How America’s Second-Tier Cities Can Catch the Superstars: Noah Smith

The Internet may be making it easier for residents of second-tier cities to enjoy big city lifestyles.

(Bloomberg Opinion)—For the past three decades, one of the central stories in the U.S. economy has been the rise of superstar cities. As the country has shifted from manufacturing to services, high-value knowledge industries such as technology, finance and pharmaceuticals have become more important.

These industries tend to cluster because skilled workers, entrepreneurs, big companies and funding sources all want to be in the same area. As a result, these industries have concentrated in cities such as San Francisco, Los Angeles and New York, which have had enormous economic booms and skyrocketing rents while many other areas of the country are left to wither.

So how can the places that missed out ever compete with a San Francisco or a New York? Some had hoped that remote work would ride to the rescue. Thanks to the internet, engineers or traders or project managers might be able to live in Akron, Ohio, while working for a company based on one of the coasts. But while technology is allowing more Americans to work outside of the office, so far this hasn’t been enough to overcome the need to be close to where the action is. Even as online communication improved by leaps and bounds, superstar cities just kept getting more dominant.

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Medical Office Buildings Draw Stronger Interest From Institutional Investors in U.S.

According to a new report from CBRE, strong fundamentals have increasingly made U.S. medical office real estate a favorite of institutional investors, keeping investment volumes at high levels and capitalization rates low this year in relation to conventional offices.

CBRE’s report cites several factors behind the continued popularity of medical office, including a steady vacancy rate at 10.3 percent despite a 10-year high in construction completions in the second quarter, a sustained increase in average asking rents since 2013, and strong demand for health-care services due to an aging population and other demographic trends.

As a result, transaction volume for medical office buildings stands 50 percent higher this year than before the recession, though it has receded from its early-2018 peak. Foreign investors, domestic institutions and real estate investment trusts are steadily getting more active the medical office market. Cap rates – a measure of a property’s income as a percentage of its price – for medical offices have pulled even with those of conventional offices after years of registering higher.

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Some WeWork Landlords May Be Left Holding the Bag if WeWork Decides to Exit Their Buildings

The company was in the habit of structuring some leases through LLC entities that featured no long-term guarantees.

Troubled co-working operator WeWork has structured some leases under LLCs that are not guaranteed by its holding company, which will leave those landlords holding the bag for the free rent and TIs they provided to help get the spaces up and running. The landlords will also be left with vacant spaces, which may be backfilled with former WeWork tenants or another co-working operator at a lower price.
“WeWork (founders) attempted a paradigm shift in the tenant-landlord relationship,” says David R. Pascale, Jr., senior vice president with Los Angeles-based real estate advisory and brokerage firm George Smith Partners. “I believe they overreached.”
WeWork’s unprofitability and its derailed IPO reflect management’s failure to focus on the profitability of the core real estate business, Pascale notes.

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Australian Pension Fund Eyes U.S. Offices, Apartments

QSuper, the second-largest pension fund in Australia, wants to invest in U.S. office and apartment buildings.

(Bloomberg)—Australia’s second-largest pension fund is betting on U.S. real estate while avoiding overpriced infrastructure assets as it chases returns in the face of a fragile global economy.

QSuper wants to buy more office buildings and apartment developments in the U.S. after purchasing Chase Tower in Texas in August, Chief Investment Officer Charles Woodhouse said in an interview. The A$110 billion ($76 billion) fund a large chunk of its assets in cash, giving it more firepower than many other funds to write big checks when it sees opportunities, he said.

“We’ve got several other transactions in the U.S. that we’re looking at very closely right now,” Woodhouse said, without elaborating. “The more of these opportunities that we can find in the unlisted asset classes that generate these high single-digit, low double-digit returns, the better.”

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Flexible Office Space Operators Focus on Add-On Services to Develop New Revenue Streams

Going forward, the success of co-working operators may rely partly on their ability to generate new revenue sources.

Looking for ways to create a better tenant experience and boost their bottom lines, flexible office operators are generating new revenue streams by offering additional on-site services and establishing new business lines.

LiquidSpace, a digital marketplace—a sort of an Airbnb of flexible office space that partners with co-working operators, serviced office operators, office landlords, and office tenants with sublet space, provides flexible office options to its clients. The company has also partnered with Steelcase to provide turn-key design and fit-out of tenant spaces within traditional lease structures.

