Suburban Office:
A Dying Breed?
By Dr. Peter Linneman,
NAI Global Chief Economist
“That the suburbs are dying as Millennials (born in the
early 1980s to the early 2000s) eschew them for the
urban core, and ultimately refuse to work outside of cities,
causing disaster for suburban office space,” is a common
refrain heard today. But is it true?
Suburban Office:
A Dying Breed?
By Dr. Peter Linneman,
NAI Global Chief Economist
Let’s start with some facts. Prior to the recession,
real suburban rents peaked at $32.67 per square foot
versus a mean (from 1994Q4-2013Q2) of $31.45, and
a vacancy rate trough of 14.2% versus a mean (from
1986Q4-2012Q4) of 17.5%. Meanwhile, CBD Class
A office real rents peaked at $53.02 versus a mean of
$40.64, while vacancy was 9.7% versus a series mean
of 14%. It is noteworthy that real suburban rents fell
14.1% as vacancy rose 530 bps, while CBD real rents
fell 17.8% as vacancy also rose 530 bps. Since hitting
bottom, real CBD rents have risen 4.6% while vacancy
has declined 190 bps. In comparison, suburban real
rents have barely moved, rising only 0.7%, while
vacancy has fallen by an almost identical 200 bps. This
data hardly reflects a new paradigm of booming CBD
office demand and the end of suburban office space.
We believe there are mean reversion tendencies for
real rents, as replacement costs closely track inflation
over the long term. In suburban office markets, real
rents in almost all MSAs are either at or very near
their historic lows. Among major markets, Philadelphia
suburban office real rents have been the least volatile,
while Atlanta suburban real rents have been the most
volatile. Suburban office real rents are generally less
volatile than CBD real rents. Atlanta, Boston, and
Philadelphia suburban office real rents all remain
at series lows, while Dallas, Northern NJ, Chicago,
Central NJ, and Denver are only marginally above
their lows. Northern Virginia is approaching its average
real rent, and a booming Houston is approaching
a new maximum suburban real rent. That is, the
suburbs are generally doing okay only if there is strong
regional growth. Chicago and Atlanta display negative
suburban real rent trends, though these trends are not
statistically significant. Nationally, suburban office rent
is barely above its late 2012 series minimum, but is
finally rising.
Suburbs are generally
doing okay only if there is
strong regional growth.
Linneman Construction Cost Indices
250
Nominal
225
Real (2011 $)
200
175
150
125
100
75
50
1988
1992
1996
2000
2004
2008
2012
The death of suburban office space, much as was the
case with the 2005-2006 refrain among homebuilders
that everyone was going to own at least one home (and
maybe 2 or 3) rather than rent, is a popular media story
today. Yet while we have never lived in the suburbs, we
are highly skeptical that a paradigm shift is underway.
Instead we think there is a cyclical opportunity for
suburban office investment. Of course, only time will tell.
It is important to note that retail sales in the suburbs
continue to boom. Also, single family home sales are
rapidly rebounding in the suburbs. Thus, it is not that
people (including both Millennials and Empty Nesters)
have abandoned the suburbs; rather, it is that an
overbuilt suburban office sector has been slow to see a
rebound in demand.
Between 1990-2000 and 2000-2010, both the central
cities and the suburbs of the nation’s largest 10 MSAs
grew, with the exception of the City of Philadelphia in
from 1990-2000, and Chicago’s central city from 20002010. From 1990-2000, the suburbs grew more rapidly
than the city in all ten of the largest MSAs, with the
exception of a booming New York City.
This pattern continued from 2000-2010, with the
suburbs of the largest 7 MSAs growing faster than
their respective city populations. This also held true
for the 10 largest MSAs from 1990-2000, with the
exceptions of Miami (#8) and Boston (#10). And even
New York City suburbs grew 130 bps faster than the
city from 2000-2010. From 2000-2010, only 2 central
cities (Miami and Boston) experienced faster growth
than their suburbs. In fact, only 4 cities grew more in
the past decade than from 1990-2000. And while they
grew slower between 2000-2010 than they did in the
previous decade, suburban population growth remained
more robust than city growth. And it is highly unlikely
that this pattern reversed over the 2 years since the
2010 Census.
It is noteworthy that both the city of Chicago and the
city of Philadelphia show very anemic population growth
over the past 20 years, even as the increasingly popular
central cores of these MSAs have experienced booming
growth. Thus while some city cores are experiencing
a renaissance, cities as a whole have not. In fact, with
their Special Services Districts, charter and magnet
schools, and high and low culture activities, the urban
cores of many MSAs have become suburban-like
in their high quality of life. But in general cities are
struggling, burdened by high taxes, bad schools and
low social service levels.
Public schools are the major problem for the middle
class, who simply cannot afford to pay city taxes and
send 2-3 children to private schools. Thus while many
of today’s young Millennials are choosing to live in the
urban core in greater numbers than in the past (though
the vast majority still reside in the suburbs), when they
have school aged children they will have little choice
but to move to the suburbs over the next 10-15 years.
Do the math: there is no way for a family earning even
$100,000 to send two children to private schools at
$35,000 per year per child. And these families care
too much about education to put their children in
dysfunctional urban core public schools.
Quite simply, office
demand has been slow to
recover as jobs have been
cyclically slow to return.
Urban vs. Suburban Population
% Change City Population
New York
% Change Suburban Population
Median Suburban Income/Median City Income
1990-2000
2000-2010
1990-2000
2000-2010
1990
2000
2010
17.1
2.6
8.5
3.9
1.59
1.63
1.58
1.32
Los Angeles
8.2
3.3
11.6
4.3
1.25
1.29
Chicago
5.9
-4.0
15.2
9.6
1.60
1.49
1.33
Dallas
26.9
15.8
35.0
32.8
1.34
1.39
1.40
Houston
19.3
8.0
29.4
41.6
1.43
1.47
1.46
Philadelphia
-4.3
0.2
8.8
6.8
1.68
1.80
1.99
Washington
6.2
9.5
21.5
18.8
1.49
1.65
1.23
Miami
6.9
13.0
29.3
10.6
1.46
1.47
1.41
Atlanta
13.8
2.1
43.9
27.4
1.67
1.55
1.29
Boston
2.8
4.3
7.3
3.5
1.45
1.51
1.38
It is interesting to note that suburban real median
income is higher in all 10 of the largest 10 MSAs in
1990, 2000 and 2010. The ratio of suburban-to-city
median real income rose notably (that is, the suburbs
became relatively richer) in 2 of 10 MSAs between 1990
and 2010, fell notably (i.e., the city became relatively
richer) in 4 MSAs, and remained unchanged in 2 MSAs.
This ratio (which is skewed in the 2000-2010 period
due to the recession) was higher in 3 of 10 the MSAs
in 2010 than in 2000. Thus, there is no pattern of city
incomes rising faster than suburban incomes, and as
long as city public schools remain a disaster, suburban
income dominance will not change as the Millenials
age. And while the “empty nest” suburbanite moving to
the city is a nice Sunday newspaper “lifestyle” story, it
remains the exception, rather than the norm.
In light of these clear demographic patterns, we believe
that the slow recovery of the suburban office sector
is cyclical rather than secular. Quite simply, office
demand has been slow to recover as jobs have been
cyclically slow to return. This is on top of the fact that
the suburban supply pipeline was greater than the CBD
pipeline before the recession occurred. This sector
is out of favor now, but looks to be on the brink of a
secular recovery due to no new supply and cyclically
recovering demand.
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