Second-tier cities suffered the economic ravages of the COVID-19 pandemic just like their counterparts in large global cities. But as the virus recedes across the country, many of these smaller metropolitan areas seem to be gaining jobs and recovering more quickly than the United States as a whole, according to commercial real estate experts. There are several reasons.
Second-tier cities have attracted people and companies over the past decade because they are less expensive places to live, work, play and run a business compared with their larger counterparts. That trend seems to be accelerating. The ability to work from anywhere, powered by technology that allows people to collaborate easily while physically separated, is also boosting the viability of second-tier cities.
Second-tier cities with universities are a rich resource for companies that need to attract a talented workforce and cutting-edge innovators.
As second-tier cities continue to flourish, global cities will likely thrive as well.
The suburbs, however, which have seen big demand since the pandemic struck, may recede in popularity as employees feel safer about returning to urban offices.
ACCELERTION OF TRENDS
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 a recent JLL report. In addition, JLL notes that there are industry clusters developing in tech, life sciences, media, professional services and finance/insurance in second-tier cities.
Recent surveys indicate the appetite for smaller cities over big ones has increased in the past 15 months. Residential real estate website Redfin polled more than 2 million of its users nationwide and found that 30.3 percent were looking to move to a different metro area in the fourth quarter of 2020, up from 16 percent during the same period in 2019. That’s the highest share since Redfin started tracking migration in 2017. The number of people moving to affordable metros in the first quarter of 2021 more than doubled from the year before. The biggest net inflows were to Austin, Las Vegas, Phoenix, Sacramento and Dallas.
A recent survey by U-Haul backs this trend. The truck and trailer rental company tracks about 2 million annual truck rentals looking for one-way trips from one state to another. It found the biggest influx of do-it-yourself movers was into Tennessee. Texas was second and Florida was third. Ohio, Arizona, Colorado, Missouri, Nevada, North Carolina and Georgia rounded out the top 10. The lowest-ranking states in this survey were Michigan, Pennsylvania, New York, Connecticut, Louisiana, Oregon, Maryland, Massachusetts, New Jersey, Illinois and California.
John Burns Real Estate Consulting found in a survey that the movement of people accelerated during the pandemic. The coastal Southeast and Florida — Jacksonville, Myrtle Beach, Charleston, Sarasota, Orlando and Tampa — attracted people, as well as the big inland southern markets of Charlotte, Atlanta, Nashville, Houston, Dallas and Fort Worth. The affordable tech markets of Boise, Austin, Raleigh-Durham and Salt Lake City were also luring workers in large numbers.
Finally, two-thirds of respondents in Gensler’s City Pulse Survey want to leave their global city for a lower-cost, smaller city that offers a high quality of life and lower cost of living. It shows that many respondents were already thinking of leaving global cities even before the pandemic hit. In the case of San Francisco, 76 percent of respondents wanted to depart. Generationally, 80 percent of Gen Xers were contemplating moves before the lockdowns.
There was already a strong trend of people moving to second-tier cities before the pandemic because of their lower cost of living, lower cost of doing business, lighter tax burden, higher job growth and more affordable housing, says Spencer Levy, global chief client officer and senior economic adviser for CBRE.
“Since the pandemic, we have had an acceleration of trends both to second-tier cities and to the suburbs,” he says. “Will this acceleration continue? Of these two trends, the movement of people to secondary cities is clearly going to be more durable than the suburban trend, which I see as relatively short-lived — certainly from a commercial real estate perspective. The move to second-tier cities began pre-pandemic, and now with the growing trend of work from home or work from anywhere, it should only increase.”
Even before the pandemic hit, coastal markets had become increasingly expensive both from an occupier and employee perspective, according to Maris Sicola, managing and founding partner at CityStream Solutions, a San Diego-based architectural and planning consultant.
“This dynamic was especially apparent in San Francisco, where many occupiers and employees have moved out because it is overpriced,” she says.
In addition, Sicola says a focus on family prosperity and well-being made moving to second-tier cities a necessity.
“The costs of living — housing, quality schools, childcare services — are increasingly burdensome on dual-income families and even more so on women raising children alone,” she says. “There are many jobs and cities where income levels are less than the cost of childcare. Many women are leaving the workforce to take care of kids simply because it’s too expensive to do otherwise. The option of locating in lower-cost cities is more likely to make economic sense for women to stay in the workforce, which is an important factor in career fulfillment, future earnings, closing the gender pay gap and providing a larger workforce for employers.”
