The Echo Boom: A New Wave of Market Change

(Click here for print version) For all of us slogging through one of the most difficult real estate markets in a lifetime, it may be difficult to believe that new growth is on the horizon. The problems of today will not be solved easily or quickly, but a powerful growth force is stirring that can push commercial real estate into a new era of change. Are we ready for it? Are we adjusting our strategies to account for the change?

As stated by Bruce Cohen, CEO of Wrightwood Capital, “Everyone seems to focus exclusively on the problems we face today – with good reason. Deleveraging, looming debt maturities, unemployment, as well as crushing government and individual consumer debt; these are all issues to take very seriously. And yet, if you focus too much on these issues, you might overlook positive influences on commercial real estate and miss fantastic opportunity. For example, what about the looming implications of the ‘Echo Boom’?”

By the Echo Boom, Bruce means the children born to the generation known as the “Baby Boom”, roughly between 1980 and 2000. Also known as “Millennials” or “Generation Y”, they are starting to have a powerful impact on commercial real estate as the first wave of this generation begins to reach the age of thirty.

Bill Mitchell, Managing Director at Holliday Fenoglio Fowler, L.P., commented during Wrightwood Capital’s recent credit roundtable that, “It’s the biggest demographic bubble since the Baby Boom, 80 million people. The center point of the boom just graduated from college last year. They are moving into urban areas and renting at $800 to $2,000 per bedroom per month. Let’s say you have as much as 15% unemployment – 85% of them still need homes. There’s a boatload of people that want a place to live and you can’t give them enough money to move to Aurora, Illinois.”

Compared to the Baby Boom generation, usually defined as the 72 - 76 million people born between 1946 and 1964, the Echo Boom generation is somewhat different. Although they are larger than the generation that preceded them and account for approximately a third of the total U.S. population, they typically come from much smaller families. The birth rates per family during that time period were one of the lowest ever in the US; less than the replacement rate of 2.1 per family (Source: Population Research Institute). All this adds up to a very powerful population wave for commercial real estate.

According to Steve Quazzo, CEO of Transwestern Investment Company, “The demographics are incredibly positive. Anyone who has children aged 20 to 25 and has seen the unbelievable competition for college in the last four years knows that there are a lot of students coming out of college and graduate school, and they are going to rent.”

Why will they rent? Certainly, most young people rent apartments in their first years out of college, but there are reasons to believe that this generation will be renting far longer than their parents did. They have the largest college debt load in history – averaging over $20,000 per student. They also face a very different labor market from their parents: a fifth of them will likely be self-employed following the trend for all employers to offer more and more short-term contracts. Renting may make economic sense, not just when they are beginning their careers, but for many more years to come. Since the end of World War II, the trend was for more and more young families to purchase a home in the suburbs, leaving rental apartments to young singles. Based on the economics today, that trend may shift towards renting throughout their lives.

That could be one contributing factor to the aggressive pricing for stabilized multi-family assets in primary markets. According to Wrightwood Capital Senior Regional Director Dan Hartman, “I’ve seen cap rates for the best stabilized multi-family drop to around 4%. Investors making those purchases are making a serious bet on market rents rising. It’s difficult to justify these prices given the current market metrics, but with a meaningful demographics surge, it might pay off in a city like New York. The rents and the values could get pushed up – they would have to for today’s aggressive deals to make sense.”

On the other hand, the state of the general economy might create some price resistance for the higher rental rates in primary cities. According to Bob Dennis, a debt fund manager at Wrightwood Capital, “Affordability is a key consideration for many in this generation. With affordability and quality of life as the backdrop, physical quality of the real estate trumps the desire for more space. In many cases, living in the urban core of some of the smaller primary and secondary cities with an emerging 24/7 feel, such as Portland, Denver, Dallas and Atlanta, will be more appealing than living just outside of the action in one of the more prolific, yet expensive, urban centers such as New York, Boston and San Francisco.”

In addition to its effects on multi-family, the Echo Boom is also impacting retail. When the Baby Boom generation moved into their peak earning and spending years, retail was expanded dramatically to serve their needs. The power centers, big box retail and mega-malls of today would not have been built without the considerable consumer demand of 76 million baby boomers. Echo boomers, however, spend at least a third of their time on the Internet, leaving little time for hanging out at the mall. Retail, of course, won’t go away, but the growing trends of entertainment and lifestyle centers will likely continue while the glory days of large format retail in exurb locations are likely behind us. There are also significant implications for the warehousing and distribution of increased shopping on-line.

One overlooked issue in particular about the Echo Boomers will have a meaningful impact on all forms of real estate…they don’t drive. According to a report by Kiplinger, (Generation Y Giving Cars a Pass, September 14, 2010) motorists aged 21 to 30 now account for 14% of miles driven, down from 21% in 1995. As quoted in that report, William Draves, president of Learning Resources Network pointed out, “This generation focuses its buying on computers, BlackBerrys, music and software and views commuting a few hours by car a huge productivity waste when they can work using PDAs while taking the bus and train.”

This certainly doesn’t bode well for the automotive industry, but it also may not help real estate strategies that rely on communities and suburbs that can only be navigated by car. The Baby Boomers fueled the growth of cities that revolve around cars, but the Echo Boomers are likely to flock to places where they don’t have to drive every day. This could be a significant drag on low density communities without mass transit and a boon to older, more compact cities. The exurbs don’t hold as much attraction for this new generation as they did their parents.

As summarized by Jason Choulochas Managing Director, Investments for Wrightwood Capital, “This generation is entering their peak period for starting companies, growing their own families, buying homes, buying goods and using a lot of real estate. This group has already fundamentally changed our business world – they invented Facebook and are forcing all of us to behave more like them – more social, more collaborative, and more connected. There are many more changes to come. Today, this Echo Boom has relevance for student housing developers on one end of the range and rental and for sale developers on the other. Tomorrow, every part of real estate will be affected.”

The undeniable force of this second population surge will certainly alter business, culture and the real estate landscape. Though it is difficult to predict exactly how they will impact our industry, there are a few emergent trends to keep in mind when making investment decisions:

• there are a lot of them – over 80 million people that have to live, work and play in some form of real estate,
• they are gravitating to urban centers even more than their parents,
• they are more plugged into the Internet and social networking than anyone before,
• they are renters, and
• they don’t drive.

The populations surge is just one of many factors determining real estate demand in the years to come – and as always, it will be difficult to determine the precise timing of growth. Demand for space will return, but it will be different and it will respond to the particular desires and behaviors of this new generation.