On October 15, 2021, PwC and the Urban Land Institute (ULI) released their “Emerging Trends in Real Estate 2022 Report.” According to PwC leaders, the annual report looks forward to the year ahead, unlike most reports that look back at the last quarter or year. The report was compiled from surveys and interviews of over 2,130 real estate executives, investors, developers and market experts. The theme that emerged more than any other from the interviews with industry leaders was that the economy and the real estate markets have held up better than most predicted.  Most thought the fallout in the months since the pandemic hit in March 2020 could have been worse. 

The recession ended up lasting only two months – the shortest on record – according to the official arbiters of business cycles.  Economic output is already back above pre-COVID levels, and jobs may recover to previous levels by early 2022.  Almost more remarkable than the speed and extent of adaptation was the pandemic’s relatively muted impact on property market fundamentals.  One reason: tenants generally did not believe that the downturn would last very long, and firms did not want to give up valuable space, especially offices, if they would only need to reoccupy that space.  Most tenants continued to pay their rent and some even renewed their leases.

Fortunately for the office sector, the economy is roaring back at its strongest rate in decades, and office–type employment gains should be solid in 2022.  Historically, office demand has closely correlated with growth in “desk jobs” – the knowledge-based occupations whose work is most likely to take place in an office setting.  That growth will fill a lot of empty office space and fuel demand in the years ahead.

Last year’s “Emerging Trends” spotlighted some of the challenges facing cities, since the pandemic was likely to reinforce longer-term trends favoring suburban growth over urban.  And indeed, property markets in large central cities generally suffered more than their suburban counterparts.

Markets to Watch

Over the past 19 years, “Emerging Trends” has surveyed its members and asked them to evaluate the investment and development prospects of what has grown to be a list of 80 real estate markets across the United States.  The survey results from the viewpoints of a diverse group of real estate professionals. The long-term impact on local markets has been hard to pin down, since hot spots and infected areas have spiked and waned since the pandemic started in early 2020.  However, looking at the markets moving up in the overall real estate prospects rankings, the suburban markets tracked in the survey have gained the most over the past year.

To be sure, the pandemic and ensuing recession reinforced some trends that well preceded the downturn.  Most notably, the popularity of large gateway markets continues to wane in favor of generally smaller “smile” markets that extended almost across the southern half of the country.  Until recently dismissed as “secondary” investor markets, these Sun Belt metropolitan areas account for the eight top-rated “U.S. Markets to Watch: Overall Real Estate Prospects” in the latest “Emerging Trends” survey.  Their ratings are tightly bunched, with only one-tenth of a percentage point separating the ratings of top-ranked Nashville and fifth ranked Tampa/St. Petersburg, suggesting a clear investor preference of this type of market.  Sun Belt metro areas occupy the top five places in the “Homebuilding Prospects” ratings.

Grouping the Markets

“Emerging Trends” last year designated new market categories with the top group being the Magnet category in that they are growing more quickly than the U.S. average.  In a sense, they are magnets for both people and companies.  Within the Magnet category there are three subgroups: Supernovas, 18-Hour Cities, and Super Sun Belt.

The Supernova markets are on a tear.  In astronomy, a supernova is the explosion of a star that creates unusual brilliance, but more generally the term refers to things that explode into prominence or popularity.  So it is with the five metro areas in this new category; Nashville, Raleigh/Durham, Austin, Boise, and Jacksonville.  All are affordable smaller markets with between 1 million and 2 million residents.  But their defining attribute is their tremendous and sustained population and job growth, which is well above national averages.  These are true magnet markets, particularly for educated millennials.  Despite their relatively modest size, all Supernovas have above-average levels of economic diversity and white-collar employment, factors that explain their strong investor appeal and should help them sustain further high growth in the years ahead.  The triumvirate of Nashville, Raleigh/Durham, and Austin took three of the top-rated spots in the 2022 survey, just a touch shy of their sweep of the top three places last year.  Though their collective size is less than that of Houston and barely larger than that of Atlanta, investment and development opportunities abound in these three metro areas, thanks to boom-like growth; together they grew by almost 10 percent over the past three years alone, adding close to a half million residents.

18-Hour Cities.  Metro areas in this now-classic “Emerging Trends” category faired relatively well during the pandemic recession, a testament to their enduring appeal.  Though growing less affordable over time – partly due to price pressures from transplants from the more expensive Establishment markets – these medium-sized cities nonetheless continue to attract in-migration due to lifestyle, workforce quality, and development opportunities, according to “Emerging Trends” interviews.  Measured by per capita GDP, workers here are the most productive of any subgroups in the fast-growing Magnets category.  Features common to all are active downtowns and urban-like suburban nodes.  The dynamic economies in these markets continue to make them popular with developers and investors alike.  Four of the seven markets in this grouping rate among the top 20 markets nationally for overall prospects, led by Charlotte, which is ranked 6th this year.  Charlotte, in particular, is the focus of much new construction, including the Vantage South End and Design Center Tower projects in the hot South End neighborhood.