“We’re the one platform where tenants can reach the entire flexible office market,” says Mark Gilbreath, LiquidSpace founder and CEO, noting that his company simplifies the discovery and transaction process.

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HNW Investors Are Giving Preference to Multifamily and Office Properties, AppFolio Survey Finds

The survey, conducted in April, found 68.3 percent of respondents were looking at multifamily acquisitions.

If a new survey is an accurate barometer, two words—modernization and multifamily—sum up the key issues weighing on the minds of high-net-worth (HNW) individuals and other property investors.

The survey, conducted in April by AppFolio, a Goleta, Calif.-based provider of real estate and investment management software, showed that the No. 1 challenge facing accredited property investors is finding a good investment manager to handle fund and syndicate allocations.

And it’s not that these investors are laboring to find an investment management firm that’s good at what it does. It’s more about working with an investment manager that fully embraces technology. In other words, they’re seeking an investment manager that’s up-to-date rather than old-school.

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Where Are Cap Rates Going in the Four Core Property Sectors?

Experts predict little change in either direction in the first half of the year.

With late 2018 jitters gone and investor optimism returning, the commercial real estate market should experience mostly steady cap rates through the first half of 2019, although there are particular market segments and geographies that could experience some bumps.

“On the interest rate side, I think everybody has dismissed, at least for the time being, the inflation threat so that kind of stress on pushing cap rates higher isn’t there right now,” says Manus Clancy, senior managing director of applied data, research and pricing with Trepp. “We went through a tough period in December when people were jittery. Now everybody has taken a deep breath; they don’t feel like the wheels are falling off either the U.S. or the global economy.”

Still some changes, although potentially muted, could be in store. Recent trends suggest there is little room left for cap rate compression, according to Matthew Schreck, quantitative strategist with online real estate marketplace Ten-X. “We expect increases to both interest rates and spreads to drive some loosening in cap rates in 2019 across all property types,” he says.

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Which Office Markets Are Best Bets for Opportunity Zone Investment?

Investors have to keep in mind that to reap full tax benefits, the value of capital improvements has to match the value of the initial purchase price.

Opportunity Zone investments are a hot topic in the commercial real estate industry right now, but which office markets may be the best targets for this type of strategy?

The establishment of Opportunity Zones offers investors a way to defer and reduce taxes on capital gains, while building equity in real estate assets and improving low-income, distressed neighborhoods.

Common traits of Opportunity Zones certified by the U.S. Treasury are: a poverty rate of more than 32 percent, median family income about 37 percent below the area or state median, and an unemployment rate nearly 1.6 times higher than the U.S. average.

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Tech Job Growth Continues to Create Demand for Office Space

Growth in technology-related jobs—particularly computer and mathematics occupations—is expected to keep office leasing strong in certain markets over the next decade.

Overall, between 20 and 25 percent of current office leasing activity is related to technology jobs, particularly computer and mathematics occupations—a subset of STEM (science, technology, engineering and mathematics), reports Rebecca Rockey, Cushman & Wakefield’s economist, head of forecasting for the Americas, and lead author of a new Occupier Insights report on the impact of certain technology occupations on the office sector. This is a stark contrast to the previous office cycle, when leasing was primarily driven by new financial services and business analyst occupations, noted the report.

In total, 1 million new computer and mathematics occupations have been created over the last seven years, bringing the total to 4.1 million computing and 167,000 mathematics jobs in the United States today. STEM jobs are being created at a faster pace than other jobs with seven of the top 10 STEM occupations being computer-related and including jobs such as programmers, network developers and designers. Of these new jobs, 85.4 percent are in office-using industries, making it the largest occupational category driving growth in the office cycle’s current expansion, according to the C&W report.

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One-Time Emerging Apartment Markets Are Becoming Emerging Office Markets

As multifamily rents in core markets have continued to climb, investors, office tenants and residents alike have turned their attention to secondary markets. According to JLL’s Investment Outlook report, secondary markets accounted for 50 percent of all U.S. office transactions last year, due to slowing demand and oversupply of product in core markets.

Renters

The San Francisco Bay Area, home to many of the top performing tech companies in the U.S., boasts some of the highest rents in the country. Several cities throughout the Bay Area were ranked in the top 10 for rent increases in 2017. San Francisco continues to lead the nation with an estimated median rent of $4,000 per month.

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