Urbanization: Big City Real Estate Markets Boom!

[Tracy Stein]

Urbanization is the growth of cities into the surrounding suburbs and the transformation of once rural areas into cities. Urbanization is here and it’s here to stay. In fact, more than half of the people on Planet Earth now reside in cities – a first in the history of humanity. By 2050, that figure will rise to two-thirds of the then-expected population of seven billion people. Clearly, people prefer city life, and that has transformed just about every facet of economic and political life, including the real estate markets here in America and around the globe, especially in developing countries, where 96 percent of all urbanization by 2030 will occur.

Urbanization creates challenges and opportunities. Real estate professionals need to understand what drives the phenomenon and how to prepare for the changes coming. In this article, we’ll shed light on the dynamics of urbanization and offer suggestions of how to invest in it.

Challenges Abound

On a worldwide basis, about 1 billion city dwellers live in slums and 700 million have inadequate sanitary facilities. Dirty conditions lead to epidemics such as cholera and SARS. Unemployment and expensive city living can perpetuate poverty from one generation to the next. The growing urban population places tremendous stresses on resources and infrastructure – food and water distribution, utilities, transportation facilities, telecommunications, sanitation, etc. Many tax and private dollars go toward repairing and expanding cities, including construction of new multi-unit dwellings, commercial properties and industrial facilities.

Governments Must Cope

Cities are often clogged with automobiles that create noxious emissions and contribute to smog, allergies, asthma and many other maladies. Governments are challenged to manage this threat to public health and to provide eco-friendlier mass transportation facilities. Other threats that urban governments must manage include crime, gang violence and terrorism. It is up to mayors and other city leaders to provide the enlightened leadership necessary to manage urban challenges while promoting the vitality of cities.

Governments also launch initiatives to help create affordable housing for the urban poor and middle classes. Large cities attract the super-wealthy who create demand for expensive luxury housing, sometimes just a few blocks away from urban slums. Property taxes are a tool to redistribute some of the wealth invested in premium real estate, but tax rules vary widely around the world.

Opportunity Knocks

Yet for all their problems, cities are hot spots of economic development and cultural enrichment. People vote with their feet, and they have voted to abandon the farm in favor of the city. Today, cities generate more than 4/5 of global GDP and have a much higher rate of economic growth compared to that of rural areas. At least two important factors help fuel urbanization:

1. Population Shifts: Activities are concentrated in urban centers, creating career and lifestyle options for younger workers. In the U.S, the Millennial generation contains 80M young people, most of whom have flocked to cities to live and work. This creates a thriving demand for urban housing, with a marked preference for renting over owning. Urban economics promote gentrification and apartment development/rehabilitation. Baby Boomers are older, yet they too are drawn to urban rental properties to enjoy city life. Empty nesters are often downsizing from large suburban single-family homes, and one recent survey found that 75 percent of retiring Boomers expressed a preference for mixed-use, mixed-age urban communities.
2. Capital Markets: American urban real estate attracts a huge amount of foreign investment. Even though low interest rates certainly help to finance property development, foreign investment is not greatly affected by interest rates, because much of it stems from wealthy foreign investors with the cash necessary to avoid borrowing. For example, Miami and Los Angeles have seen large urban development projects funded by Chinese investors. Many real estate professionals observe that demand for new construction has exceeded supply for a while.

A Changing Landscape

Urbanization has changed city landscapes many ways. Multi-unit dwellings are a response to the strong antipathy workers feel for commuting. In many cities, residents may prefer not to own a car and rely on local shopping, rental bikes, taxis and mass transportation. There is evidence of retail REITs adjusting their portfolios to focus on urban retail. One survey reports that 53 percent of Americans prefer neighborhoods that are close to work, restaurants and shops, and 61 percent prefer smaller housing to long commutes.

Hotels are seeing an uptick in extended-stay guests. A survey by the Hilton chain reveals that 55 percent of guests prefer walking over other methods of transportation, which may be one reason why 66 percent of Hilton guests book hotel rooms based on location rather than price. Homewood Suites, a part of the Hilton chain, has dedicated itself to expanding its presence in several large cities across America, a change from the previous strategy of focusing on the suburbs. Demand for urban living spaces is driving adaptive reuse of abandoned office spaces and condo buildings into hotels. Dual-branded hotel properties, which share a site and operating expenses, are gaining popularity.

Attracting Headquarters

Another urbanization phenomenon involves companies relocating headquarters to cities, a move that helps to attract and retain employees. City governments often try to entice companies to the downtown area by creating new parks and renovating mass transit facilities. Chicago is a good example of a city succeeding at luring companies from the suburbs, with firms such as United, Lenovo, Hillshire Brands, Motorola, Kraft-Heinz and ConAgra making the move. Naturally, office rents are rising as developers scramble to erect office skyscrapers. Landlords are responding by making significant commitments to renovating existing buildings so that they can compete with the new structures going up. The trend is not likely to slow until rents become prohibitively high.

Urban Property Is Good

Some cities will need to increase commercial and lifestyle components to boost their attractiveness to new urban dwellers. This often means that developers need to incorporate shopping amenities into urban residential projects. City dwellers want a short walk to buy groceries and to shop. Of course, preferences can change over time, but cities usually enjoy at least 50 years of growth for each cycle of population movement. American cities by and large are not as densely populated as are international ones, so there is plenty of room for growth. Ultimately, owning urban property can be a very good thing.