The final Magnet category, “Super Sun Belt” are large and diverse markets, but still affordable, forming powerhouse economies that attract a wide range of businesses.  Despite their size – these metro areas average over 5 million residents, the second most of any sub-group in the survey – almost all are among the fastest-growing markets in the country.  Moreover, their economic performance has been solid through thick and thin.  Though every market has lost jobs during the pandemic recession, recovery has been much quicker and more complete in the Super Sun Belt markets.  By year-end 2021, these metro areas are projected to collectively regain nearly all their lost jobs, while the United States is expected to still be down almost 2 percent.

This category includes longtime survey favorites Atlanta, Dallas/Fort Worth, and Tampa/St. Petersburg, which consistently rank in the top 20.  Interviewees most commonly cite the solid growth prospects, business-friendly environment, and favorable quality of life as reasons for the popularity of these metro areas.

Population growth in these markets is fueling a lot of development and employee growth- and vice versa.  Atlanta, Dallas/Ft. Worth, and Phoenix all saw population growth over 5 percent over the past three years, adding about 86,000 residents – all of whom require new housing, services, and workplaces.  Said one Atlanta interviewee, in what applies to all these markets: “Low cost of land, climate, and available jobs make the market attractive.  Hence, the influx of people moving here.”

Property Type Outlook

Once again, industrial/distribution leads the pack, ranking first for both investment and development prospects, as it has for nine straight years dating back to 2014.  Perhaps the biggest industry story coming out of the pandemic is the resilience of the overall property segment. This resilience – on top of generally disciplined lending, building, and investing during the last cycle – helped sustain liquidity in the capital markets through the dramatic economic downturn and recovery in 2020.  Add to that a robust economic forecast, and the industry is even more confident looking forward.  Gauged by the “Emerging Trends” survey, investment prospects increased for every major property sector this year.  Arguably more impressive, the investment outlook is healthier now for more than three-quarters of the subsectors than they were two years before the pandemic.

As to the office sector, if a time traveler visited 2021, from the past and reviewed office property data, he or she might conclude that the pandemic was only a minor shock to the sector.  Office vacancies rose moderately, but few tenants missed rent payments, and – in large part because office leases are long term – the impact on asking rents and property values has been minimal.

Offices emptied out during the pandemic.  Usage was lowest in gateway metro areas that were locked down more thoroughly than cities in states such as Texas and Florida.  Office use certainly will grow as infection rates wane and vaccination rates rise, even as the pace of both will differ by market.  Companies are reconsidering total space needs as well as design and health and safety concerns.  “Employers need to take seriously that people are looking for a good place to do work,” said one senior executive at an architecture firm.  Another analyst noted that working remotely has shed light on issues such as loneliness and burnout.  “We’re starting to see a growing recognition (of how design impacts) mental health issues,” he said.

Key to the design deliberations will be how to remain productive while supporting collaboration, corporate culture, and mentoring young workers.  A survey conducted by international architecture and design firm Gensler found that the time workers spent collaborating with colleagues fell to 27 percent during the pandemic from 43 percent before, while the individual focus time more than doubled to 62 percent of time spent working.  Gensler warns that the disparity may “negatively impact company creativity and productivity.”

Indeed, those concerns are borne out of the ‘Emerging Trends” survey, in which three-quarters of those surveyed said it is of “considerable” or “great” importance to go to an office to enable effective collaboration and company culture, with more than 60 percent saying it is important to “deliver in-person coaching or training.”

There are myriad reasons that firms would normally have people working together in an office.  As stated by a capital provider, “People can’t advance the shared consciousness and the culture of their firms without people physically in the office, and people can’t grow their careers without physically being around people in their office.” The chief investment officer at a national real estate investment company added, “Companies will try hybrid models, but everyone will eventually be back in the office.  It is just too efficient to have everyone in one place.”

Another important factor in gauging future demand is where office talent wants to live.  During the pandemic, workers were freed from an office base, prompting some exodus from the central districts of high-cost gateway metro areas.  That has given credence to proponents of secondary and tertiary market growth who contend that families – unbound from the need to be physically present in urban offices – will increasingly choose metro areas with cheaper housing, more living space, less traffic, less crime (whether in perception or reality), and better schools.  “The pandemic has accelerated the life shift of millennials,” noted one researcher.

