Suburban Office: It’s Not Dead Yet
By Adam Falcheck*
“The report of my death was an exaggeration.” – Mark Twain
The recovery continues for commercial real estate although progress is slower than most would like and it’s certainly uneven. The largest ten or so investment management firms seem to be attracting over half of the new institutional capital allocations. The core markets are experiencing respectable activity and dropping cap rates. Retail and multi-family is doing quite well with rising values and low vacancy rates. Hospitality, industrial and CBD Office are more of an uphill battle, but they are getting there. There is, on the other hand, the ongoing problem of suburban office. Can it return to better times once more?
What’s Wrong with the Suburbs?
As recently as 2006, the US had a thriving and robust suburban office market. The average cap rates for suburban and CBD office were nearly identical whereas today, the spread is near historic levels and suburban office space still suffers from considerably high vacancy rates.
With investors looking beyond core investments for more value-add opportunities, will the suburban market return as the next investment arena? Perhaps. The suburban jobs may have disappeared but the human capital hasn’t. And, being essentially “reset” by its collapse in 2009, it may still be possible to find – through a thorough understanding of the way suburban markets develop from here on out – a select few genuine opportunities.
Where Are the Signs of Life in Suburban Office?
Suburban office, after a very good run, seems to have become a pale and sickened version of its former self; and yet, the suburbs themselves haven’t gone away. People still live there (though fortunate echo boomers and empty nesters seem to be doing their best to stay or relocate in the central cities) and there is still activity. So, why is it taking so long for suburban office to get off the mat? The problem is that it’s a victim of its own success.
Let’s look at the boom before the recession. In the 100 largest CBD’s in the US from 2000 to 2007, the total number of jobs grew by 3.7% while the suburban areas 10 to 35 miles outside of the CBD grew by 9.6%. That outer-rim job growth in turn drove a significant increase in suburban office demand, leasing activity, investment, and construction. Most of this demand was driven by professional services, decentralized finance jobs, real estate, construction, and manufacturing.
Before the recession, employment was at historic levels and growth was particularly steady in the education, healthcare, and various housing sectors (e.g. construction, mortgage finance, retail, furniture, leasing, and rental services). When the US entered the recession, nearly all industries shed jobs and productivity dropped, with particular depth in the construction and manufacturing industries, and with unprecedented breadth in the service industry (an industry typically insulated from receding economies).
In all, the five industries with the greatest job losses from 2007 to 2010 were construction (19.8% loss), manufacturing (14.6% loss), professional business services (8.9% loss), information (7.6% loss), and wholesale trade (7.6% loss); a total of 2.3 million office using jobs were lost by 2009 alone and, when the recession ended in 2010, nearly 7 million jobs were lost in the US’s 100-largest CBDs. The value lost to GDP was similarly extraordinary.
Real estate fundamentals reacted accordingly and the national office vacancy rate increased 5.1% to 17.7% nationwide in 2009 before stabilizing at a similar level throughout the recession. Office prices fell as vacancy rates increased throughout all markets: core, gateway, and tertiary. The lower rental rates in core cities caused a subsequent flight-to-quality toward trophy assets. As vacancy rates began to decrease in core trophy-assets, cap rates compressed and real estate values rebounded. In suburban office space, conversely, vacancy rates continued rising, prices dropped, and cap rates expanded.
Where Is the Opportunity?
Suburban office may be one of the few investments that can be purchased at an extreme discount and have inevitable appreciation. However, pin-pointing exactly where these investments should be made will be the key factor in uncovering the investment opportunities. The diagram above highlights MSA’s by the share of jobs outside the downtown area. Within the last decade, the suburban areas in these MSA’s grew as their respective employment bases expanded. Unfortunately for us, the recession “reset” much of any predictive capacity this map offers. It may not, however, be as much a shot-in-the-dark as we think.
Where Are the Desire Lines?
“It’s easier to build a building than to build a market.” That statement, said by one of NAREIM’s members, couldn’t be more apt. There are very few things in this world that can create markets; certainly governments try and have a very hard time doing, it’s simply hard to do. But remember, Steve Jobs didn’t create a market when he handed down the iPod. What Steve Jobs did was discover a market; he discovered a desire that people had to ditch the Walkman and records and bring their music around with them. Similarly, there are people in the suburbs who have real estate needs and real estate desires, and they are willing to spend money to satisfy them.
