In the thick of the COVID-19 pandemic, most employees were working where they lived and living where they worked. Social distancing measures and the rise of remote work opportunities kept many people indoors. Small apartments, high rents, and the expensive cost of living in metropolitan cities caused many urbanites to reevaluate housing options.
Nearly 30% of urban-dwelling millennials (who make up the majority of today’s workforce) decided to relocate to the suburbs during the pandemic. Secondary markets such as Dallas, Cleveland, and Philadelphia surprisingly saw some of the nation’s most significant increases in buyer demand.
The great suburban migration paired with mandatory business closures significantly impacted the economy, especially in large cities. From New York to Los Angeles, many non-essential businesses permanently closed their doors, with approximately 800,000 businesses in total closed for good (200,000 more than the annual average before coronavirus).
As vaccines roll out nationwide, businesses and local shops and restaurants are finally reopening. Many of the people who fled from primary markets are now in secondary and tertiary markets. The question remains: will those people move back to the city or stay in the ‘burbs?
Commercial real estate investors are itching to understand whether urban or suburban properties are the smarter play. Before diving into any major financial decisions, investors should understand the differences between investing in urban and suburban real estate, along with the different types of CRE investments to consider.
Urban Versus Suburban
According to a survey by Morrison & Foster, many commercial real estate investors are confident that large cities will bounce back to pre-pandemic levels. For the time being, however, only 47% think primary markets are best suited for commercial real estate investment, while 37% are hedging their bets on secondary markets.
With the rise of remote work, office leasing took a hit in major American cities. Although offices are indeed reopening, many companies are embracing a hybrid work model and choosing to downsize their existing space. That being said, there is evidence that people are returning to urban areas. For instance, in New York City, migration rates are currently growing more than twice as fast as they were in 2019.
For commercial real estate investing purposes, it’s best to look at the pros and cons of the different markets and their fundamentals.
Urban Commercial Real Estate
- Cities have significantly more foot traffic than the suburbs.
- Urban cities offer public transportation, many companies, several attractions, and a diverse array of amenities.
- There’s a large pool of potential tenants.
- Urban centers usually have higher taxes, with a city tax in addition to state tax. (For example, San Francisco has relatively expensive transfer taxes, ranging between 0.5% to 3.0% depending on how much a property is worth.)
- There is less space for new development.
- Crime rates can be higher.
Suburban Commercial Real Estate
- Investors can get more square footage per dollar.
- Taxes and utilities tend to be lower.
- There’s more room for new development.
- There are not as many potential tenants.
- Fewer businesses, amenities, and attractions.
- Less foot traffic depending on location.
Types of Commercial Real Estate
Luckily, for those who want to invest in commercial real estate — whether in the city or the suburbs—there are many routes they can take. Below are some different classes of commercial real estate investments and their current outlook on the market.
Office leasing certainly took one of the hardest hits during the pandemic. Gross office leasing transactions declined 47% year-over-year in 2020, and vacancy rates rose to more than 17%, according to a report from JLL.
Many companies are choosing to move toward a hybrid remote/in-office model, but that does not mean they will completely eliminate office space. It is likely that sizing needs, on-site offerings, and work styles may shift.
The mass migration to the suburbs spiked a huge need for multifamily housing nationwide, even in secondary markets. The supply of homes on the market is currently at a 10-year low, and decreased supply has driven prices up. Moreover, CBRE has predicted that by early 2022, the multifamily market will return to pre-COVID vacancy levels and will see an increase in rentals.
Retail was undoubtedly one of the hardest-hit sectors during the pandemic. Major retailers permanently shut down more than 12,000 locations across the US as consumer spending habits shifted to online shopping in the wake of mandatory shutdowns. However, the sector has shown promising signs of life in the last few quarters, with prices on Crexi for retail rising by 28.9% in Q2 from year-over-year metrics.
Industrial Real Estate
While brick-and-mortar retail slowed down pre-pandemic, COVID-19 accelerated the rapid growth of e-commerce and sparked a huge need for industrial space such as warehouses and fulfillment centers throughout the country — from Boston to St. Louis to Portland. CBRE research shows that nearly 80% of US industrial markets are expected to see positive rent growth over the next 12 months.
Investing in REITs or using online tools such as crowdfunding apps have exploded in popularity during the pandemic. REITs are often viewed as safe investments that pay out high dividends and do not require an investor to purchase a physical property.
A 1031 exchange allows investors to defer capital gains taxes if they swap one investment property for another of the same type within a specific time frame. There is also a 1031 improvement exchange, where you use proceeds from an investment property’s sale to improve your replacement property. This is a great option for those who already have a commercial investment property looking to sell and reinvest the earnings.
Investing in commercial real estate is a significant financial decision, and choosing a location can be nerve-wracking. On the one hand, the suburbs are teeming with new growth, but major cities are expected to make a comeback over the next couple of months and years. When deciding where to invest, it will ultimately come down to an individual’s budget, goals, and short-term/long-term plans.
Ben Mizes is the Co-Founder and CEO at Clever Real Estate, the nation’s leading real estate education platform for home buyers, sellers, and investors.