Not the Burbs

By Jonathan D. Miller

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Last week I was reviewing Emerging Trends findings with a group of executives at a major public pension plan sponsor. My talk centered on how they needed to reduce performance expectations in the wake of the increasingly obvious dearth of high returning opportunities in the real estate marketplace. Sure, clever investors can and will make scores on one-off deals and development projects. But the likelihood of nailing consistent 10 to 15 percent let alone 20 percent or greater annualized returns on transactions is highly problematic given the ongoing lack of tenant demand. And the risk of underperformance remains considerable even though we are in the third year of recovery, coming out of a steep downturn.

There were lots of hang dog looks in the room—that’s not what  pension executives want to hear when they face increasing gaps in matching returns to liabilities as more beneficiaries retire. They are having enough problems squeezing blood out of stones in their ailing stock and bond portfolios.

“What about suburban office?” asked a staff economist, “isn’t Blackstone making a big bet on that sector, buying a big portfolio?”

Of course, time will tell what happens, and Blackstone may have pulled off a coup. But they certainly are making a contrarian bet if there ever was one. National suburban office vacancies (close to 20 percent) track well ahead of central business districts (under 15 percent), and in many major markets the disparity is greater. The suburban-downtown vacancy gap has been evident for more than a decade and could widen when you take into account move back in trends among the young adult generation—prime hiring candidates for most companies. And as we have discussed before, bigger companies continue to shrink space requirements in Era of Less downsizing and increasingly look for the most central locations to house necessary workers. Technology allows them to outsource work to people wherever—in the burbs or across the globe. But for headquarters types, location near the center of the action where other major firms are and close to infrastructure pathways becomes more crucial. And disparate suburban settings, especially office parks on the fringe, no longer look too attractive to most organizations.

In the past suburban office became desirable at lower price points when major market office building rents started to spike in prime central business districts. But few markets have been enjoying rent spikes, and near term escalations aren’t in view. And when you consider rising transportation costs and the pocket book pain on top of all the lost time commuting in and around suburban districts, what’s the point?

Of course, the suburban house owning dream has been turned on its head over the past five years—more folks gravitate to infill apartment renting out of fiscal necessity. And the mall scene isn’t what it used to be now that consumers realize bills come due on all those credit cards and home value increases won’t cover the charges.

So how can you be sanguine about suburban office? I can see gambling on a one off high quality building with deflated values at the center of an urbanizing suburban node. But beware the next round of development when new projects inevitably temper any chances for rent growth and soften occupancies. And what’s the point of buying a 1980s vintage suburban office campus unless you’ve got some creative re-use strategy?

The suburbs aren’t the answer for those pension executives. 

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