The Death of the Suburbs Has Been Greatly Exaggerated

REIT magazine: January/February 2014

You can’t pick up a newspaper or a trade journal these days without reading that successful companies and all their young, cool employees are moving downtown.

The cutesy brick-and-beam office buildings, rehabilitated waterfronts and access to new ballparks are reeling in all the employers, while downtown restaurants and apartments are reeling in their workers. What’s more, the parents of these brainiac fashionistas are also moving downtown as their nests empty and they themselves suddenly become cool again. These articles give you the impression—or just out-and-out insist—that all demand growth for commercial real estate is downtown; the suburbs are doomed.

‘Premier Suburban’ submarkets are not only thriving, but growing at a stronger pace than the CBDs.

Well, that line of rhetoric is clearly a little flawed. The suburbs are not dying, especially when it comes to demand growth in the office market. The best suburban markets—our “Premier Suburban” submarkets—are not only thriving, but growing at a stronger pace than the central business districts (CBDs). Suburban office markets were on fire in the third quarter of 2013, taking 88 percent of national net absorption while holding a 73 percent share of the square footage. The strength in net absorption is broadly based: 2 million square feet in nine suburban markets in the third quarter.

Does this mean that any old suburban development deep in a cornfield has commanded occupancy recently, or will in the future? Far from it. There are two important trends that investors need to understand about office demand.

The first megatrend is that the highest-quality space, what we define as four- and five-star buildings, commands the occupancy. Lesser-quality space does not draw consistent demand growth. Rents as a percentage of employee compensation have never been lower, so employers are sweating the rent less and putting more into hiring the right talent. A high-quality office building is part of a good compensation package. The top people employers want are in relatively short supply, despite the average unemployment figures. Also, four- and five-star buildings are more efficient, usually requiring fewer square feet per worker, ameliorating total costs.

The second concept is that tenant demand is focused on high-quality locations, which can be in somewhat dense nodes in the suburbs (most common) or in the CBDs. Employers, especially the high-value-add firms that will pay the highest rents, don’t care about free parking and cheap rents in a distant cornfield, but want a location with top-flight restaurants, shopping, and housing options. In Denver, that could be LoDo downtown or the Denver Tech Center; in Seattle, Bellevue or Belltown.

Pulling this all together today, four- and five-star buildings in the submarkets we classify as “Premier Suburban” have had consistently more demand growth over time. They posted year-over-year demand growth of 2.2 percent as of the third quarter of 2013, far more than 0.7 percent for top CBD markets. Significantly lagging are the non-Premier Suburban markets, as well as the average- or below-average-quality CBD buildings.

A good case study is the biggest office development project in the U.S. right now, the Exxon Mobil campus in the Woodlands submarket of Houston. This campus should eventually total 3 million square feet. It will house employees from the Houston CBD and suburban buildings in Virginia and Ohio in five-star buildings in a “Premier Suburban” location.

The future is about the best buildings and the best locations, but they won’t only be downtown.

Hans Nordby is a managing director with PPR, a CoStar company.

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