We had the privilege of attending a special closed-door presentation by Scott Homa and Phil Ryan who are the Senior Director and Director respectively of Office Research Department at Jones Lang LaSalle (JLL) U.S. last month. This was an online Zoom event and was kindly organised by Manulife US REIT.

Both Scott and Phil have had many years of on-the-ground research and experience in the various U.S. markets and sub-markets. They provided a very comprehensive overview the U.S. macro-economics, identified high growth cities, elaborated on U.S. population migrations, identified factors that make a city attractive and as a result push up demand for commercial rents, powering the growth of real estate in those markets.

We found the presentation very insightful and very refreshing. Both Manulife US REIT and JLL kept the sharing very forward-looking while putting the COVID-19 recovery story behind. They also identified cities and which have high rental growth submarkets potential in the coming years.

Reading in between the lines of the event organisation and content, we would say that this is likely to be a precursor to potential acquisitions by the REIT in the coming 12 months.

The event started with the sharing of the U.S. key macro-economic indicators which point towards a healthy recovery in the U.S.

Source: Jones Lang LaSalle (JLL) U.S.

From a general economic perspective, the U.S. has clocked strong economic growth with various forecasts putting expectations for a 6% to 8% year-on-year GDP expansion by Q42021. If achieved, this would be among the highest GDP growth figures in the past few decades. This growth appears to have also translated down to the employment market with a fall in unemployment rate to just 6.1% in April2021. For comparison, the unemployment rate was 10.2% in the month of July2020.

The biggest factor that gives JLL the confidence that all these economic factors translate to the office leasing market is the increase in real estate tour activities which is a leading indicator to the signing of Letter of Intent (LOIs) leasing deals. Tour activity was up 28% in March 2021 and 160% quarter-on-quarter in Q12021. These figures point towards a pent-up leasing demand and are viewed by the JLL team as early indicators that potential growth is returning to the office leasing market.

Before reading on, it is worth taking a pause to define certain geographic regions which were used commonly across the presentation by JLL:

• Gateway Cities – large, urbanised cities traditionally formed along the U.S. East and West coasts as a result of past economic booms. These cities have a long-standing perception of being highly diverse, culturally established, and bursting with opportunities which attract major corporates to setup office to source for the best talent. Examples include New York, Boston, Los Angeles, San Francisco, and Chicago.
• Emerging Markets – cities that experience a large structural inflow of domestic population immigration attracted by new opportunities especially from the traditional gateway cities. Rapid migration drives demand for real estate and attracts corporates to setup office to capture talent. Examples include Austin, Charlotte, Pittsburgh, Phoenix, Nashville, Minneapolis, and Columbus.
• Sun Belt – U.S. states stretching from Southeast and Southwest coast which generally experience a larger proportion of hotter and sunnier weather over the year. Examples include states like Alabama, Arizona, Florida, Georgia, Louisiana, Mississippi, New Mexico, South Carolina, Southern California, North Carolina, Nevada, and Utah. Examples of cities include Houston, Austin, Miami, Atlanta, Phoenix, San Diego, Tampa, Charlotte, Orlando, San Antonio, Sacramento, San Jose and Charleston.

Source: Jones Lang LaSalle (JLL) U.S.

• Rust Belt – Northeastern and Midwestern U.S. states, once industrial manufacturing hubs in the automotive, heavy industries, mining, raw materials processing, steel, and coal sectors but which experienced significant deindustrialisation, economic decline, population emigration and urban decay as a result of declining industrial activity beginning in the early 1980s. Examples include states that run westward from Central New York through Pennsylvania, Ohio, West Virginia, Kentucky, Indiana, the Lower Peninsula of Michigan, Northern Illinois, and eastern Wisconsin. Examples of cities include Detroit, Gary, Flint, Cleveland, St. Louis, Buffalo and Cincinnati.

