CBRE: In search of a residential gold mine

This article is sponsored by CBRE Investment Management

Beyond gateway cities there are smaller – but growing – urban locations that offer attractive residential real estate investments. The key to finding them is to follow migratory patterns and people’s general movements, often unveiled through micro data, argue Steve Gullo, head of residential, and Brett Fawley, director, insights and intelligence, at CBRE Investment Management.

What is driving the growing appetite to invest in Tier 2 cities and beyond?

Steve Gullo: The factors driving us to new locations are the migratory patterns of people seeking affordability and quality of life, and where companies are choosing to locate, partially in response to where talent wants to live, but also due to a lower cost of doing business.

Brett Fawley: From a capital market perspective, it’s the ability to get higher yields. It’s important to think about our institutional clients and what role this investment plays in their overall portfolios. Apartments and housing often are meant to be a stable, long-term part of the portfolio, which is occupancy driven with a steady cashflow, and so if you can find that kind of stability at a higher yield then that’s attractive.

In which residential markets – secondary or even tertiary – are you investing today that would not have been considered institutional grade until recently?

SG: San Antonio and Nashville are secondary cities – meaning not gateway cities, but still larger, growing cities that have become attractive to institutional investors. We have been active in these two markets, which really institutionalized during this past cycle.

More recently, some tertiary cities are institutionalizing as we speak. For instance, Rochester, Minnesota or Huntsville, Alabama. We have invested in both of these markets but in very specific situations and with specific product types. I wouldn’t have told you that we would invest in Huntsville, Alabama five years ago, but we invested there this year in a single-family rental format and we can point to other institutional ownership in both of these markets.

Could you give some examples of the specific product types or situations that make these markets attractive?

SG: In San Antonio, for example, we think that investing towards the middle market is the right strategy. It does not have the same level of wage growth in STEM [Science, Technology, Engineering and Mathematics] jobs that other markets do – like Austin just down the highway. Still, San Antonio has a very stable employment base with some key large employers, such as the United Services Automobile Association, the military and the South Texas Medical Center. These industries contribute to a stable population that is experiencing growth by virtue of San Antonio’s relative affordability compared to Austin. Accordingly, we want to make sure that we’re investing in property that matches the depth of the demand profile – garden-style product at a price point that lends itself to being a little bit more affordable.

In Rochester, Minnesota we invested in luxury product because of who was renting there. Rochester is home to the Mayo Clinic, which is one of the top hospitals globally. People from all over the world come to work and study or to seek treatment there. A lot of those who are seeking treatment are foreign and wealthy.

Additionally, those who are working and studying at the hospital are high earners. As a result, you have a high-end clientele with very few high-end living options in the market. It’s also an area that has barriers to entry in terms of new development, so we won’t see much more competitive supply going forward and the durability of that supply/demand relationship is appealing to us.

How are you uncovering assets in these smaller markets?

BF: Coming up with market rankings is, in some ways, outdated. It’s really about micro locations. And about the kind of search. You can say, ‘These are my top markets and now I’m going to go into these sub-markets and identify the best locations within them.’ Or you can say, ‘I’m going to identify the 800 best micro locations,’ and then it might turn out that one of them is in Rochester, Minnesota, which you would never have uncovered if you had just looked at market ranking. Or Cranberry Township, Pennsylvania, which wouldn’t be uncovered if you started by filtering markets.

We also use a lot of granular micro data. The most powerful data today is people’s movements – a lot of that is tracked on mobile data. To uncover Cranberry Township, for example, it was about commute patterns. We were able to dig into this data and see that even though this place looked like a bedroom community, it actually had more people commuting into it than commuting out of there.

Aside from San Antonio, which other secondary cities offer opportunities to invest as people migrate for a better standard of living and lower rents?

SG: Sacramento, California is poised for strong performance due to its relative affordability against San Francisco and Los Angeles, which are very expensive markets. A much smaller tertiary market example is Richmond, Virginia, which offers a high quality of life and affordability. Again, we would be very selective about finding the right product for the demand profile.

Richmond is another market that we think lends itself to the Build-to-Rent single-family format of housing. A large part of the demand story in this market is the desire for space and affordability relative to Washington, DC, and the rise of the flexible work environment we are in today makes living in these markets much more achievable.

Fort Worth, Texas also has some good demand generators because it’s more affordable and secondary to Dallas. Yet again, people are moving there because they want more space and can get more for their money without sacrificing proximity to amenities, employment and transportation.

In residential, does the upside potential outweigh the risks of entering new markets?

SG: Yes, because it goes back to the necessity of housing, and because it’s a necessity, that translates to durability of demand. So, as long as people want to live in a new market, because it’s an essential need, the risk profile is different with residential than other property types.

If that’s where occupiers want to be, we have to be there – we have to respond and we have the tools that allow us to get smart on that market
efficiently.

BF: You could flip that question the other way. What the pandemic demonstrated was that diversifying your residential portfolio as much as you possibly can – by product type, geography and target demographic – is going to provide the most stable and steady return in the long run. The more we can build a portfolio that is representative of how and where people live – and it’s distributed the same way – the more stable and steady our strategy will be.