The two most precious commodities in commercial real estate are large assets with high yield (coveted by investors) and deep pools of talent centered around colleges and universities (highly desired by today’s occupiers). No less important — but perhaps less appreciated — is market momentum, which often is the key driver of the biggest market success stories in the past several years.
Momentum can be measured in several ways relevant to commercial real estate. One is rent growth. The higher the rent growth, the more tenant demand that exists in a market relative to supply. Job growth, particularly for office-using jobs, is an equally important measure of market momentum for the same reason. An even more meaningful measurement of market momentum is high-tech job growth, which is both office-using and, because of its relatively high pay compared to other jobs, creates a multiplier effect or virtuous cycle of broader job growth in the local economy.
Placing increased importance on these momentum factors will lead investors and occupiers to markets other than the large gateway cities and even markets with the strongest university bases. While asset-rich gateway cities, like New York and San Francisco, have strong pools of homegrown university talent and will always attract large occupiers, these attributes alone are no longer enough for either investors or occupiers.
Secondary markets like Cambridge, Massachusetts, and San Jose, California, are well-known momentum markets with some of the strongest talent bases and rent growth in the U.S. Less well-known are markets like Tempe, Arizona; Ann Arbor, Michigan; Salt Lake City, Indianapolis, Pittsburgh and Montreal, all of which are gaining tech occupiers and investors because of their deep pools of talent and potential for higher investment yields. Interestingly, while the Raleigh-Durham area of North Carolina scores highly in CBRE’s 2017 Tech-30 Report, the city of Charlotte, North Carolina, scores higher due to its accessibility and critical mass even though the major university concentration is much higher in Raleigh-Durham. This brings home the point that momentum can top even one of the most university-rich markets.
Markets that are showing the greatest momentum (rent growth) are Orange County, California, (23 percent), Nashville (21 percent) and Atlanta (18 percent). Certain city submarkets average a rent premium of 16 percent relative to their broader markets and some are well more than this, including Cambridge, Massachusetts, (120 percent), Santa Monica, California, (92 percent) and Palo Alto, California, (71 percent). Part of the reason for this rapid rent growth is low vacancy and significant barriers to entry for new supply. The Mount Pleasant/False Creek submarket of Vancouver fits this bill, with vacancy at less than 4 percent. And most of these submarkets are extremely tight relative to their overall markets.
Markets that show the best combination of job growth and rent growth, plus the added benefit of lower costs than in gateway cities, include Dallas, Denver, Minneapolis and Toronto; these mid-sized to larger cities possess the trifecta of deep talent pools, high yields relative to their gateway competitors and faster rent and job growth than the average, the critical momentum factor.
While cost pales in comparison to talent and investment yield, it is a consideration for many occupiers (even in tech, as not all tech jobs require the same level of skill or education). Deep pools of highly qualified labor abound in many of these smaller and mid-sized markets.
Cities should never lead with cost as a differentiator from their competitors. It is a race to the bottom, since there will always be cities willing to offer more incentives to lower costs. Those that offer the complete package of talent, investment yield and momentum (high rent growth and job growth) are better positioned to attract investors and occupiers.
This article first appeared on the NAIOP blog.