Urbanization has been the pre-eminent trend in global real estate for decades, as millions flocked annually to cities around the world seeking better lives.

Since 2007, more people have lived in cities than outside them, with the margin between the two increasing steadily each year, according to United Nations data. In 2018, the intergovernmental organization projected that more than two-thirds of the world’s population would live in cities by 2050. But that was before covid-19 turned the urban growth model on its head.

Cities have accounted for 90 percent of infections, according to the UN. Consequently, the virus has choked off the social vibrancy and economic vigor that have long made cities attractive and necessary. Although there is little doubt that  commerce in those areas will enjoy a post-pandemic resurgence, it is unclear to what degree this will be the case. As businesses and schools continue to adapt to online environments, the appeal of big – and expensive – cities has been questioned.

Now, real estate investors must grapple with how these developments have impacted their assumptions about urbanization, a megatrend that had underpinned strategies across the industry.

A regression to rural living is unlikely. But the ongoing crisis has accelerated a shift in investors’ focus away from dense, costly cities, particularly in the US, to medium-sized alternatives. “We’re talking, in the US, about people leaving New York City, San Francisco, maybe Chicago,” Paula Campbell Roberts, director of global macro and asset allocation for KKR, tells PERE. “They have continued to go to Atlanta, Dallas and Raleigh – other cities.”

In the US, the growing regions of the West and South are weathering the covid storm better than the East and Midwest, according to the National Council for Real Estate Investment Fiduciaries’ Fund Index. Through the second quarter of 2020, properties in the West delivered a total return of 4.3 percent compared with Q2 of 2019, and those in the South 2.3 percent. Meanwhile, total returns in the East and Midwest were 1.9 percent and -0.7 percent, respectively, over the same period.

Already the liberation of remote work has seen some city dwellers decamp to less dense settings, thereby causing suburban housing markets to boom and city rents to flounder. Companies are weighing their options for relocation too, PERE understands, and considering low-rise campuses over towers in central business districts. As a result of these preferential changes, institutional investors are re-examining their portfolios and their long-term expectations.

During a September webinar hosted by European sector association INREV, Karim Habra, head of Europe and Asia-Pacific at Canadian pension investor Ivanhoé Cambridge, said he was worried about how the office landscape would evolve as a result of this crisis. “There’s no way back to where we were,” he said. “It all depends on younger workers and where they want to work. If we didn’t already have big office exposure, I would say this is a great opportunity. The big challenge will be how to anticipate change early enough, then make the changes to meet the needs of tomorrow.”

Other property types are also facing paradigm changes if big cities remain out of favor. Hotels have been the hardest-hit sector so far, and a long-term decline in business travel would exacerbate those issues for gateway hospitality. High street retail was already strained before the pandemic and is losing favor to grocery-anchored shopping centers. The prospects for dine-in restaurants are not much better.

Skeptics are quick to point out the many times the death of cities has been prematurely foretold. But as Prashant Tewari, a partner with Cleveland-based advisory and investment firm Townsend Group, tells PERE, it does not take a seismic shift to push an investment off course.

“Some part of this work-from-home is here to stay and, in real estate, you don’t need 20, 30, 40 percent of people to go a certain way for it to have an impact,” he says. “It could just be 1 or 2 percent, and all of a sudden you start to see an impact on growth and subsequent value of properties.”

A tale of two cities

Much of the conversation about de-urbanization in the US has focused on its two biggest real estate markets: New York and San Francisco.

Though anecdotes abound, it is difficult to say precisely how many people have left those two cities and what share of those departures are permanent moves rather than temporary relocations. Private equity firm KKR measured these changes through proprietary spending data from its portfolio company FISERV, a fintech business. Analysis of spending activity by 100,000 credit card holders suggests 45 percent of Manhattan residents and 55 percent of San Franciscans have left their cities for some amount of time during covid.

Most Manhattanites went to nearby suburbs or less dense outer boroughs, though a significant number decamped for Arizona, Colorado and even southern California. The San Francisco diaspora has been more widespread, with denizens departing for locales throughout California as well as Colorado, Arizona and Florida.

