2018 Best Commercial Real Estate Markets to Invest In: Part I
With a new year among us comes new opportunity for investment, particularly investment in commercial real estate. In this post, I will discuss 4 large US markets which I believe to be ripe for commercial real estate investment. When determining a market’s attractiveness for investment, I looked to a few main fundamentals and indicators.
- Job and population growth
- Access to a talented workforce
- Diversification of the industries that drive the market’s economy
- Rent growth
- Inventory deliveries, absorption, and vacancy rates
I looked to these indicators because they help to paint a clear picture for a real estate market’s health, rent growth expectations, resiliency in an economic downturn, and overall future demand. All of these factors are major macro contributors to real estate values and investment returns.
My post includes the following markets, which are stacked in alphabetical order and are not ranked amongst each other for which is better.
Over the 5-year period from 2012 to 2017, about 180,000 households were created in the Atlanta metro area. This represents one of the largest gains in household creations of any US city over the 5-year period. Much of the migration to Atlanta is thought to be from the growing positive perception of the city due to its comparatively low cost of living, warm weather, start-up business friendliness, and growing presence in a host of different industries. Over this same period, the number of jobs in Atlanta grew about 20%, outpacing the national average growth which was closer to 10%. Atlanta mints about 40,000 new college graduates each year from schools like Georgia Tech, Emory, and University of Georgia. Some of the industries that are driving the economy in Atlanta include technology, IT, film, transportation, consumer goods, and financial services.
The Atlanta apartment market, in aggregate, had an average vacancy rate of 9.0% in 2017 and 12-month rent growth rate of 3.6%. This compares with the national average vacancy rate of 6.5% and rent growth of about 2.7%. The vacancy rate of 9% was due to 11,700 new apartment units added in 2017, of which only about 9,500 were absorbed by renters. I expect these new apartment deliveries to be absorbed in 2018, driving vacancy rates down as the market continues to see an influx of millennial migration to work at some of the nation’s best technology companies while taking advantage of the low cost of living.
The Atlanta office market had an average vacancy rate of 11.7% in 2017 and 12-month rent growth of 4.1%. This compares with the national average office vacancy rate of about 10.5% and rent growth of about 3.0%. The office vacancy rate continues to outperform Atlanta’s historical average vacancy rate of 13.6%. The lower than historical average vacancy rate in 2017 has been a result the strong job growth and an absorption rate of about 75% on the roughly 2,800,000 square feet of new office deliveries. The volume of new office space deliveries falls short of the national delivery average and I expect this trend to continue into 2018. This trend of low supply but high demand has created a lucrative environment for office deals in Atlanta. The West Midtown and Central Perimeter submarkets are personal favorites of mine and they pose opportunities to repurpose industrial buildings into “creative office space” that are in high demand by many companies today.
Over the past 10 years, Texas’ capital city of Austin has expanded its employment base and number of jobs by about 3% per year, or more than twice the national employment growth rate. Labor demand continues to be strong in Austin, which boasted an unemployment rate of about 2.6% in 2017. The University of Texas at Austin, largely considered a Public Ivy, has a student population of over 50,000. Many of these students are picked off immediately upon graduation to work in Austin’s booming technology industry. High-tech Labor demand has been so strong in Austin that there has been a high-tech labor shortage, causing many Austin technology companies to have to begin poaching talent from other Texas markets and Silicon Valley’s technology focused labor pool. This out of state talent poaching can be seen as a plus for the Austin market, as it fills labor demand while also increasing population for the city. Austin’s population of 20-34-year-old millennials totals about 500,000, or about a quarter of their total population. It is unlikely that these highly educated millennials will be leaving anytime soon and are expected to make up more than 75% of the US workforce by 2020. The greater Austin metropolitan area was also rated as the best places to live according to U.S. News and World Report, based on exceptional job growth, migration and desirability. Some of the industries that are driving the economy in Austin include technology, household goods, leisure and hospitality, natural resources, government, and health services. Well-known companies that make up a portion of these industries in Austin include, Charles Schwab, IBM, Apple, Google, Samsung, Whole Foods, Facebook, and University of Texas at Austin.
Vacancy rates in Austin reached historical lows in 2012 after beginning to experience huge job and population growth. The current apartment vacancy rate in Austin is 8.9%, which is above the national average due to more than 36,000 apartment units being delivered by developers since 2012. Developers have begun to back-off of building luxury apartments in the Downtown and University submarkets and are now focused on more condominium developments. With lofty expectations for continued job and population growth in Austin over the next few years, along with slowing apartment deliveries, I expect the apartment vacancy rate to trend down going forward as apartment absorption by the millennial continues. Apartment rent levels in Austin are now about 20% above pre-recession levels, compared with the national average apartment rents that are about 15% above pre-recession levels.
