Why smaller cities could prove a better bet for property investment
The key factors that make a city attractive to real estate investors remain constant. However, the relative attractiveness of global cities shifts over time, driven by cycles and secular technological and social changes.
Transaction data from MSCI shows the biggest cities in real estate investments are mainly the world’s major gateway cities, established real estate markets in large cities across developed nations. The cyclical downturn means transaction volumes have fallen sharply in recent years, but the names of the cities that investors are targeting remain largely unchanged. The list of most active markets comprises the largest cities in the US, Europe and Asia-Pacific.
Simon Durkin, global head of real estate research and analytics at investment manager BlackRock, says: “Investors typically prefer the large markets, given their potentially greater liquidity and transparency. Although there may be opportunities in smaller markets, on a risk-adjusted basis, we believe the larger, more mature markets are preferable for liquidity reasons.”
Big or small
The global cities most popular with real estate investors tend to be those which combine economic growth, population growth and efficient infrastructure. Investors also seek out cities in nations with a strong rule of law and a stable currency.
“These cities typically benefit from job market expansion in sectors like technology, healthcare and finance, which drives demand for residential and commercial properties,” says Alfonso Munk, co-CIO at developer and investment manager Hines.
Global gateway cities also score well on other metrics than real estate investment. The Oxford Economics Global Cities Index 2024 scores 1,000 global cities on economic factors, human capital, quality of life, environment and governance. The Oxford Economics top 10 cities ranking is headed by New York City, as is the MSCI transaction volumes ranking.
Six cities: New York City, London, Tokyo, Paris, Los Angeles and San Francisco, are in both lists. Notably, Oxford Economics does not solely rank on economic size and scale, so their top 10 ranking finds room for secondary cities including Seattle and Zurich.
Justin Curlow, global head of research and strategy at Paris-based manager AXA IM Alts, says: “The global gateways of London, Paris, New York, Tokyo, will not see too much change in attractiveness over time. These are larger urban conurbations which provide transparency and liquidity, but also dynamism. Think about emerging tech clusters in London as an example, the transport improvements of Grand Paris or the revitalization of Hudson Yards in New York.”
However, the most recent real estate downturn has been particularly pronounced in the office sector, which is a major part of global gateway cities’ asset base. Meanwhile, NOI from industrial and even retail assets has held up in many smaller markets, while residential demand is present in any sized city.
Tom Leahy, head of EMEA real assets research at index provider MSCI, says: “The truism is that in downturns, investors are attracted to more liquid markets, so they tend to shift away from secondary, tertiary and smaller cities and move towards the larger markets. However it is slightly different this time, partly because the downturn is very focused on the office sector. Assets in the favored living and industrial sectors tend to be more widely distributed.”
Many of the cities which saw strong transaction growth in the year to June, according to MSCI, were smaller cities in developed markets, such as Sheffield, Newcastle and Warsaw in Europe, and Sapporo in the Asia-Pacific region, all of which saw transaction volumes rise by more than 100 percent.
Large global gateway cities do not suddenly disappear from view, but they may become less attractive to investors, resulting in sharp falls in transaction volumes.
Curlow notes: “The San Francisco Bay Area is an area that, 10 years ago, probably would have been at the top of people’s shopping list. However, today it has a lot of challenges and I’m not sure it would feature too highly on many target lists.”
New world order
There have been changes in the way investors look at cities, driven by factors including the covid pandemic and sustainability concerns. The shifting nature of work has affected where people want to live, and cities are a critical part of driving output and innovation.
Durkin explains: “The pandemic has significantly altered what many investors look for in a city, as it reshaped living preferences, work patterns and economic trends.”
The amount of success employers have had in bringing staff back to the office has varied widely across global cities. Office attendance in large North American cities and London, for example, has been weaker than in most APAC and in some European cities.
“We know that having employees in the office can create a vibrant city environment and benefiting all parts of the built environment, including retail, residential and hospitality,” Durkin adds.
A further consideration for real estate investors is housing affordability. In cities all over the developed world, the cost of housing is a headache for governments and consumers. It also means that those cities with more affordable housing are increasingly attractive to employees, and therefore to employers. A city with strong inward migration is naturally attractive to real estate investors across all sectors. This has led to a new wave of investment into certain cities around the world.
Curlow says: “There’s a number of very interesting, culturally diverse, livable cities with good housing affordability and a healthy labor market. These are great places to live and which are seeing some very outsized growth, such as Nashville, Denver, Dublin, Copenhagen and Melbourne.”
Sustainability is also becoming an important factor for real estate investors, due to concerns about climate resilience. Some cities are seen to be more vulnerable to the effects of rising temperatures and sea levels, or to extreme climate events such as storms, floods and heatwaves.
“The pandemic has significantly altered what many investors look for in a city, as it reshaped living preferences, work patterns and economic trends”
Simon Durkin
BlackRock
Cushman & Wakefield’s Climate Risk – Global Cities Outlook report scores 100 cities around the world on their vulnerability to the effects of climate change. It found cities in Asia, such as Shanghai and Mumbai, and coastal cities in the US, such as Miami and Orlando, to be most exposed to climate hazards.
Durkin says: “Although climate resilience has become an increasingly significant factor for investors, there is still a huge gap between capital allocation and the scale of capital required to address the challenges posed by climate change. Cities more vulnerable to climate change, such as Miami or coastal cities in Asia, could become less attractive or viable options for investment.”
Growing popularity
The list of leading cities in terms of real estate investment changes slowly, but change does occur over time. In the past couple of decades, Asian cities such as Shanghai and Seoul have made their way into the top 10, and others will too as they grow and their economy develops.
Development is as important as growth; many emerging cities face barriers to growth in real estate investment, especially when it comes to attracting global investors. India’s large cities, Manila and Jakarta, are growing fast but attract relatively little overseas capital. Though, this too is changing.
Chiang Ling Ng, co-CIO at Hines, says: “Large, mature gateway cities are expected to retain a significant share of global commercial real estate investment. The list will likely see more diversification as secondary, high-growth cities gain traction, especially in regions benefiting from rapid urbanization, economic expansion and tech-driven growth. Over the next decade, we can expect a more balanced mix of traditional and emerging markets in the top 10.”
High populations and high growth mean that larger Asian cities are in prime position to become the gateway cities of the future, but they will also need to develop more transparent economies and stable currencies. For example, MSCI’s Leahy notes that while Istanbul is a large and growing city, the flow of international capital into Turkey has stopped because of currency volatility.
“In time, the largest cities in India and perhaps even big African cities such as Lagos might become a bigger part of the global real estate market,” Leahy predicts.
While the strength of cities is an important top-down factor in real estate investment considerations, investors need to find assets and willing sellers. Furthermore, a city’s attractiveness will vary widely by district and even from one street to the next.
AXA’s Curlow says: “You can pick a really good neighborhood in an overarchingly mediocre city and see better performance than in the wrong neighborhood in a global gateway city.”
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