Prices for apartment properties in the suburbs grew at the same pace over the last five years as they did in central business districts (CBDs).
“Returns from property appreciation over the past five years were virtually tied between suburbs and downtown areas,” according to an analysis of investment returns among privately-owned, institutional-grade real estate across the top 50 U.S. apartment markets by MPF Research, the market intelligence division of RealPage Inc.
The trend represents a significant change. In the past, apartment properties in urban downtowns tended to provide the best investment returns from appreciation. That was especially true over longer periods that included economic downturns. But over the last five years of economic recovery, suburban apartment properties have caught up to apartment properties downtown, particularly in the strongest suburban submarkets, where rents are rising most quickly.
Strong returns
In both suburbs and CBDs, the return on investment from price appreciation averaged 7.3 percent over the last five years, according to an analysis of NCREIF data by MPF/Yieldstar. That includes an average return from appreciation of close to 8.0 percent in suburbs where rents and the number of jobs grew quickly and an average return close to 8.0 percent in CBDs where the number of jobs grew quickly.
These strong returns from price appreciation are impressive. But rents are also rising more quickly in the strongest suburbs than in CBDs. Apartment buildings downtown now often have to compete with the many newly opened high-rises. Rents grew less than 2.0 percent for apartments in CBDs in the 12 months that ended in the second quarter, according to research firm CoStar Portfolio Strategy. Rents grew twice as quickly—by more than 4.0 percent over the same period—in prime suburban and suburban markets.
“Urban areas have enormous volatility in rent movement—and got hit the hardest in the last recession,” says Jay Parson, vice president for MPF, which has already published several reports that show the apartment rents have risen more quickly in high-performing suburbs than in CBDs. “Top tier suburbs got hit less in the recession, and perform just as well, if not better, in good times.”
Downtowns still strong in downturns
Over longer periods of time that include economic downturns like the Great Recession, apartment properties in CBDs show better price appreciation than do properties in the suburbs.
“Urban areas still benefit from superior capital appreciation… They will hold their value better in bad times. Not because of cash flow, obviously, but because of perceived liquidity,” says Parsons. In other words, because so many investors perceive urban areas to be superior to suburbs, it’s easier to find deep-pocketed buyers for urban assets in tough times.
“There is now a disconnect between where investors see the most value—urban areas—and where investors are actually generating the most income—top-tier suburbs,” Parsons adds. “It will be interesting to see how long that dichotomy can persist… are investors chronically undervaluing top-tier suburbs?”
Strong rent growth is the fundamental driver behind property price appreciation for suburban properties. In many top suburbs, apartments are even more difficult to build than in downtown areas. In suburban markets where developers have been able to build more apartments than downtown, rents have grown less and price appreciation has lagged.
For example, in the suburbs of Washington, D.C., developers have managed to open more new apartment building than the sub-markets need. Many developers have been forced to offer concessions of lower rents to potential resident to lease up vacant apartments.
“As a result, these properties have not experience the same degree of rent growth and cap rate compression as the urban markets,” says Walter Coker, managing director for HFF, a capital services provider. “As the abundance of supply diminishes in the D.C. suburbs, we expect strong rental growth and associated value increase to resume.”