The trend of people moving to second-tier markets has probably been going on for a decade, noted Phil Ryan, director of U.S. office research for JLL.
“During COVID-19, people had the ability to work remotely,” he says. “When recent data started coming in from alternative measures — things like change-of-address forms and tax-related data from the government — what we saw was that people who were planning to move to the suburbs in the next couple of years did it in one year, which caused huge increases in housing prices. That says, the trend for migration to secondary markets is there, and we don’t expect that to stop, barring some sort of structural shift.”
WORK-FROM-ANYWHERE OR EVERYWHERE
Working from anywhere during the pandemic may well have changed workplace habits for years to come, which bodes well for second-tier cities. Employers seem to be more flexible about work schedules, which employees are increasingly demanding.
According to the latest report by Owllabs.com, a website that tracks remote working, 50 percent of people surveyed said they will not return to jobs that do not offer telework options. The report also found that people are using video meetings 50 percent more than before the pandemic; working remotely saves at least 40 minutes a day on commuting time; 75 percent of people are equally or more productive working remotely than in the office; one in two people would move for a job that allowed them to work remotely; and 80 percent of those polled expect to work from home at least three days a week going forward.
A recent PwC survey found that both employers and employees view remote work favorably. A total of 83 percent of employers now say the shift to remote work has been successful, and less than one in five executives say they want to return to the office as it was pre-pandemic.
What started as people seeking shelter from the pandemic storm could turn into a major lifestyle stampede.
“Initially, people moved from the 24-hour cities to country living, which really started to occur during the summer of 2020,” says Bill Hunt, president and CEO of Elmhurst Group in Pittsburgh, Pa. “That’s fallen off. At a certain point, people will say, ‘maybe I won’t move back to New York City, but I do need more of an urban environment.’ This bodes well for secondary cities like Pittsburgh and others. I’ve seen first-hand people moving away from the 24-hour cities during the pandemic to secondary cities and then staying put. These secondary cities have a stickiness to them that keep people there. In this work-from-anywhere economy, people are saying they have the quality of life they need.”
Rapidly advancing technology has facilitated the work-from-anywhere trend. Sicola says the pandemic forced companies to catch up quickly and adopt video conferencing, document collaboration and other remote working tools. It also forced technology companies (Zoom, Microsoft, Dropbox, etc.) to handle a massive surge in demand and deal with security issues.
“Everyone, especially managers, has now experienced remote working first-hand,” she says. “It is much more likely to be incorporated into our overall working culture now than before the pandemic. Along with the rise of flex space, this makes having smaller offices spread across more markets more feasible than it was before, which presents an opportunity for smaller metros.”
THE UNIVERSITY ADVANTAGE
Second-tier cities with universities have a real edge over non-university towns, according to Hunt.
“Universities provide many amenities that are not always in other secondary towns,” he says. “They provide theater, culture, museums, coffee shops and upgraded city neighborhoods. Pittsburgh has been fortunate to have Carnegie Mellon and the University of Pittsburgh, among others. Carnegie Mellon is particularly valuable with its two tech niches tied directly to the future U.S. economy — artificial intelligence and automation technology.”
As the United States seeks to become more competitive in research and development, Sicola says there is a big opportunity for second-tier cities with universities such as Raleigh-Durham, N.C.
24-HOUR CITIES WILL ENDURE
Levy suggests not writing off big cities such as New York and San Francisco.
“Our studies show that the outlook for 24-hour cities continues to be strong,” he says. “Although there may be a net loss of people on an aggregate basis, the most talented and highest-paid people still will flock to the 24-hour cities. The major cities — New York; San Francisco; L.A.; Washington, D.C.; Boston, Chicago — will be challenged in the short term, but they have a bright future long-term.”
Ryan noted that gateway markets continually get a disproportionate amount of inbound people from international migration. It has fallen off in the past year and a half due to COVID-19, but growth should pick up in those ports of entry. Further, he says in the early days of the pandemic, many wondered if companies would move their main offices out of cities to suburban locations.
“What we are seeing today is that gateway cities are attracting highly skilled and talented people,” Ryan says. “These are the people who drive a lot of the innovation and productivity and require in-person work. Secondary markets are thriving in ancillary and support services such as payroll, accounting, compliance and regulatory affairs that can be done in a more remote, cost-effective setting, with a smaller but growing share of innovation jobs.”
