As the pandemic lingers, buyers and renters are rethinking their obsession with the bustling streets and bright lights associated with city life. An elevator ride, once seen as an opportunity to briefly chat with a neighbor, is now a potential danger. The proximity to entertainment and restaurants no longer matters as business owners make the hard decision to close down or limit access.
In response, buyers and renters are turning their sights to suburban areas with less density and more greenspace — two prized features for those who have spent the pandemic in cramped spaces. So, what does this mean for real estate investors who spent the last decade building their empires in the city?
Is it time to ditch the high rises for open spaces?
Don’t call it ‘urban flight’
“There’s a lot of talks right now about urban flight, and there’s a lot of talk about the suburbs,” Atlas Real Estate Group CEO Tony Julianelle told Inman. “A number of our larger institutional investors would like to have more exposure in the suburbs than they have now; however, I think it’s way too early to call that a fundamental shift.”
“There’s a quote from Warren Buffet a few years ago where he said, ‘When everybody is greedy you should be afraid, and when everybody is afraid, you should be a little greedy,'” Julianelle added. “I’m probably not stating that perfectly, but the concept [stands].”
He continued, “It feels like some of this shift to the suburbs or the exurbs further out is driven by fear right now, and to say that people’s desire to be in an urban area isn’t going to rebound substantially once we’re past coronavirus is premature.”
John Burns Real Estate Consulting Managing Principal Ken Perlman echoed Julianelle’s assessment, saying it’s too early to draw parallels between the public’s current interest in suburban areas and the urban flight of the 1950s and 60s when wealthy white Americans abandoned cities for sprawling developments.
“I’d like to stop a little bit short of using the term urban flight,” Perlman said. “To me, that implies there’s this mass exodus out of the cities, and I believe that cities are still viable, and there will be people who want to live in the cities, and employment concentration still exists in the cities.”
“With that said, we are seeing is this migration to more suburban communities as people look for more space,” he added. “What we’ve seen with COVID-19 is that people have said, ‘Hey, I don’t necessarily want to live right in the middle of everything. I don’t want to live with a ton of people on top of me or close to me. I don’t want to have to crowd into a densely-populated condo building.'”
Beyond COVID-19, Perlman said the “movement to the suburbs” is also a result of other factors, such as historically low-interest rates and evolving generational housing needs.
“You overlay [the pandemic] with the fact that interest rates are at historic lows and our forecast is that between 2021 and 2023, interest rates will stay at our below 3 percent,” he explained. “So homes are infinitely more affordable than they’ve ever been, and so as buyers start to look for more space, they’ll start to look for the best value for their money. That’s translating to the suburbs.”
When it comes to generational housing trends, Perlman said older millennials (born 1980 to 1989) are responsible for much of the shift toward urban, luxury high-rise living. However, these millennials are now building families — meaning they need more space.
“We wrote a book called Big Shifts Ahead, and in it what we did was look at different demographic groups by the decade they were born and we split the millennials up into two groups,” Perlman said. “Those older millennials, those born in the 1980s, are now starting to move into their household formation years.”
“Someone born in 1980 is going to turn 40 in 2020,” he added. “So from a family profile, from the perspective of where and how they want to live, I think there’s a natural evolution demographically toward the suburbs as well.”
Diversity is key to survival
Julianelle, who has more than two decades of mortgage and investing experience, said investors must avoid making brash decisions based on current trends and instead focus on diversification.
“I don’t think it’s a bad idea to be diversified in your asset holdings,” he said while noting it would be unwise to simply offload urban investments unless they no longer fit your goals.
“I think asset type and amenities will be impacted in the short term,” he added. “The amenities of new Class A properties are usually very communal. You have great gyms, a rooftop deck, some swimming pools, and things that were unusable for several months.”
He continued, “I think investors are going to look a little closer at the amenities, the outdoor spaces like patios and balconies, and how they create those things that are more attractive.”
For investors who want to expand into suburban markets, Julianelle said they must understand one thing: the path of development.