The Austin office market had an average vacancy rate of 8.3% in 2017 and 12-month rent growth of 2.1%. This compares with the national average office vacancy rate of about 10.5% and rent growth of about 3.0%. The lower than national average vacancy rates have been the result the strong job growth and investor/employer interest in new office deliveries. Because of this strong interest for office real estate in the greater Austin area, as leases roll on these properties over the next few years, rental rates and NOIs are should continue to rise. Austin has had one of the strongest economies in the US over the last decade and is expected to grow another 15% or so over the next 5 years. Much of the growth and demand in Austin has been concentrated in the central business district, however because of this, the city is starting to see expansion into more suburban areas, including the Southeast submarket where cap rates are currently more attractive than the downtown and central business district submarkets. It is important to note that while the technology industry is not the whole economy in Austin, it does make up a large portion of the economy currently. If the US were to experience a technology driven recession in the future, Austin could be at risk of feeling that burn.
Out of about 50 markets in the US with a population of at least 500,000, Denver's 2017 unemployment rate was the lowest, at a barely visible 2.7%. In 2016, Denver ranked first on the US News and World Report of Best Places to Live based on its availability of jobs, overall desirability, and quality of life. Examples of industries that drive Denver’s economy include natural resources, aerospace, oil, technology, transportation, and telecommunications. In addition, the healthcare and marijuana industries in Denver have experienced significant growth over the past few years and are expected see major investment over the coming years.
The Denver apartment market had an average vacancy rate of 7.7% in 2017 and 12-month rent growth of 2.6%. Denver delivered about 7,500 new apartment units in 2017, with 6,300 of those units being quickly snapped up. Denver suburbs have been largely ignored by apartment real estate developers over the past several years while they largely favored the more urban submarkets. Because of this, vacancy rates have been very tight in Denver’s suburbs such as Aurora and the Southeast submarket. I expect to see growing population numbers in Denver’s submarkets in 2018 and subsequent years due to relative affordability over Denver’s urban submarkets.
The Denver office market had an average vacancy rate of 11.1% in 2017 and 12-month rent growth of 2.1%. This compares with the national average office vacancy rate of about 10.5% and rent growth of about 3.0%. The office vacancy rate in Denver is due to an influx of speculative development, which gave prospective tenants more options than they had a few years back. Given this, office real estate delivery is showing signs of slowing in certain submarkets, which could contribute to a manageable level of office space inventory going forward when compared to historical averages. I expect the suburban Denver markets to continue to be attractive for investment over the next few years due to their lower supply relative to Denver’s central business district.
The Tri-City Region in North Carolina makes up about 20% of the state’s population and includes the cities of Raleigh, Chapel Hill, and Durham. This region is home to Research Triangle Park, a national leader in medical and healthcare research, and currently attracts about 80 new residents a day for its strong job growth and high quality of life. More specifically, Durham’s population growth has outpaced the national average population growth in each of the last 5 years, with more than 30% of the total population being made up of 20-34-year-old individuals. Employment growth in Durham has also outpaced the nation in the last several years, with over 3.5% growth in some of the years in the current economic cycle. Education and medical related industries have been a couple of Durham’s major economic drivers and Durham is home to prestigious higher learning universities such as University of North Carolina – Chapel Hill, Duke, and Duke Medical. These universities are some of the largest employers in Durham and make employment levels in the city rather resilient in economic downturns due to their relatively “recession proof” nature. In addition to employing a large number of people, these universities also provide about 200 companies in Durham’s Research Triangle Park with direct access to their highly educated graduates. Other large industries that contribute to Durham’s economy are professional and business services, leisure and hospitality, manufacturing, and financial services. The growth in the overall number of jobs in Durham is also expected to outpace the number of jobs in the US through 2022.
The 2017 apartment vacancy rate in Durham was 7.7% and developers grew Durham’s inventory of apartment units by more than 5% in 2016 and 2017 with more than 2,200 new units delivered in this time period. Rental rates in Durham grew more than 4% in 2016, well above the US average. Rent growth has since slowed to about 2.3% over 2017, and I expect further stabilization of Durham’s economy over the coming years to lead to continued propulsion and rent growth in the city’s apartment market.
The Durham office market had an average vacancy rate of 9.7% in 2017 and 12-month rent growth of 1.6%. More than 700,000 square feet of office space was delivered in Durham in 2017, or about 50% more annual office construction than usually occurs in Durham. Despite the large jump in office space deliveries and even more expected in 2018, Durham has continued to boast an office vacancy rate below the national average, which is reflective of Durham’s strong employment market. Durham’s Downtown submarket has seen the highest level of office deliveries in recent years, with about 10% of the submarket's inventory being built in the past five years. However, even with the elevated office deliveries, vacancy in this submarket was still less than 5% to close out 2017. The current low vacancy rates in Durham’s central business district may be signaling a high demand for the new office space for years to come.
Over the last several years, all the markets discussed in this post have displayed traits that created environments that were attractive for real estate investment. Going forward, I expect these markets to continue to possess strong economic and fundamental characteristics that will continue to make them a hotbed for real estate investors. The factors that I considered do not make up all things that need to be taken into account when making a real estate investment, however they can help to provide a great picture of each market’s macro investment environment.
I will follow up with a “Part II” of this post that will include 5 more of the nation’s best large markets for commercial real estate investment.
Economic and real estate data in this post is according to CoStar Group’s market research reports as of December 20, 2017 and the Bureau of Labor Statistics as of December 8, 2017.