Making First-Rate Investments in Secondary Markets

May 15, 2019

Smaller markets may yield bigger returns

While commercial real estate in major metropolitan areas remains in high demand and continues to command top rates, supply is limited and competition is fierce for the spots that do become available. Many investors are therefore turning their attention (and dollars) to secondary and tertiary markets. And with good reason—transaction volume in these markets soared from $2 billion in 2000 to $45 billion by the close of 2017.

Markets: A brief overview

Market definitions are fluid and can depend on the specific needs of a developer or investor, but there are general guidelines that can help professionals navigate the landscape. Population, job growth, capitalization rate analysis, occupancy rates, and the volume of sales and investment in a community are some of the traditional indicators in a market classification. Nontraditional indicators such as a region’s professional sports franchises or the number of direct flights may also come into play.

Out of the more than 50 metropolitan statistical areas (MSAs) with populations over one million and the 30 MSAs over two million, five to seven of them—New York, San Francisco, Boston, Los Angeles, and Washington, D.C., with Chicago and Seattle sometimes thrown in—are considered core markets. The “secondary” level includes places like Denver, Phoenix, and San Diego, with “third-tier” tertiary markets like Las Vegas, Pittsburgh, and Salt Lake City rounding out the list. Characteristics of this last category include a population of under one million, a mix of traditional and alternative economic indicators, and controlled but consistent job growth.

Why secondary and tertiary markets?

There are many reasons to consider investing in these smaller markets that will have an impact on both your budget and long-term prosperity:

There’s less opportunity in major markets. Many developers find themselves all but priced out of New York, Los Angeles, Chicago, Boston, San Francisco, and Washington, D.C. In tertiary markets such as Orlando and Austin, prices (and costs of living) are lower due to less competition—and populations are growing.
Eighteen is the new 24. While the “big six” mentioned above are valued as 24-hour cities, 18-hour cities like Denver, Nashville, and Portland are growing in popularity with renters and owners across generations.
E-commerce is a huge economic engine. The continued rise of digital retailers has pushed industrial production into secondary and rural areas, spawning healthy economic growth.
They are more stable during a downturn. And therefore, more appealing late in the investment cycle.
It’s easy to overlook them. Many investors are boxed in by traditional schools of thought and may miss the opportunities inherent in these markets.

Before you build …

While it can be tempting to jump into secondary or tertiary markets with both feet, it’s important to do your homework and make sure each region is a good fit for your investment needs.

Economics at a glance don’t tell the whole story. It’s important to look at a market’s individual traits and put them side-by-side with national trends. There are also factors outside of traditional drivers that can have a big impact on a region’s fortunes. Denver without cannabis or Orlando without Disney are far different investments than naked numbers may show on paper.

Finally, a dose of reality is always helpful. The growth of these markets can’t last forever and in the event of another economic downturn, be prepared to pivot should the local economy take a dip.

Invest early, be patient

In the words of hockey legend Wayne Gretsky, “skate to where the puck is going, not where it has been.” Early investors in secondary and tertiary markets may find a great opportunity where others haven’t yet ventured. Morris Southeast Group is proud to serve South Florida—one of the nation’s most vibrant and exciting secondary markets—and hope you will consider partnering with us. For a free consultation on property management services or commercial real estate investment, call us at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.