Office transaction volume is on the road to recovery due to healthy capital markets, but volume is likely to be weak in 2022 because underwriting future cash flow remains difficult and bid-ask spreads remain wide.  Buyers are looking for discounts while most sellers are holding firm.  Preliminary indications show that many investors are buying the future growth story in suburban and secondary markets.  Capital availability remains healthy for properties with stable cash flows and in secondary markets that investors see potential for above-trend growth.  Much like leasing dynamics, sales are concentrated in strong markets and best-in-class properties with predictable cash flows.  “Capital is the tale of two cities. It’s moving to cities that investors believe will do well in the next cycle,” said the regional director of a major owner/developer.

Despite the uncertainty, overall prices are remaining roughly on par with pre-pandemic levels.  Doubts about future cash flow are balanced by low-cost debt in the 3 to 4 percent range and extraordinary demand from investors who see U.S. commercial real estate as attractive relative to other investment sectors.  Although office is behind multifamily and industrial in the property type pecking order, debt markets are liquid and equity is not in short supply.  Another factor is that cap rates of favored asset classes have tightened so much that office property yields look attractive by comparison.  Unless there is an economic shock or a capital belt-tightening, pricing trends seem likely to hold.  That said, the office sector has much going for it.  Office-using industries including technology and professional services represent the backbone of future job growth.

According to CBRE’s 2021 Americas Investor Intentions Survey, 72 percent of respondents were actively pursuing alternative investments, up from 54 percent in 2020, and life sciences/medical offices represented one of the most sought-after categories.  Medical office transaction volume was not immune to the effects of COVID as logistical hurdles hampered deal volume in the 2nd and 3rd quarters of 2020.  However, according to Real Capital Analytics, volume rebounded to $4.4 billion in the fourth quarter of 2020, the highest fourth quarter on record.  The resilience of the medical office sector through the pandemic and past economic downturns and the long-term favorable demand prospects for health care services are expected to continue to attract investor attention in 2022 and through the long term.

Additionally, the COVID-19 pandemic has pushed the life sciences industry into the spotlight both as a hopeful solution to the global health crisis and by investors with capital to deploy into high-growth and alternative asset class.  Like the technology boom that grew out of Silicon Valley over the last 20 years, the life sciences industry is on trajectory of similar expansion.  The lab development pipeline is filling fast to meet the challenge.  The major clusters take the prize in terms of scale, with Boston accounting for more than half of the national lab development pipeline underway as of mid-year 2021.  However, new markets of opportunity are emerging where the fundamentals to support new industry growth exist.  Markets to watch include Raleigh/Durham, Philadelphia, Austin, and Pittsburgh, each boasting strong demographic growth, a high concentration of science, technology, engineering, and mathematics (STEM) degrees, and access to funding that is steadily increasing.

As new capital continues to enter the space over the next year, expect more lab developments and conversions to begin.  Conversions can be a viable option if the base building has a floor plate measuring between 30,000 and 60,000 square feet, clear height of at least 12 feet, increased electrical service and dedicated freight loading, among other factors.  Investors and developers considering this option will need to invest $135 to $400 per square foot depending on geography and scope of conversion required.

The latest “Beige Book” report, issued by the Federal Reserve Board March 2, 2022, based on information collected on or before February 18, 2022 indicated that economic activity across the United States expanded at a modest pace since mid-January.

The regional economy in Richmond’s Fifth District grew moderately in recent weeks.  The industrial segment remained very strong with low vacancy rates and rising sale prices and rental rates.  Office leasing improved, especially for Class A space with lots of amenities as tenants are looking to “right size” due to an increasing hybrid workforce.

On balance, business activity in Philadelphia’s Third district grew modestly in the current Beige Book period.  Non-residential construction and leasing activity held steady.  Contacts continued to cite institutional projects and industrial/warehouse space as the strongest markets.  Prospects for office space will become clearer once workers return to offices on a consistent basis.

Economic activity in Atlanta’s Sixth District expanded at a moderate pace, on net, from January through mid-February.  Commercial real estate (CRE) activity was mixed.  Conditions in the industrial real estate sector remained robust.  The office sector improved modestly as more employers reopened, but contacts indicated that elevated levels of sublease space could hinder market rent growth until absorbed.  Contacts continued to report robust competition among CRE lenders, however, some reported a modest tightening of underwriting standards.  Smaller banks and non-bank lenders have been identified by market contacts as the more aggressive of CRE lenders.

Updated 3/15/22