Reports of US cities’ demise seem greatly exaggerated

Insights from Morgan Stanley Research


Summary: Despite talk of COVID driving a long-term exodus from big cities, Morgan Stanley Research analysis shows that many are booming or rebounding. What does that mean for assets tied to urban living?

During the height of the COVID-19 pandemic, media reports detailed what appeared to be a sweeping migration out of US urban centers. A theory developed that the pandemic had perhaps changed Americans’ views on city living and that, post-pandemic, this exodus from cities could be permanent. It was little surprise when apartment real-estate investment trusts (REITs) and other assets tied to urban living came under pressure.

But as businesses open again, could investors simply have been under the influence of what behavioral psychologist Daniel Kahneman calls WYSIATI, or “What you see is all there is”? In other words, a cognitive bias in which humans subconsciously draw conclusions solely on immediately available information. 

“The truth on city populations, in our view, appears more nuanced, and more positive,” says Michael Zezas, Head of US Public Policy Research at Morgan Stanley Research. “Cellphone tracking data show that not all cities lost population, and many only lost people to neighboring counties, reflecting the enduring economic viability of those areas.”

To better understand the pandemic's impact, Morgan Stanley Research analyzed multiple data points in dozens of US cities to create a framework around city health. Ultimately, the results help assess the risks and opportunities for investments tied to urban living, including REITs and municipal bonds.

Chart - Overall, 18% of consumers moved since February 2020, largely in higher and lower income brackets.

Boomtowns and laggards

Although US Census data is often used to gauge population growth, the once-in-a-decade cadence makes it a blunt instrument. To get a more timely read on population changes, Morgan Stanley analyzed cellphone ping data at the zip-code level in 46 metro areas, while also factoring for apartment rents by geography, office rent growth, and sublet availability.

The key finding: Population shifts varied by city, in some cases significantly. To illustrate this, Morgan Stanley Research assigned a collection of cities into four categories:

  • Booming cities—Five US cities—Jacksonville, FL; Memphis, TN; Phoenix/Mesa, AZ; Albuquerque, NM; and Atlanta, GA—not only maintained population growth through the pandemic, they saw rent growth in offices and apartments. “These cities are more than temporary escapes,” says Zezas. “They are growing for strong intrinsic and durable reasons.”
  • Rebounding cities account for 21 metros in the analysis, including San Antonio, TX; Charlotte, TN; and Las Vegas, NV; to name a few. These cities lost population but show budding growth signs via cellphone data, as well as positive inflections in office and/or apartment rents. “People may have left the core of these cities because they had the means to relocate, but either will return or remain residents of periphery communities,” Zezas explains.
  • Steady cities lost population and now show mixed signs of rebounding. “These cities could easily end up in either of the other three categories and bear close monitoring,” says Zezas. Many of the nine cities in this category, such as Austin, TX; Portland, OR; Seattle, WA; and Denver, CO; were booming prior to the pandemic.
  • Lagging cities showed below-trend growth before the pandemic and have yet to show consistent signs of a rebound. It's likely no coincidence that the four cities in this bucket—Los Angeles, San Francisco, San Jose, CA; and New York—are among the largest and most expensive US markets.

Apartment REITs may still have upside

From a market impact perspective, the data pointed to an attractive outlook for apartment REITs, although local market dynamics will always be a driving force.

Apartment fundamentals are improving quickly, even in major coastal markets, as discounts are rolled back, given a rebound in demand. While apartment REITs are trading around historically high multiples, the housing sector is trading below 10- and 15-year average premiums, and may also be a potential inflation hedge.

An uncertain outlook for office REITs

The forecast for office REITs looks a bit cloudier. Cities may rebound, but uncertainty around hybrid work models could mean risks. “The office is not dead, but this next expansion cycle will be shorter and lower for office landlords,” says Vikram Malhotra, equity analyst covering the US office REIT industry, cautioning that while valuations may seem cheap, "the easy money has been made."

Indeed, historic price-to-earnings multiples could be misleading, as corporate tenants factor work-from-home arrangements into their long-term leasing plans.

Chart - US office vacancy rates have moved roughly 400 basis points higher

Housing market sits on solid ground

Broadly speaking, the pandemic has been positive for housing-related assets: Low interest rates, strong consumer balance sheets, and positive demographics have driven demand for single-family homes in most major markets. Still, the outlook varies by market: Home prices are surging in many smaller cities and suburbs, while price appreciation has been more muted in densely populated areas.

Munis could be a blind spot

State and local governments are only beginning to understand the economic implications of the pandemic. Muni bond spreads—which measure the yield difference between two bonds—are already thin, meaning investors should proceed with caution.

“Shrinking populations are generally a reliable, though lagging, negative indicator for municipal bonds,” says Zezas. “Fewer residents often means reduced revenues and ultimately a higher cost of borrowing for muni issuers who have to offer higher yields at lower prices.”

Bottom line: There’s more than one side to the story when it comes to the post-pandemic outlook for US cities. Investors exploring REITs and municipal bonds may want to consider how population shifts across the four categories present opportunities—as well as risks—before making investment decisions. 


The source of this Morgan Stanley article, Reports of U.S. Cities’ Demise Seem Greatly Exaggerated, was originally published on July 16, 2021.

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