Scott and Phil shared a list of what they observed are high rental growth cities growing between 6.7% to a jaw-dropping 51.0% in the last 5 years! Although this is a large range, bear in mind that each and every city has unique demographics, economic characteristics, economic drivers, and clusters that result in the real estate rental growth trajectories observed.

It is worth noting the U.S. averages for context when discussing these cities so that readers can have a comparison of the growth rates:

• U.S. average population growth over the last 5years: ~4%
• U.S. unemployment rate in Apr2021: 6.1%

Source: Jones Lang LaSalle (JLL) U.S.

Source: Jones Lang LaSalle (JLL) U.S.

Cities like Austin, Nashville, Phoenix and Salt Lake City experienced a large influx of population of local migrants from other states. One main draw to states like Salt Lake City (Utah), Nashville (Tennessee) and Austin (Texas) is lower state income taxes below 5%, with Texas and Tennessee standing out with zero state tax. Comparatively, states like California, New Jersey and New York charge state taxes at 13.3%, 10.75% and 8.82%, respectively.

Source: Jones Lang LaSalle (JLL) U.S.

Phoenix (Arizona) is attractive on the other hand not because it has low taxes; its state tax currently hovers at 8.0%. However, it has a significantly lower cost of living compared to its peer cities; its cost of living ranks #76 in the major U.S. cities. For the purposes of comparison, New York City, San Francisco, Seattle and Boston, in terms of their cost of living, rank #1, #3, #6 and #8 respectively.

With the increased migration due to the influx of residents looking to lower their cost of living, corporates also choose to setup in Phoenix to acquire talent at a lower cost, both in terms of salary as well as office leases. A CBD class A office building in Phoenix averages a lease of US$30.34 per sqft. In comparison, New York, San Francisco, Los Angeles, and Boston average around US$96.32, US$86.94, US$65.52, and US$78.38 respectively.

Source: Jones Lang LaSalle (JLL) U.S.

Source: Jones Lang LaSalle (JLL) U.S.

Some cities experienced a confluence of factors that resulted in an explosion of new jobs. Mitsubishi Motors North America for example migrated its HQ from California to Nashville, Tennessee, creating many new jobs and bringing in fresh migrants who presently work for Mitsubishi. Facebook also announced that it was spending US$800million to construct a 982,000sqft data centre in Nashville and is estimated to support approximately 100 jobs and will have more than 1,100 construction workers on-site at peak.

Other examples include Honeywell moving its HQ from New Jersey to Charlotte, North Carolina and Tesla setting up its Gigafactory in Austin, Texas and throwing out job advertisements for 10,000 jobs through 2022.

Besides Tesla, Austin has also become a magnet for many big tech firms choosing to expand beyond Silicon Valley and the Bay Area. Nicknamed “Silicon Hills” for its hilly terrain on the west side of Austin, Texas has attracted big tech names with its low tax policies such as Dell’s global HQ, Advanced Micro Devices (AMD), Amazon.com, Apple Inc., ARM Holdings, Cisco, eBay, ESO, Facebook, Google, IBM, Indeed, Intel, PayPal, Procore, Silicon Labs, Texas Instruments, Oracle Corporation, VMWare, and many others.

As a result, cities like Charlotte, Nashville and Austin received an explosion of migrants who follow these major corporate relocations, driving up real estate prices.

Source: Jones Lang LaSalle (JLL) U.S.

Source: Jones Lang LaSalle (JLL) U.S.

It is interesting to observe cities like Pittsburgh, Pennsylvania which did not experience significant job growth but still attracted many immigrants which pushed up housing costs and real estate leases. It was observed that these cities had a significantly lower state tax, lower cost of real estate, as well as less stringent COVID-19 movement controls and restrictions.

The traditional gateway cities like New York, Boston, and Chicago are higher up north in latitude and therefore experience colder and harsher weathers with longer and colder winters, shorter daylight hours, lower proportion of sunny days and shorter and colder summers. With the Internet enabling a greater proportion of knowledge workers to workfromhome, some have opted to live in the Sun Belt regions where the climate is milder and warmer.

