There are many ways to divide the investable real estate markets of the US, but when it comes to determining which are best positioned to deal with the looming crises of the future, it is not a matter of liberal versus conservative, Sun Belt versus coastal, or even gateway versus secondary.
Jonathan Rose, president and founder of Jonathan Rose Companies, a development and investment firm focused on green, affordable multifamily properties, says the cities best positioned for the future are those with “progressive policies.”
“It doesn’t mean those are necessarily progressive cities, but they’re policies that are trying to mitigate the effects of climate change and provide more social equity, and along with the changing populations of those cities, we’re seeing those cities be very proactive,” says Rose. “A lot of innovation is happening in those cities, which makes them welcome places for investment.”
Future readiness is becoming a key consideration for managers that are increasingly expected to have robust ESG practices. A 2021 survey of real estate investors by the advisory firm Hodes Weill & Associates found that half of institutions have an ESG policy, up from one-third in 2015. Such considerations have shifted from “nice-to-have” to “have-to-have,” the firm found.
Institutional capital also has a broader array of potential destinations. Nine of the top 10 most desirable US cities at present are non-gateways, according to a 2022 survey of real estate investors by the London law firm DLA Piper. Austin, Texas was the top choice, followed by Raleigh-Durham, North Carolina and Nashville, Tennessee.
The decade-long trend of relocation by individuals and businesses to low-cost, warm-weather markets was accelerated by covid-19. Florida, Texas, North Carolina, Arizona and South Carolina saw the biggest inbound net migration during the pandemic, according to the Federal Reserve Bank of Dallas. Meanwhile California, New York, Illinois, Massachusetts and Maryland saw the most departures.
Untethered to physical workspaces, office workers no longer feel compelled to remain in major metropolitan markets, Rose tells PERE. “It’s making the rest of America competitive with the gateway cities,” he says.
Yet, many of those cities are also more exposed to climate change than traditional investment hubs. More severe hurricanes and rising sea levels threaten Southeast markets near the Atlantic and Gulf coasts. Extreme heat, forest fires and drought plague the West. Extreme weather is driving up insurance premiums, operating budgets and the cost of building more resilient properties. Some lenders are also charging more for debt on projects in high-risk areas.
Because of these factors, Tanja Milosevic, associate vice-president of ESG at Grosvenor Property Americas, says some markets are inherently more favorable when it comes to environmental risks and sustainability.
“While every city has this potential [to be sustainable], temperate cities with limited exposure to natural disaster risk, including flood, fire and blizzard, would seem to be naturally advantaged,” says Milosevic. “We also find that denser cities, on average, offer more scope for progress on sustainability.”
A subsidiary of the UK-based manager Grosvenor Group, the firm invests in offices, apartments and retail properties in six North American cities: San Francisco, Washington, DC, Seattle, Vancouver, Chicago and Los Angeles.
Grosvenor has committed to net-zero carbon emissions by 2030, Milosevic says, and the firm uses a “climate value at risk” framework to evaluate the properties and markets in which it invests. She adds that it has found the governments in those six cities willing to work with them to make properties both sustainable and profitable.
Milosevic also notes that these cities have taken a proactive approach to ensuring their infrastructure can withstand evolving climate risks. This has made these cities popular among ESG-minded investors.
“The most progressive investors will inherently look for partner cities that have policies that help facilitate the delivery of socially, environmentally and economically impactful schemes.”
Firms such as Grosvenor, which has been investing in North America since the 1950s, know the bureaucracies of major metros that serve as barriers to entry. Many of today’s hot markets have grown in popularity by working with private interests and slashing red tape.
“Denser cities, on average, offer more scope for progress on sustainability”
Grosvenor Property Americas
New York-based Savanna Investment Management, a developer that specializes in office properties in its home market, found this to be true in West Palm Beach, Florida. The firm helped craft a new zoning code in the city that grants density bonuses for investments in public goods, including building to a Leadership in Energy and Environmental Design, or LEED, standard.
“If you get LEED Silver, you get a certain amount of extra feet on the building, if you get LEED Gold, you can go even higher,” says Peter Rosenthal, the firm’s chief development officer. “The city wrote that into their up-zoning documents as an environmentally friendly clause. Everyone should be doing this regardless because it’s the right thing to do, so if municipalities can help support it and encourage it, I don’t understand why they wouldn’t.”
Rose says his firm similarly leans on local government support to make its low- and moderate-income housing ventures feasible. A common mechanism for this is tax abatements granted in exchange for preserving affordability. He points to Denver as an example of a city that is especially forward looking on this front.
Many fast-growing cities recognize that public investment is necessary to address the country’s affordable housing crisis, but some are in states that are less accommodating than others, Rose notes. Tennessee and Texas are known for opposing tax incentives for affordable housing.
This is not true for all the Republican-led governments of the South, however. Rose says strict partisan ideology does not always apply to ESG matters, especially at the local level. He points to Greenville, South Carolina, as being proactive on housing issues, and the state of Georgia for providing incentives to supplement the federal Low-Income Housing Tax Credit.
“The whole Republican-Democrat difference breaks down when you get to the city level,” says Rose. “A mayor’s job is to deliver, to get things done, and they are held accountable. That’s why you see a Republican mayor of Albuquerque [New Mexico] really focused on homelessness. At the level of mayors and city councils, you see much more innovation and commitment to solving problems than at the national level.”
The past two years have been transformative for American cities, and if current trends continue, more change is coming. For real estate investors and managers keen to face these challenges head on, there are many considerations to be made. But the first step is finding the cities gearing up to do the same.