The social media platform LinkedIn has tracked a similar trend in the professional ranks during the pandemic. Dense urban markets such as New York, San Francisco, Seattle and Boston saw substantial net declines in the number of users claiming them as their home markets. Meanwhile, cities such as Jacksonville, Salt Lake City, Sacramento, Milwaukee and Kansas City have also seen substantial upticks.

Rob Reiskin, senior managing partner and head of Americas for London-based Round Hill Capital, says the pandemic has accelerated a migration pattern already at work: of people moving from traditional economic hubs to smaller, but growing, markets boasting a better quality of life and a lower cost of living. “These trends have been ongoing,” he says. “A lot of folks have upped sticks from the North-East, Los Angeles and other West Coast markets, and Chicago, and have gone to mid-size markets. Going from a mega-city to a smaller, more manageable city is de-densification because you’re not in a concrete jungle, but rather a less dense city, or you’re at the edge of an urban location.”

There are pull factors besides those pushing people out of mega-cities. States such as Arizona, Florida, Georgia, North Carolina, Tennessee and Texas have used favorable tax schemes to draw in businesses and workers. Reiskin said his firm’s multifamily assets in suburban parts of those Sunbelt markets have been well received by renters who want easy access to job centers without living in a 24-hour city.

As a result of this migratory trend, apartments in the West and South have been a driving force in private real estate funds during the past decade. Multifamily assets in the regions have delivered total returns of 11.8 percent in the South and 10.4 percent in the West since 2010, according to the NCREIF Property Index. Meanwhile, the index as a whole has tracked a return of 10.17 percent over that same period. Campbell Roberts, who authored a white paper titled The New Normal: The Long-Term Impact of Covid-19 on Cities & Consumers, said the lower cost of living in Sunbelt markets has been particularly attractive to middle-income individuals and families, many of whom are rent-burdened in big city markets. The additional financial strains of covid-19, she anticipates, will drive more high- to low-density migration in the coming years.

“It is more likely for an average household to pay over 50 percent of their income in rent if they’re living in one of these very large, dense urban gateways,” she says. “When you consider that most middle-income households have little, if any savings, the value proposition becomes very clear.”

A similar dynamic is also likely to play out within gateway metropolitan areas, with more high-earners willing to embrace suburban living if they have greater work-from-home flexibility. “It is conceivable that one or two days a week will be allowed by many businesses,” Campbell Roberts says. “If you think about the commute equation, that’s going to allow many people to live further outside gateway cities, so there are tailwinds for wealthy households in suburbs near gateways as well.”

All the single families

Contemplating this, institutional investors are already embracing the shift and buying up single-family rental properties. This summer, several top managers have launched funds or formed joint ventures aiming to buy or build within the sector, mostly focusing on the US Sunbelt region.

With credit and down payment requirements blocking many from entering the ownership market, Bert van den Hoek, senior portfolio manager for North America at Bouwinvest, says the Dutch pension manager sees an opportunity to approach the space with affordability in mind. “Within the residential space, we feel covid-19, at least in the short term, will drive the suburbanization trend,” he tells PERE. “We believe single-family rental is one sub-sector that shows a lot of potential because it represents an affordable alternative over the long term. As a firm, we focus on affordable housing because, fundamentally, that is where we see opportunities for long-term, sustainable returns.”

US companies have spent much of the past five-plus years exploring alternative locations for headquarters. However, a new trend is for office occupiers to rethink their use of headquarters entirely. Minta Kay, head of the real estate group at New York-based law firm Goodwin Procter, says several of her clients – including banks, accounting practices and other law firms – are looking to build on the success of the remote working experiment by adding locations in suburban, secondary and even tertiary markets closer to where their employees want to live.

With long-term leases already on their books, most of these occupiers would keep their existing offices in central business districts as corporate hubs. However, they would also provide smaller, potentially flexibly leased locations for workers to congregate closer to home. “This is not a company setting up their back office in Charlotte. This is a different phenomenon,” Kay says. “It’s not cost-driven. It’s talent-driven.”

A more diffused office environment is one of several cultural shifts that could reshape the investable real estate landscape in a de-densifying world. Reduced business travel is another. Facing travel restrictions and individual health concerns, many industries have accepted video calls as a viable substitute for face-to-face meetings. Even the private fund space, which resisted remote fundraising at the onset of the crisis, now sees it as a more efficient way of doing business.