Coupled with other factors elaborated above such as lower state and local taxes, lower cost of real estate, lower cost of living as well as a growing number of job opportunities, cities like Austin, Phoenix, Nashville, Charlotte, Miami, Denver, Orlando, Atlanta, and Tampa all experienced a net inflow of domestic immigrants.

There is a global shortage of high quality talent in the domains of software technology and life sciences. Wages in the science, technology, engineering, and mathematics (STEM) fields have been steadily rising. Corporations are on a talent hunt to secure the best and brightest talents, sparking a war for talent.

As a result of this global shortage, organisations are forced to seek talent in creative ways, including targeting cities that produce or have a higher concentration of STEM talent.

Examples of large public educational institutions in the U.S. that generally have a good proportion of STEM graduates are Texas A&M University, Purdue University, The Ohio State University, University of Michigan, Georgia Institute of Technology (Georgia Tech), University of Minnesota and University of Utah. Not to mention the traditional private STEM universities such as California Institute of Technology (CalTech), Duke University, Massachusetts Institute of Technology (MIT), Princeton University, Rice University, Stanford University, Harvard University and University of California (UC), which all simultaneously contribute to the concentration of STEM degree holders in their respective cities.

As a result, certain high STEM concentrated cities benefit from the rapid expansion of technology and life sciences companies expanding office and floor space in those cities to secure a steady stream of talent.

Other cities like Minneapolis, Minnesota also did not experience a significant increase in job growth as well, but its leading University of Minnesota produces a large proportion of science, technology, engineering, and mathematics (STEM) talent which attracts corporates to hunt for talent. This drives up office demand.

With local talent in these fields in demand in these cities, coupled with the Internet enabling a greater proportion of knowledge workers working from home, talented knowledge workers who are experiencing lockdown fatigue as well as those wanting a larger living quarters at a lower cost to be able to workfromhome more comfortably were attracted to these cities.

Source: Jones Lang LaSalle (JLL) U.S.

The factors that drive sustained growth for real estate especially in the office sector tend to start with an explosion of populations with STEM or other high-skilled talents. This leads to increased demand in real estate.

The highest growth markets tend to experience a confluence of multiple factors that drive domestic real estate growth. JLL identified the 3 most dominant factors:

• Talent Pool
• Quality of Life
• Affordability

Source: Jones Lang LaSalle (JLL) U.S.

Putting all these factors together, Charlotte, Phoenix, Salt Lake City, Austin and Nashville have been identified as the top-5 highest growth markets in terms of Class A office demand in the last 5 years. The influences that spiral their demand in an upward trajectory at the point of writing are still presently intact.

Source: Jones Lang LaSalle (JLL) U.S.

The media in general tends to publish more stories covering the doom and gloom of the office sector because of the COVID-19 pandemic. However, from what we have learnt from JLL’s sharing, many of those gateway cities that are mentioned in the press already had other prior factors that drove the population to migrate out of those cities. These factors have already long been at play; the COVID-19 situation merely accelerated those trends.

The same factors that drive migration out of some of these gateway cities are the same factors that attract the migrants to other cities in the U.S. For example, high taxes, high cost of living andunfavourable weather have already been driving the outflow of domestic migrants. The severity of the COVID-19 pandemic drove these gateway cities to tighten their movement controls and lockdown measures, and this exacerbated the migration situation.

The destination that these domestic migrants moved to were the exact opposite in terms of those factors – lower taxes, lower cost of living, warmer weather, and milder restrictions on social movements, coupled with major corporates moving their HQs and expanding into those cities further driving demand for real estate as employees migrated together with their employers. Besides favourable business environments, the war for STEM and high skilled talent also resulted in corporates expanding their offices to those cities to acquire the best talent, which drove up demand for real estate.

As for investors, taking time to consider the complex dynamics of the U.S. office market could very well help us navigate the complex markets and suss out potential investments and deals. Even better if we are invested in a REIT that is already doing that for us!

This article first appeared on Probutterfly.com.