Regarding office utilization in gateway markets, Ryan is seeing decreases of 5 percent or less on an aggregate basis. Companies with hybrid models that let between 5 percent to 25 percent of their employees work remotely on a given day are also de-densifying their offices so that each employee has more space when working in person. The net result is taking the same or similar square footage pre-pandemic and reconfiguring it for fewer employees.
What will keep gateway markets thriving is scale and depth, according to JLL. For example, the New York area has 20 million people, Los Angeles has 13 million and the San Francisco Bay Area has 7 million.
“Once you get away from these major markets, you have a fractional number of potential employees,” Ryan says. “The talent pool is so much larger in a gateway city as opposed to the second-tier city. If a company suddenly decided to move from a gateway market to a second-tier market, they would lose access to a lot of people.”
Hunt says: “Corporations may decide rather than having a large office building in Manhattan, they could convert to smaller offices in New York, and add locations in secondary and tertiary markets. I don’t feel big companies are going to suddenly say, ‘OK, everyone can work from home.’ There is too much value with ‘WFW’ [work from work].”
There is always an ebb and flow of population to and from big cities, explains Hugh Kelly, author of the book 24-Hour Cities: Real Investment Performance, Not Just Promises.
“Frankly, it is too early to know what will happen with the big cities,” he says.
Kelly notes that the pandemic has indeed caused great disruptions, but he is not sure if the movement of people out of cities that has taken place so far is a short-term coping mechanism or related to the longer-term trend.
SUBURBAN TREND MAY COOL
While Levy of CBRE believes the 24-hour cities will prosper, he sees the trend of people moving from cities to suburbs cooling.
“The question is, will you see the same trajectory over the next few years?” he says. “The answer is no, you will not. What we have seen in this acceleration of trend regarding the suburbs was three or four years of movement crammed into one year. It will probably flatten out now.”
Levy does not see corporations moving their headquarters to the suburbs, but he does see more satellite offices in what is termed the hub-and-spoke model.
“We will also see a rise of what is one of the lesser known but hottest sub-asset classes, which is single-family rentals,” he says. “There are more single-family rental units than multifamily rental units in the U.S.”
THE BEST OF SECOND-TIER REAL ESTATE
While all real estate is admittedly local, Hunt, of the Elmhurst Group, offers advice on the best product types for second-tier cities, based on his experience in Pittsburgh.
“Every property was hit hard during the pandemic,” he says. “The hotel sector will come back quicker in secondary markets than in primary markets because secondary markets are less reliant on large conventions and international travel. This gap will not last long, though, as the overall industry will return by early [2022], even in the larger cities.”
Pittsburgh is unique when it comes to industrial development, according to Hunt.
“Pittsburgh never had large distribution centers because we lacked a highway beltway system and a strong interstate network,” he says. Because of that, products were supplied from distribution hubs in Columbus and Cincinnati to the west and Harrisburg, Pennsylvania, to the east.
“Now, with next-day and last-mile fulfillments, there has been a major rush to build smaller distribution centers throughout our region, which has caused an industrial boom here,” he says
Hunt is developing a new product that he calls an innovation center. It will be two buildings of 80,000 square feet each, with high-bay manufacturing taking roughly half the space and office taking the other half.
“It is modern day high-tech flex space,” he says. “Every tenant will have its own space, as there is no common area, and the prospects we are targeting are at the nexus of software and hardware. Examples include robotics companies that are researching automated systems. Software engineers can work alongside the actual product on the manufacturing floor. We feel this is space for the future.”
Although Elmhurst Group does not develop multifamily, Hunt sees a need for the product.
“In Pittsburgh, for example, some of the most successful developments are pursuing the medical employees who previously commuted long distances to get to the hospitals,” he says. “Now they can live perhaps two to three blocks from their place of employment.”
As for retail, Hunt is realistic about the product type.
“At the end of the day, high-quality malls are going to remain in demand,” he says. “In Pittsburgh, we have four or five regional malls. We will probably end up with only two or three. People may still continue to shop, but the mall they visit may no longer be in their neighborhood.”
Ron Derven is a contributing editor to Development magazine. This story has been reprinted with permission from the fall 2021 issue of Development magazine, published by NAIOP, the Commercial Real Estate Development Association. The original version of the article can be read at this link: https://bit.ly/3zBDBiY