The Big City Rebound and Its CRE Implications

July 10, 2023

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With key demographic trends reversing, are gateways getting a second wind?

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The pandemic established new commercial real estate winners and losers by sector and geography. In the aftermath, with a population shift back to big cities, the dynamics dictating CRE market movement shuffled the cards once more, reasons Moody’s Analytics Senior Economist Ermengarde Jabir.

The COVID-19 era of 2020-21 witnessed a population migration away from urban centers, particularly in Northern states, Jabir said. But since 2022, many metros considered pandemic losers have enjoyed a net positive population inflow. New York City has seen a modest gain in residents, Miami and Houston have witnessed large increases, and Seattle, San Francisco, Los Angeles and Chicago have watched out migration decline.

Office pains still in the books

CRE demand is directly impacted by population shifts, Jabir emphasized. The office sector was insulated in 2020-21 by the longer lease terms of the asset class and uncertainty about office returns, she added. But preliminary second-quarter 2023 vacancy rates of 18.9 percent are nearing historic highs of 19.3 percent set in 1986 and 1991.

Population shifts and office occupancy levels directly impact urban retail, she continued. While remote work has taken a toll on street-level urban retail in major metros, it’s proven a plus for neighborhood and community shopping center retail.

“Those who moved away from large urban centers as a result of the pandemic are now shopping more frequently where they live,” Jabir said, noting that for this retail category, vacancy peaked at 11 percent in 2011 but has since declined. It is expected to end 2023 at 10.2 percent, and fall below 10 percent in the outer years of Moody’s Analytics’ forecast.

Industrial’s hard shell

Turning to the industrial sector, Alliant Credit Union is reluctant to advance money on retail and office classes relying on density to drive growth, said Steve Wyent, commercial real estate lending underwriter for the firm. The same isn’t true of industrial.

“We have been bullish on industrial due to the resiliency of this asset class and the fact it doesn’t seem to be affected by demographic shifts in the overall population from urban core to suburban,” he said. “It also doesn’t seem to be negatively affected by migration out of older urban areas experiencing population declines.”

Markets that have experienced greater in-migration since 2019 have greater newer industrial supply as a percentage of total availability, he reported, adding, “However, all markets saw strong double-digit growth in industrial supply.”

Paired with reduced vacancies indicated by Moody’s Analytics/REIS data for markets as a whole 2016 to 2023, “this would suggest strong absorption across the board,” he said.

Ready to gain: NYC, Chicago, Philadelphia et. al.

Though working nationwide, Glenn Brill, managing director of FTI Consulting, is based in Brooklyn and keeps a close eye on New York City. He’s unsure whether New York’s rebound will translate to office demand, noting different sectors are responding differently to hybrid work.

“JPMorgan Chase is building a 2 million-square-foot office tower on Park Avenue, and I believe they will expect people to work on site,” he noted.

As population rebounds in New York City, Brill believes retail and industrial will strongly benefit. “Retail in New York City is really a leisure-time activity for lots of folks,” he said. “They shop in brick-and-mortar because they want to, it’s fun, and they have money to spend. And New York City has the best and the most unique brands. The same is true of restaurants. The rebound in population is very positive.”

New York City industrial growth is fueled by desire for convenience and home delivery, a big pandemic-era gainer. A population rebound sparks convenience purchasing.

“It’s very positive for industrial space focusing on last mile, just-in-time deliveries and inventories,” Brill said. “Effectively, the delivery companies want to get closer to their customers. (…) Go out to Red Hook in Brooklyn, Amazon has put up a very large box, not 1 million square feet, but not small, and there to deliver to Brooklyn households.”

The industrial sector of other major metros is also enjoying growth, even in cities like Chicago and Philadelphia losing population before the pandemic and continuing to shed denizens during COVID-19, Wyent said. Basing his findings on Moody’s Analytics/REIS data for the markets as a whole from 2016 to 2023, he reported Chicago witnessed a total increase in asking industrial rents of 37.4 percent and a decrease in industrial vacancy from 7.8 to 2.6 percent. Philly saw an increase in asking industrial rents of 50.4 percent and decrease in industrial vacancy from 8.7 to 3.3 percent. These numbers were in the same ballpark with Phoenix and Fort Worth, two metros that have been among those experiencing the greatest in-migration in recent years.

South Florida grows some more

Meantime, metro Miami has witnessed a major increase in new residents across every demographic and from many countries, said Ben Jacobson, partner with Forman Capital in Palm Beach, Fla. “I’ve not seen the office market slow down at all,” he said. “You’re seeing a lot of the firms moving into Class A towers are new entrants to the Miami market. We haven’t seen a lot of tenants upgrading much. But if you’re a law firm from New York City, Miami is still considered a value. Filled up? I don’t know about that.

But we haven’t seen a softening in the office market. (…) A lot of tech firms are asking for all classes, A, B and C. Some don’t want Class A, they want open floorplans and even want them in industrial settings that might be Class B or C.”

As for industrial growth in metro Miami, he said, “Last-mile distribution centers are popping up all over the area, and there is definitely a lot of growth in demand.”

Also bullish on South Florida’s office market vis-à-vis other big cities is Todd Rosenberg, co-founder & managing partner of Pebb Capital.

“While work-from-home and hybrid configurations will take a bite out of overbuilt office markets such as Chicago, Los Angeles, Washington, D.C., and New York, submarkets like Southeast Florida are growing because they never had a lot of office supply before,” Rosenberg said. “Over the past 30 years, development was concentrated on condos, apartments and hospitality. (…) South Florida still does not have enough office to supply the companies looking to open even their smaller footprints here.”

Valley of the Sun growing

In Phoenix, the largest commercial projects tend to be manufacturing and technology-focused. So said Anita Verma-Lallian, founder of Arizona Land Consulting. Taiwanese chipmaker TSMC is planning a second semiconductor chip factory in North Phoenix, Intel is developing two new plants totaling $20 billion in Chandler, while KORE Power continues building its battery cell manufacturing plant in Buckeye.

Along with LG Energy Solutions’ $5.5 billion investment in its Queen Creek facility, to be North America’s largest stand-alone chipmaker, the industrial development puts Arizona in the forefront in developing and manufacturing technology, Verma-Lallian reasoned.

Of the big city rebound, Brill remarks, “It’s obviously very positive, because it creates household formation. With more people working, more people buying homes and more people shopping the effect is you’re going to get more economic activity, and that flows down to real estate where people live, work and play.”