Suburbia has gotten a bad rap of late. The popular narrative among apartment investors, lenders and developers is that urban trumps suburban. That is certainly true in terms of liquidity, fueled by investor appetite. But is it also true of fundamentals?
A new study by MPF Research shows that the differences in performance are much slighter than widely perceived. In fact, apartment occupancy and rent growth over multiple cycles are remarkably similar between central business districts and “good” suburbs, while renter turnover is – surprisingly – a bit higher in CBDs. And given cap rate compression and price appreciation in urban spots, suburban deals may offer more upside at this stage of the cycle – at least for investors who aren’t 30-year holders.
How is that so? There’s a key flaw in the anti-suburban argument, and it’s a simple one: Not all suburbs are the same. Evaluating all suburbs as one group is like evaluating all football teams mashed together. If you separate winning teams from losing teams, key differences emerge. In the same way, MPF Research’s study aimed to separate “good” suburbs (defined below) from the rest – and found a significant performance gap between the two groups. “Good” suburbs, boosted by many urban-like qualities, perform in line with CBDs. Other suburbs lag notably behind.
These findings come at a time when urban hype has never been hotter. Halfway through the 2010s decade, apartment development in CBDs has totaled nearly 250,000 units. That’s already more than completed in the entirety of any decade since at least the 1940s, according to data from the Census and MPF Research. In relative terms, 27% of all apartment development since 2010 has been concentrated inside CBDs. That’s double the share seen in the 2000s and quadruple the share seen in the 1980s and 1990s. Even with the construction spree, cap rates for urban in-fill deals tend to be about 50 bps lower than comparable suburban properties.
Is the urban hype warranted? Absolutely. MPF Research’s study does nothing to deflate urban enthusiasm. In fact, demand for apartments inside CBDs remains robust. Urban strength is very real. But it’s not coming at the expense of the suburbs – as is commonly portrayed. Yes, there are dying suburbs – often illustrated by a rotting mall and vacant strip centers – with weak demand drivers. But there are also vibrant, active suburbs that share some of the city centers’ attractive drivers. And that’s the crux of MPF Research’s findings: “Good” suburbs perform in line with CBDs because they share many of the same characteristics: more jobs, higher incomes, higher home prices, more amenities and proximity to major highways or rail stations.
MPF Research’s study of the nation’s top 50 metros defined “good” suburbs as submarkets outside a central business district that had two characteristics: They’re located within economically healthier metro areas (those with net employment growth of at least 3.0% over the last six years) and have average monthly rents that top their parent metro’s norm.
It’s a fairly simple line of demarcation, but it tells a compelling story.
Over the last four years (covering the current up-cycle), both CBDs and high-rent suburbs in economically healthier metros averaged year-over-year rent growth of 4.2% compared to 3.8% in lower-rent suburbs. In economically weaker metro areas, CBDs notched average rent hikes of 3.7%. High-rent suburbs in those metros averaged growth of 3.0%, while low-rent spots came in at just 2.5%. Over the last eight years (a period covering multiple cycles, including the recession), year-over-year rent growth averaged 2.6% inside high-rent suburbs of economically healthy metros. By comparison, in those same metros, CBDs averaged growth of 2.7% and lower-rent suburbs posted growth of 2.3%. In slower-growth metros, CBDs averaged just 1.8% — while both suburban groups came in around 1.0%. Even in a down cycle, performance is remarkably similar between CBDs and “good” suburbs. In 2009, the trough year for the apartment industry, both groups notched rent cuts of about 4% before rebounding strongly in 2010.
Similar patterns play out on the occupancy side. A common perception within the apartment industry has been that renter demand in stronger inside CBDs, and therefore occupancy rates are higher and turnover lower. But the data doesn’t support that widespread perception. Occupancy rates tend to match between CBDs and high-rent suburbs in strong metro areas – both averaging 94.7% over the last eight years and within a tick of 95.5% within the last four years. Vacancies tend to be higher in other segments of the market, and especially so in lower-rent suburbs of weak metros.
In perhaps the most surprisingly finding, CBDs produce slightly lower renewal conversion rates. From December 2011 to December 2014, CBDs generally tracked 200 bps below high-rent suburbs in terms of renewal conversion rates in a study of the nation’s top 20 markets. And of those 20 metros, only four averaged higher conversion rates in CBDs than in suburbs. Those stats were pulled from RealPage Performance Analytics, which features daily lease transactional data – giving us a glimpse into data that had never before been available.
Given that high-rent suburbs are seeing lower renter turnover and similarly low vacancy rates, conventional wisdom in the apartment industry might be overstating the impact of single-family homes in suburban locations and understating the tendencies of transient urban renters to remain transient.
Here’s one more takeaway: The industry perception is that inner-ring suburbs adjacent to CBDs are superior to outer-ring areas. But this proves true only in a handful of metros. Think of your hometown or adopted hometown. Imagine yourself in the heart of downtown. From there, go north through the entire metro area. The next day, go south. Then east, and then west. In almost any metro area, it’s highly likely you’ll experience very different settings in each direction – different demographics, employers, amenities, and lifestyles.
The best suburbs tend to be clustered in the same geographic areas of a given metro – spots with lots of jobs and amenities, higher incomes, and home values. In Dallas or Atlanta, that generally means to look north. In Phoenix or Seattle, head east. In Charlotte or Nashville, go south. In Los Angeles or Houston, west.
MPF Research released these findings at NMHC’s Apartment Strategies on January 20. And it was part of what turned out to be a great month for the suburbs.
- NAIOP published a study of office properties, and found similar performances in CBDs and “vibrant” suburbs. Here’s a sampling of other reports echoing the same theme.
- The Wall Street Journal posted an article calling “the end of the suburbs” one of top five American migration myths.
- Trulia published research showing that population growth is higher in the suburbs than in urban areas.
- And the National Association of Homebuilders released survey results showing that most Millennial buyers prefer suburban single-family homes over owning in center-city areas.
There’s more and more evidence that “suburbia” is not a bad word in real estate. But let’s not get carried away and suggest urban has lost its luster. Urban apartments are still good – often very good. Apartments in the right suburbs can also be very good … and perhaps at a lower cost.