Inc., Target Corp. and Best Buy Co., have developed more compact store concepts in the past two years to allow for easier entries into urban markets.
The results of PwC’s and ULI’s “Emerging Trends in Real Estate 2013” survey show that markets with the best walkability scores also rank much higher on investors’ and developers’ interest list, says DiRocco.
“We definitely see more opportunity, whether it’s truly downtown situations or urbanized inner-ring suburbs,” says Don Briggs, senior vice president of development with Federal Realty Investment Trust, a Rockville, Md.–based retail REIT. “What cities provide is a human element; they are great places for people to connect with each other.”
Reflecting this change in preferences, one out of every three apartment units under construction today is located in a CBD area, according to CoStar research. Moreover, 42 percent of all projects in the works today are transit-oriented developments, located within a 15-minute walk from a subway or railway station, notes Erica Champion, senior real estate economist with CoStar. That’s a twofold increase from transit-oriented projects built during the 2000–10 period.
Transit-oriented developments help bridge the gap between downtowns and inner-ring suburbs by cutting down commute times and limiting the need for car ownership. Those areas continue to be successful because they appeal to families with small children, who would like to enjoy the advantages of urban living but are also concerned about good school systems, says O’Brien.
Briggs notes that what happened during the downturn reinforced his firm’s commitment to building only in primary markets with high barriers to entry, including transit-oriented centers in inner-ring suburbs. This spring, for example, Federal Realty broke ground on two large-scale transit-oriented developments on the East Coast—Pike & Rose in Rockville and Assembly Row, 3.5 miles outside Downtown Boston. When completed, Pike & Rose will contain 3.5 million sq. ft. of commercial space, including office, retail and multifamily uses. Assembly Row is set to contain 5 million sq. ft.
Pike & Rose is located within a quarter of a mile of the White Flint metro station, in an area that’s expected to become the next suburban CBD for Montgomery County. Starting next year, Assembly Row will be served by a new MBTA transit station.
The question is, what’s going to happen to all the office buildings, shopping centers and apartment complexes built in the path of population growth in the mid-2000s? The answer depends on the market and the property type in question, say the researchers.
Erica Champion and Robert Bach, for example, say suburban multifamily projects should eventually recover, as rental rates in the cities become too high and some people are forced to relocate further away from the urban core. Champion notes that a disproportionate number of new apartment units being delivered today fall in the luxury category and there are only so many people that can afford them.
Similarly, class-A office buildings in the suburbs will likely become more in demand as urban rental rates get too expensive for some businesses, reports Spencer Garfield, managing director with Hudson Realty Capital, a real estate fund manager with more than $1.5 billion in assets. That won’t happen until the U.S. experiences a steady rise in employment, but it is bound to happen eventually, Garfield says.
“If the economy is so strong that [office] rental rates in Manhattan average $100 per sq. ft., then companies are going to look in suburban locations to cut costs,” he notes.
The outlook gets much dimmer when it comes to shopping centers and class-B and -C office complexes that had been decimated during the downturn. Ryan McCullough, a real estate economist with CoStar, estimates that at shopping centers where vacancy spiked above 40 percent during the downturn, occupancies haven’t improved even as the economy has.
“There is a lot of distress right now in areas where developers anticipated the path of growth that hasn’t materialized,” McCullough says. “We are seeing a lot of these converted to other types of uses—data centers, recreation centers. And a lot of these will just sit there and nothing will happen. They will still be dark 10 years from now.”
This article was republished with permission from National Real Estate Investor.