Global cities are the heartbeat of private real estate investing. When they locked down in 2020 due to the pandemic, markets were rocked and investment coffers were quickly shut. When economic recoveries began in earnest in 2021, transaction volumes picked up and capital flows returned. In 2022, with post-covid mega-trends now firmly entrenched, cities are changing in response.
New way of life
Many of these city-level demographic shifts are driven by changes to our lifestyles brought on by pandemic conditions, most obviously the wide acceptance of hybrid working. A survey by McKinsey found that 58 percent of Americans have the opportunity to work from home at least one day a week. This represents a considerable proportion of people whose lives may be dramatically altered by this level of flexibility. People can live further away from the office and travel in less frequently, placing greater emphasis on the value of space in their property decisions – something that carries particular significance for urban populations after being confined to homes for months on end during lockdowns.
Living in the biggest and most economically successful cities also comes at a major cost for residents, and cost is of utmost importance for people during this time of inflation and steeply rising utility charges. According to the UK Office for National Statistics, the growth rate for the Consumer Prices Index including owner occupiers’ housing costs reached 8.6 percent in the 12 months to August 2022.
Real estate investors are acutely aware of the net effect of these factors. Regional cities are attracting residents with the promise of a higher quality of life and lower cost of living. Urban populations are demanding more space and accommodation further outside of the city center. Millennials are starting families and moving to the suburbs. As private investors clamber to address this imbalance of supply and demand, research firm Savills finds that over €27 billion was invested in multifamily residential across Europe in the first half of 2022 – the highest H1 ever recorded.
In commercial property association AFIRE’s 2022 International Investor Survey, 81 percent of respondents agreed that the “prolonged pandemic has permanently altered cultural attitudes towards consumption and live-work preferences.” To what extent, then, is real estate capital finding new destinations on the map of global cities?
Secondary cities across the globe – those in non-gateway/primary markets – are moving ever higher up real estate investors’ wish lists. As investment volumes have recovered, allocators are increasingly looking to secondary cities to counteract yield compression and increased costs in primary markets.
“Global gateways tend to have more long-term advantages, with higher levels of immigration ensuring they remain dynamic,” says Donald Hall, head of research, Americas at Nuveen Real Estate. “However, in the US, it has really been regional markets that have been strong of late, with the rise of work-from-home policies having an impact.”
In the US, AFIRE’s survey found that 71 percent of investors are planning to increase their level of investment in secondary cities over the next five years. Secondary cities Atlanta, Dallas and Seattle all feature in the top five US cities for planned investment among respondents. Furthermore, over a third are targeting Austin – which the study classes as a tertiary city – the second-largest proportion after Atlanta.
By analyzing annual average deal volumes in major property types, MSCI Real Assets reveals that cities in the US Sun Belt are among the top volume gainers globally when comparing 2008-19 with 2020-H1 2022. Dallas jumped from ninth to third position, recording the largest increase in average investment volume, up $21.7 billion, largely due to strong growth in the industrial and residential sectors. Reflecting the trend of net-inward internal migration in the US South, Atlanta, Phoenix, Austin and Miami also saw big increases.
Secondary cities represent an obvious opportunity to diversify revenue streams, but also to match investor portfolio requirements with the right kind of yield. Brett Fawley, director, insights and intelligence at CBRE Investment Management, sees secondary cities as a good fit for residential investing. “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,” he explains.
Diversification is another critical reason for the rise in secondary city investing, reflecting the maturity of the asset class. Capital has to be put to work, and if the past two years have taught us anything, it is that socioeconomic trends can turn on a dime. Despite the current macroeconomic volatility, Tier 2 cities are an opportunity not to be missed for a growing cohort of managers.
Panning for gold
No matter which market tier, identifying the cities offering the most investment promise now and in the future can be a scientific exercise in determining the quality of life. Patrizia, for example, uses 48 indicators in its Living Cities Index, which range from market fundamentals to connectivity and innovation. Applying the ‘15-minute city’ principle to the research – whereby most daily urban activities should fall within a 15-minute walk or cycle from home – the firm uses artificial intelligence to rank locations based on their surrounding amenities. Patrizia says this gives investors a better understanding of a city’s strengths, risks and potential.
Even within a city, finding the right submarket is key to performance. For Adrian Baker, chief investment officer of APAC direct real estate strategies at CBRE Investment Management, this is particularly true for logistics in Asia-Pacific. “For instance, there is quite a bit of new supply coming into the Fukuoka market, but a lot is located far from Fukuoka city center. With assets that are easily accessible from the city, however, there has been very strong demand and zero vacancy.”
Another key factor in any discussion of a location’s future potential is sustainability. This is especially pertinent for managers whose investors demand stringent ESG reporting, or those looking to futureproof portfolios. Every city has the potential to be sustainable, but there are various advantages and disadvantages to consider. Economics may come into it. But climate risk is heavily influenced by geographical location – earthquakes, floods and volcanic eruptions are all risks to contend with.
And then there is politics, which can be a barrier to ESG-minded property development. In the US, ESG is branded a partisan issue by some Republican-led legislatures, and without local-level support it can be a challenge to get social housing developments off the ground. When it comes to ESG, red tape can be a red light for real estate investors.
The expansion of the institutional-grade property remit has added more viable locations to the global opportunity set. Demand for medical offices, life sciences laboratories, student housing and data centers is driving the fast growth of many cities across the world. In the life sciences space, companies are moving closer to city centers to tap into the academic and resourcing advantages afforded by proximity to universities and tech companies.
In another example of a cluster of cross-pollinating property types, Atlanta, a growing hub for data centers, has also attracted major internet-related businesses such as Facebook and Microsoft. And with investors hungrier than ever for a slice of the data center pie, data from MSCI Real Assets shows the city has experienced a boost in liquidity during the pandemic years.
For investors searching for the right locations to grow their capital, post-pandemic trends such as these have flung open the gates to more global cities than ever before.