The two competitive advantages of a CBD over a suburb are closer and more widely available amenities, and the economic, social, and cultural externalities from higher densities. In regards to increased amenities, it is important to remember that cities didn’t create these amenities. Entrepreneurs who saw the needs and desires of the people around them intercepted these desire-lines and supplied the demand. Firms who take out space in the city pay a considerably higher per-square-foot rate but benefit from having amenities provided independently and avoiding the issues that plague suburban office parks.
Yet, the demand for these “city-like” things doesn’t disappear as you move away from the CBD. In the suburbs, people go to far greater lengths and travel far greater distances to access these amenities and often these amenities bring people closer together, creating a place of high density – we’re talking about markets, theaters, clubs, stores, and public space. What’s happening is that suburbs that respond to the desires of their population, by necessity, are becoming more “city-like” with increased diversity, amenities, and density.
Suburban Office Location – Urban Office Attitude
As the economy and jobs market continues to improve, some suburban office will likely recover. Not all of it will and certainly not from simply picking up from where it left off in 2009. However, the next stage in suburban office is already presenting itself. The suburban office markets that don’t “feel” suburban are already on investors’ radars, post-recession – markets like Tysons Corner, Virginia; Venice, California; Charlotte, North Carolina; and Portland, Oregon.
How to tell which markets will win and which will not requires the investor to figure out what markets are “city-like”. Do the markets have progressive land use policy? Are there universities and graduate schools that can contribute to entrepreneurship? Are they dense? Do they have an “anchor-industry” (e.g. technology, energy, healthcare)? Also, look at the anchor-city. Suburbs act like the anchor-city’s echo and the health of the anchor will determine the health of the suburb. Finally, sit back and think: does this place feel like a city? A city has a way of life and a culture that will continue to grow. In order for that suburb to have the desired magnetic effect, there has to be something in that market that people can hold on to and call their own.
There’s no doubt that a recovery will occur in the suburban office market. Suburban jobs will return and people will occupy office space. But, the desire lines this time around point to new demands and offer new opportunities for the investor. And, with a younger, more connected, and more mobile workforce coming into employment, those desire lines will absolutely point to one region over another. Because people recognize that real estate is more than a collection of boxes, they – employers and employees – will simply seek out what they want.
Underneath it all, a person’s use of real estate is a reflection of where they want to be, where they can best achieve their goals, and where they want to claim ownership – it’s not about square footage but what you do with it. The markets for this are out there, they are developing, and the opportunities for extreme value plays will only disappear as this becomes more apparent.
*I would like to thank Jane Dorrel at CBRE Global Investors for her guidance and help in writing this article.
 Elizabeth Kneeborne, Job Sprawl Stalls: The Great Recession and Metropolitan Employment Location, Management Policy Program at Brookings (2013), available at http://www.brookings.edu/~/media/research/files/reports/2013/04/18%20job%20sprawl%20kneebone/srvy_jobsjobsp.pdf.
 Christopher J. Goodman and Steven M. Mance, Bureau of Labor Statistics, Division of Current Employment Statistics in the Office of Employment and Unemployment Statistics, Employment Loss and the 2007-09 Recession: An Overview 1 (2011), available at http://www.bls.gov/opub/mlr/2011/04/art1full.pdf.
 Supra note 1.
 Supra note 2.
 See Kenneth T. Rosen, State of the Commercial Real Estate Markets, 15 Wharton Real Estate Review 34 (No. 1, 2011), available at http://realestate.wharton.upenn.edu/review/index.php?issue=106.
 See generally Antonio Ciccone and Robert R. Hall, Productivity and the Density of Economic Activity 86 The American Economic Review 54 (No. 1, 1996), available at http://www.crei.cat/files/filesPublication/87/090505103655_productivity20and20the20density20ciccone%5B1%5D.pdf.
 See Aaron Chatterji, et al., Clusters of Entrepreneurship and Innovation (2013), available at http://www.hbs.edu/faculty/Publication%20Files/130424-CGK-IPE_45be2057-0f20-4dc2-98d4-e422198bd55c.pdf.
 See id.