Remote working has given many of the country’s office workers a hall pass to work from home, and these days, that home can be anywhere.
People have taken full advantage of the freedom of remote working to make a move to a new city or state. According to Redfin, more homebuyers are looking to relocate to a new metro. Based on Q3 2022 sales activity, nearly one-fourth of homebuyers (23.3 percent) were looking to move to a different city compared to about 18 percent prior to the pandemic. Research conducted by Gensler also shows the percentage of urban residents who want to relocate to another city has continued to rise over the past two years. Gensler’s City Pulse Survey Spring 2022 survey found 35 percent of urban residents reported wanting to relocate, compared with 28 percent in spring 2021 and 23 percent in spring 2020. Among the 12,500 people surveyed across 25 global cities, respondents from U.S. cities are nearly 1.5-times more likely to want to move from their current cities than those in non-U.S. cities.
“The migration patterns are real, and the ‘smile states’ have been huge beneficiaries of that population growth,” says Byron Carlock Jr., lead of the U.S. real estate practice at PwC. “With permission to work where they want, folks embraced that and moved for both affordability and quality of life attributes,” says Carlock. In particular, people have been attracted to non-income tax states such as Florida, Texas and Tennessee. The exodus out of the San Francisco Bay Area has benefited key cities in the West, including Boise, Las Vegas, Phoenix and Salt Lake City. There also has been a “rural revolution” with people who have moved further and further out into cute small towns where there are good schools and more affordable housing. “It’s too early to tell how “sticky” those migration trends are and how many people will stay, but the migration patterns are clear,” says Carlock.
Nearly three years after the outbreak of the pandemic, everyone is still trying to figure out what the future holds for remote and hybrid work, which has significant implications for cities, as well as the infrastructure and real estate needed to support demand. According to McKinsey’s American Opportunity Survey, 58 percent of workers have the flexibility to work from home at least part-time, and more than one-third of the 25,000 people surveyed (35 percent) said they currently have the option to work from home five days a week.
Most experts agree mobility created by remote working only accelerated a migration shift that was already occurring. “Most of the destinations that people talk about as being these Zoom cities were already on that trajectory heading into this more remote work environment,” notes Lee Menifee, head of Americas investment research at PGIM Real Estate. People that were tired of the high costs, high taxes and congestion common in coastal gateway markets were relocating to more affordable areas that offered a variety of other perks such as better quality of life, good schools, outdoor recreation or a warmer climate.
CITIES MANAGE GROWING PLANS
The rise of 18-hour cities emerged well before the pandemic with secondary cities that added amenities and worked to create vibrant downtown hubs to attract both people and employers. Second-tier cities such as Atlanta, Austin, Charlotte, Dallas, Denver, Miami, Nashville and Raleigh have seen 10-year population growth of between 10 percent and 30 percent, outpacing the 2010-2020 U.S. population growth of 7.1 percent, according to JLL. Effectively, many cities had laid the groundwork for the bigger migration shift that occurred during the pandemic.
“I think the pandemic and the growth gave validity to those strategies,” says Carlock.
There is no shortage of rankings of emerging markets and growth markets to watch. Markets that frequently top those lists, including those published in the annual Urban Land Institute and PwC Emerging Trends in Real Estate report, are Nashville, Austin, Dallas/Fort Worth, Atlanta, Charlotte — and virtually the entire state of Florida.
One of the core factors that often positions secondary markets for success is an institutional presence, such as universities and health systems. A focus on “eds and meds” has become a popular investment theme in recent years. Cities also need to offer some type of attractive cultural amenity that helps tip the scales and attract interest, notes Phil Ryan, director of the JLL City Futures program. Examples include a vibrant live music or restaurant scene, such as is the case in Nashville and Austin, or outdoor recreation that people are finding in mountain west regions, such as Denver and Salt Lake City.
“A lot of younger people have resigned themselves to the fact that bigger cities are expensive. As great as it would be to be there, it’s just not a tenable proposition. They don’t want to go somewhere that is generic, they want to go somewhere that has that extra cultural presence and things to do to make up for that,” says Ryan.
The downside of the boom in secondary cities is that it can result in an erosion of the benefits that attracted people and companies in the first place. The two biggest pinch points are transportation and housing. Most secondary cities in the United States are lacking in modern transit systems, such as light rail, which makes it difficult to scale up to accommodate commuting and movement of people. Remote work has helped lessen gridlock to some degree, but traffic congestion is still a growing problem. Demand for housing also is driving up costs and putting pressure on the supply of affordable housing.