As part of what she describes as a movement toward “essentialism,” Campbell Roberts expects in-person meetings to be limited to only the most necessary circumstances, and for international travel to be muted over the next several years. To that end, the International Air Transport Association, a trade group for world airlines, does not anticipate a recovery in global demand until 2024.

This creates another schism between gateway and non-gateway markets. Without business conferences and other high-profile events, major market hotels will continue to struggle. Meanwhile, hospitality assets in drive-to destinations have already shown signs of improvement and are being incorporated into new fund strategies. “There is an increased interest in strategies around lodging with a focus on limited-service hotels and even motels,” says Doug Weill, co-managing partner of New York advisory firm Hodes Weill & Associates. “People would rather be able to drive right up to their rooms and not be in full-service environments.”

Likewise, Weill notes that strategies focusing on grocery stores and other necessity retailers have been more attractive now that more people are eating most of their meals at home: “As people think more about demand shifts, it’s more than just housing and office.”

Cultural differences

Although covid-19 is a global issue, responses to it have varied internationally and even state-by-state within the US. Manhattan firms, for example, have been reluctant to compel employees to come into their offices. As of early October, CBRE tracked just 12 percent of office workers active in the buildings it manages.

Inna Khidekel, a partner in the capital markets team at Salt Lake City-based Bridge Investment Group, says the firm has seen 60 percent of its office tenants re-occupy their spaces, with some properties seeing more than 80 percent. Bridge’s office investment team has been working out of its Atlanta headquarters since May.

Most of the firm’s office holdings are in suburban markets, aside from one building in downtown Chicago. During the pandemic, the manager signed 78 leases with tenants – some new, others renewals or extensions – accounting for roughly 620,000 square feet. The average square footage leased was about 10 percent more than pre-covid, Khidekel says. Rather than downsizing for a shift to remote work, occupiers are keen to provide their employees with space.

“Post-covid, you’ll probably have a more flexible workforce,” she says. “But that doesn’t change the fact that you’ll need more flexibility, more amenitization and more space overall. That’s reflected in tenants taking more square footage, and the rents that we are able to capture in those leases are accretive in many markets.”

The divergent responses to the pandemic are even starker when contrasted across international markets. Korea and Japan did not embrace working from home as vigorously as other parts of the world, and those who did stop commuting returned to their normal routines more quickly. Many European cities embraced shelter-in-place policies like those in the US. But there are fewer discussions about a shift to suburban areas or secondary markets. This is, in part, because there is not the same supply in those markets, with the possible exception of London, says Steven Hason, managing director and co-head of Americas real assets for the Dutch pension APG.

Culturally, Americans have a greater tolerance for migration than their counterparts in Asia and Europe, Hason tells PERE, adding that the depth of the US real estate market makes relocation easier. “We have a very active rental housing market in the US, so there is the ability for people to be more mobile and make decisions for a shorter time period if they choose to, and there’s just more options,” he says. “That’s all supported by enhanced infrastructure networks to work remotely and have more mobility.”

Urbanization is still a driving force in some markets. The populations of the Nordic capitals of Copenhagen, Stockholm, Oslo and Helsinki, for example, are expected to grow by 10 percent by 2030, according to the Nordic Council, an intergovernmental alliance between the northern European countries. Though small by world capital standards – Stockholm, the largest of the cities, has a population of 2.4 million – that collection of capitals is expected to comprise 20 percent of the region’s population by the end of the decade.

Jani Nokkanen, chief executive of Copenhagen-based Nordic Real Estate Partners, says this trend has not been disrupted by covid-19, as young people continue to pour in from rural areas for education and employment – even in Norway, where the government has taken active measures to subsidize rural communities. This migratory trend, combined with supply constraints, leaves little choice but for the population to continue concentrating in large cities.

“Our view is that, yes, there will be some permanent impact in office and how people work,” Nokkanen says. “But we don’t, for example, expect changes in how care home or residential markets move. There are other trends pushing so, so hard [toward urbanization].”

