Research Shows Changing Urban-Suburban Real Estate Preferences

Urban planners and designers have been fighting sprawl development for over three decades.

We know that low-density auto-oriented patterns have imposed major social costs whether registered as negative environmental, fiscal, public health, or equity impacts. However, real estate investors have preferred suburban properties for some time, and the suburbs continue to grow in most parts of the country.

But in the past six years, real estate investors have changed their minds about where the best opportunities are located. They are paying premiums to own commercial property in urban areas.

Analyzing Capitalization Rates for Real Estate Investment

I have compiled information on "capitalization rates" available from Integra Reality Resources, Inc. (IRR) for office and multifamily properties since 2006. Capitalization rates (usually abbreviated to "cap rates") measure return on investment.

In real estate appraisal, cap rates are used to estimate the future worth of an income-generating property by dividing the annual net income expected from the property by the appropriate cap rate. Real estate investors use cap rates to compare properties that they may buy or sell. Cap rates are expressed as a ratio or percentage, and investors refer to basis points (100 basis points or bps = 1%) when comparing cap rates.

For example, if industrial properties in one market are selling at a cap rate of 8.34 percent and at a cap rate of 7.23 percent in another market, the difference is 111 bps. Real estate developers and investors use cap rates to make decisions about financial feasibility and investment opportunities.

Shifting Investor Preferences in Real Estate Markets

IRR publishes cap rates for 11 specific property types (industrial, flex, neighborhood retail, etc.) but distinguishes office and multifamily only by location, specifically CBD office, suburban office, urban multifamily, or suburban multifamily.

Before the Great Recession, IRR cap rates indicated that investors preferred suburban office and multifamily to urban office and multifamily properties. But for at least the past six years (2011–2016), investment preferences have changed. Real estate investors now prefer CBD office properties to their suburban counterparts and urban multifamily to suburban apartments.

This change is very important to urban planners and designers. We have been advocating denser, mixed-use, transit-oriented development for some time. Finally, the money is on our side. Real estate investors have become our allies. We can present factual information on cap rates as we work to again make our cities vibrant places to work, learn, live, and play.

Top image: Detroit's central business district in 2011. Photo by Flickr user Barbara Eckstein (CC BY 2.0).