“If you have movement that is based on quality-of-life issues as one of the primary reasons, anything that starts to hurt that advantage is somewhat of a win for somewhere else,” says Ryan. In some cases, that has sparked a return to primary markets, but it has primarily benefited tertiary markets as that next group of growth markets, he adds.
INVESTORS NAVIGATE POTENTIAL RISKS
Institutions are taking advantage of the growth occurring in secondary markets. At the same time, there are concerns about cracks emerging that could be magnified with a potential recession ahead. “What makes us worried is that a lot of these cities have very different economic drivers and very different outlooks, and yet for a moment in time, these markets were treated by investors as being all the same,” says Menifee.
The rapid pace of growth has made it difficult to make a mistake in secondary markets over the past two years. Industrial and rental housing in particular have benefited from demand that has fueled double digit rent growth. However, signs of slowing are already emerging. “I think there will be a period again this year where all of those markets start to look the same again, but for the wrong reason. They’re all getting a lot of new supply in a weaker economy,” says Menifee.
The challenge and the opportunity ahead are to determine which secondary markets are structurally likely to outperform versus weaker markets that may struggle. The obvious factors investors are looking for are population and job growth. However, it is important to distinguish between the quantity and quality of that growth. PGIM views markets such as Charlotte and Phoenix as driven more by quantity. There are particular strategies that work around that growth, such as developing housing at a relatively low-cost basis to service the people coming into those markets and people who are already living there. In contrast, markets such as Austin, Nashville or Raleigh have specific drivers that revolve around technology and other sectors that drive higher levels of income. “In those markets, you may be able to look at investment around higher cost housing where you can get growth in households and growth in incomes that support rent growth over the longer term,” says Menifee.
Investors also are keeping a close eye on looming risks in secondary markets. Compared to gateway markets, secondary markets generally have fewer barriers to new supply. “Construction pipelines are the single biggest risk factor that we’re thinking about when making new investments in secondary markets today,” says Will Pattison, head of real estate research and strategy at MetLife Investment Management. That focus has been magnified by current economic conditions and expectations of a recession ahead. In the apartment sector, for example, there are some markets where there is 3 percent to 4 percent of stock under construction. That volume is likely to put downward pressure on rents over the next several years.
“When we underwrite assets in some of those markets, we essentially price ourselves out of winning deals. So, it is a big issue, and I don’t think the market overall is appropriately pricing the risk of construction pipelines, or the upside of markets with lower construction pipelines,” says Pattison.
CAN CITIES MAINTAIN MOMENTUM
Another challenge for investors is determining whether growth in secondary markets is sustainable. Is that growth a flash in the pan if the cities can’t manage that growth? “There is a move toward a more holistic and strategic understanding of the nuances within these markets than there previously has been,” says Ryan. Investors are looking at both the core drivers and the differentiators. As markets mature, they start to specialize in certain subsectors. Charlotte, for example, in banking and fintech, Austin with software development and Raleigh with life sciences.
Migration is expected to slow in a more challenging economic climate. There also is a potential risk that drivers behind the boom in secondary markets, such as remote working, could swing back the other way. Heading into a recession, workers are choosing to return to office for job security, while some employers are requiring employees to come back to the physical workplace. Both employers and investors are still looking for clues in the future of remote and hybrid work. Most companies have accepted that hybrid work is likely permanent.
“We’re now in the phase where people are deciding what that schedule is and not if that’s the schedule,” says Ryan. Deciding whether the new schedule is two, three or four days in the office varies from company to company, and likely will vary depending on the job and industry. “It is very much an organic process rather than a formal policy,” he adds.
Certainly, remote work isn’t the only factor fueling migration shifts. Well before the pandemic, technology was enabling a growing gig economy, and in some cases, people that left the workforce during the Great Resignation simply never came back. Demographic shifts and an aging baby boomer population also have fueled migration trends. Will there be a boomerang effect among people who left a gateway market, such as Chicago, New York City or San Francisco? There is already some evidence that return is occurring, such as apartment rents in New York City that have rebounded to pre-pandemic levels. However, while the pace of growth in secondary cities may slow, the growth that has already occurred — and likely is still ahead — continues to expand the investment universe for investors beyond the gateway markets.
Beth Mattson-Teig is a freelance writer based in the Minneapolis area.