Given the different responses to the virus regionally and within certain markets, many institutions have put new investments on pause until they better understand how people will interact with cities post-pandemic. An example of this is Japan’s Government Pension Investment Fund. During the INREV webinar in late September, Hideto Yamada, the pension’s head of global real estate, said office buildings had gone from the “top of our investment list” to become its greatest question mark.

“We have seen research comparing work-from-home habits pre-covid to post-covid and are concerned about what percentage that will change and how to offset the impacts of lower density per square foot in an office,” Hideto said. “That has to be our biggest challenge.”

Politics at play

As much as public policy has helped steer migratory patterns away from gateway cities in recent years, the political action taken in the months and years ahead will be even more critical to determining the long-term viability of large urban areas in the US. After covid-19 all but brought economic activity to a halt, governments supported by big cities are barreling toward budget crises. New York City is projecting a $9 billion shortfall over the next two years, and New York State projects tax collection will fall $14.5 billion short of initial expectations this year alone and $62 billion short through 2024. Elected officials are considering offsetting these costs with tax hikes for their wealthiest citizens. But many have already fled to Florida, which collects no income tax, or have pledged to do so if faced with a substantially greater tax bill.

What to do about cash-strapped mega-cities and states has been the primary point of contention in the debate between Congressional Democrats and Republicans over a second federal stimulus package. President Donald Trump has cast the issue in strictly partisan terms, claiming Democrats merely want to bail out their poorly governed home states.

During PERE’s US Roundtable (see p 34), Boyd Fellows, managing partner of ACORE Capital, said Democrat victories in the presidential and Senate elections would likely bring about more aid for big cities while continued Republican control would mean “protracted pain in the cities, making them less attractive to live in for a longer period.”

On the ground level, local politicians have been hostile to large real estate investments in their cities. The strongest example of this is the fierce resistance the New York City Council and other elected officials foisted upon Amazon after the e-commerce titan announced its plan to build a new headquarters in the borough of Queens last year. The opposition was so intense, the company quickly scrapped the project to focus its expansion efforts elsewhere. More recently, in September, the city rejected an expansion bid for a mixed-use development on the Brooklyn waterfront called Industry City – and with it, a projected $100 million of tax revenue.

Campbell Roberts is confident gateway markets will return to prominence after the pandemic, noting the historical resilience of New York through outbreaks of yellow fever, cholera and the 1918 global flu pandemic. But she notes that doing so will require considerable budget reconciliation and structural reforms. “Gateway cities were already being reborn and now, more than ever, they need to be,” she says. “A lot of whether or not this is successful depends on cities having adequate funding and leadership. In the short term, they are challenged. But if we get balanced budgets, funding from the Federal Reserve and other support, cities five years from now certainly can thrive.”

Despite the myriad issues facing gateway cities, some institutional investors remain steadfastly committed to the metropolis. “There are short-term phenomena that are leading to suburban residential and satellite office preferences,” said GPIF’s Hideto. “We recognize and accept it. But when talking about demographics, education and labor forces, these trends I believe will not see much change in the long term and so I’m still a believer in gateway cities, in developed urban areas.”

Big Apple

Large corporations have not turned their back on these markets either. Facebook, Apple, Amazon, Netflix and Google, five of the largest companies in the world by market capitalization, have all signed major leases in New York City during the past year. These range from Apple’s 220,000-square-foot lease at 11 Penn Plaza to Google’s 1.3 million-square-foot commitment to the St John’s Terminal building.

It is still too early to say how much of an impact the covid pandemic has had on workforce migration. Data compiled by moving company Hire A Helper show that 15 percent of moves during the first half of the year were made directly because of the coronavirus. Large metropolitan areas saw the biggest net out-migration in that analysis, but overall volumes were below that of a typical year.

APG’s Hason says much of the fallout from  covid-19 will not be known until after a vaccine becomes widely available, or the population develops herd immunity, which means it is too soon to make any sweeping changes to investment strategies. “The de-urbanization theme is present in the marketplace,” he says. “But we don’t know if it’s a trend yet. My feeling is within two years we may be having a re-urbanization discussion. Every time people have bet against big cities, they have been wrong in the long term.”