In a recent study of NCREIF (National Council of Real Estate Investment Fiduciaries) data on investment returns for privately owned, institutional-grade apartment properties across the top 50 housing markets (excluding New York and Northern New Jersey), as well as Yieldstar data on apartment fundamentals, MPF/YieldStar Research found that risk-adjusted returns are actually higher for high-rent suburban investments than they are for urban-core properties.

These findings run counter to the conventional investment wisdom cited by Brandon Crowell, MPF market analyst and author of the MPF/YieldStar Research study, which recommends an urban-core investment strategy.

MPF/Yieldstar Research, both divisions of RealPage, grouped its real estate investment return data into submarkets based on ZIP codes and classified each submarket as a CBD (central business district) or suburban location. Then, it grouped each submarket by high or low job growth and further split the suburban category by high and low rental prices, creating six investment data groups altogether.

The total returns on apartment real estate investments, grouped by timeframe, location, rent rate, and job growth.

The total returns in the Suburb: High Rent/Superior Job Growth Metro category, which Crowell calls the “good suburbs,” have either equaled or exceeded the total returns for the CBD: Superior Job Growth Metro categories over the course of three years (12.6% suburban, 12.0% CBD), five years (12.8% suburban, 12.5% CBD), 10 years (both 9.1%), and 15 years (9.6% suburban, 9.3% CBD).

“If these results are surprising,” Crowell says, “it’s because previous urban/suburban studies failed by lumping all suburbs together. The problem is that not all suburbs are equal … . And regardless of rent level, the clearest factor in shaping NCREIF returns was a rather simple one: the economic health of the parent metro.”

When further adjusted for risk, the high-rent, high-growth suburbs outperformed CBDs across all four time periods. This is because, according to MPF, in measurements of risk and return over the course of 10 years, high-rent, high-growth suburbs carry less investment risk than “good CBDs.”

The distribution of income and capital returns over the past five years in each investment category.

In order to get to the root of the lower rate of risk in the suburban market, MPF has analyzed the core real estate returns in each location, grouped by capital appreciation and income returns. According to MPF, income provides stability during periods of stress and incurs less risk. Over the course of the past five years, the “good suburbs” have recorded higher income returns than the “good CBDs.”

Without taking job growth or rent rates into account, income returns for suburban groups increased by 5.8% annually over the past five years, while urban core income returns increased by 5.1% during the same period. Appreciation returns were roughly the same between both groups. Combined, the CBD groups generated 12.4% annual returns, and the suburban groups generated 13.0% annual returns.

“[Suburban investment] emerges from this research study as a market inefficiency,” Crowell says, “a rare segment where investors are likely understating value and overstating risk.”

The annual rates of rent growth in each category over the past ten years.

According to the YieldStar data, which cover apartment market fundamentals and new supply, the 3.0% average annual rent growth in the good suburbs has also outpaced the 2.8% average annual rent growth in the good CBDs over the past 10 years. Crowell notes that the fastest-growing CBDs have seen the greatest volatility, or rate of risk, in their rent rates, particularly from 2009 to 2011.

Nearly 470,000 new units are under way in the nation’s top 50 markets, and one-third of those units are slated for the urban core. MPF predicts that new supply will peak in Q3 2017, which will create a supply saturation in the good CBDs with a predicted inventory expansion rate of 9.3% in Q3 2017. (For comparison, the current annual inventory growth across the top 50 markets is 1.0%.) MPF expects a concurrent slowdown in rent growth, with a possible rebound in 2018.

To conclude the report, Crowell addresses the misconceptions that can lead analysts to believe that investment properties in the urban core provide the greatest reward relative to risk. For instance, recent supply trends prove that good surburbs are often a challenge for apartment developers to break into, due to their restrictive zoning, while many cities are encouraging downtown housing development. He does acknowledge that transaction-based appreciation likely exceeds appraisal-based appreciation in cities, but he doesn't think fundamentals drive appreciation. He attributes appreciation to investors’ perception of risk and its effects on development and acquisition activity.

“Investors should watch carefully the balance between fundamentals and pricing in urban spots, particularly over the next few years,” Crowell says. “And don’t discount the right suburbs. The desirability for suburban product, especially in areas with burgeoning employment growth or scarce single-family alternatives, can generate high returns both on the income side and the appreciation side.”