“You have to understand the path of development,” he said. “It’s going to have an enormous impact on appreciation over time.”
Julianelle said Oklahoma City is a case study in urban and suburban development, especially as secondary Southern cities experience a boom in demand.
“If I buy an asset in Heritage Hills in Oklahoma City, I’m right outside of downtown in a beautiful neighborhood with fantastic homes,” he said. “However, in Heritage Hills, there’s not a lot of empty lots someone can buy and build a house on.”
“If I go to Edmond, there’s no end to where I can build,” he added. “When you’re geographically constrained, meaning there’s some barrier to how much new construction there can be, you’re going to have a different appreciation story than if you have an asset in a suburb where they’re building a new asset a mile away.”
“You’re going to be constrained by the value of that new construction,” he continued. “It’s a basic framework for understanding the path of development.”
Furthermore, Julianelle said investors must be wary of jumping into markets dependent on one industry, especially as the economy works to stay afloat.
“When you think about who’s living in the nicest apartments in downtown Oklahoma City, they’re probably working for Devon Energy,” he said. “If Devon is healthy and hiring and they see positive prospects, then there’s going to be a lot of demand for that type of asset.”
“If Devon is laying people off and contracting, then that asset will suffer,” he added. “This is one of the reasons we don’t buy assets in Oklahoma City, although I love Oklahoma City.”
Learn and adjust
Houston-based real estate agent and investor Jackie Swagerty has learned the lessons Perlman and Julianelle shared the hard way. Before the pandemic, Swagerty had an extensive waitlist for her furnished single-family homes near downtown Houston’s medical corridor.
“As a business owner, everything’s affecting us like it’s affecting everyone else,” Swagerty said after noting she contracted the virus twice. “As a real estate investor, the biggest impact was that four of my furnished rentals for travel nurses close to downtown Houston.”
“You’d think that with a major, medical epidemic that I would have increased demand from travel nurses, but what’s happening to me is that all of my travel nurse contracts got canceled,” she added. “I had all of them vacant starting in March, which has never happened because I usually have a waiting list.”
“I guess the hospitals quit doing elective surgeries, and all the nurses left and they’ve just started coming back recently.”
Swagerty said the pandemic has forced her and fellow investors to adjust their investing tactics, tighten their pockets, and reevaluate their current portfolios.
“I have tightened up my rules,” she said. “I used to go up to a 72 percent or 75 percent [after repair value], but right now I’m not buying anything above a 67 to 70 percent ARV because I want to see what’s going to happen with the market and I’m trying to be conservative on my acquisition side.”
“I don’t think we know what’s going to happen yet,” she added. “Evictions haven’t started back up or if they have, it’s very new, and foreclosures are still on the table. I think all of my fellow investors are preparing.”
Swagerty said she plans to purchase more properties this year, but she won’t be so dependent on furnished rentals for travel nurses and other professionals.
“I think in times like this, really remind investors how important diversification is,” she told Inman. “A lot of times, you get really good at one niche. I got really good with furnished travel nurse rentals, and you start pursuing that niche.”
“Just like a stock market portfolio, a real estate portfolio needs to be relatively balanced as well,” she added. “If you’re too heavy on one side and the market doesn’t uphold that and it can go down really fast.”
If this isn’t the end, then what is?
For city slickers who aren’t ready to venture into the suburbs, Julianelle, Perlman and Swagerty all said demand for the city won’t be going away, as there will always be buyers and renters who prefer urban life.
“People will choose to live urban now and in the future,” Perlman said. “It’s convenient, there’s access to services, and at one point the coronavirus situation will be resolved. There will still be a demand for living in cities and urban housing.”
However, he said investors must prepare for how the coronavirus might impact how future generations view city living.
“I do think that just as the Great Depression influenced how people that were born that generation and lived in that generation lived the rest of their lives, I do think that coronavirus and this quarantine is going to have a longer-term impact on the way people live,” he said.
“I do think that at least for the foreseeable future, this will be top of mind and people will be looking for more space in less dense environments.”