Investment Returns From Smaller Cities Anything But ‘Secondary’

Sharestates has helped real estate investors and developers seeking funding to find each other in leading cities in Texas and California as well as throughout the densely populated East Coast. But the Sharestates platform also extends into sections of the United States that are just as eager to develop their real estate stock even if they aren’t as crowded. Utah, Minnesota, Alabama, South Carolina and other states that don’t garner as much attention in Real Estate press also attract Sharestates investors’ attention.

And there are plenty of reasons why. Sometimes the best tactic is to go where others aren’t following and where you’re not following anyone else. So let’s turn our attention to how real estate operates in secondary markets as opposed to how it does in big cities.

Defining our terms

Just to be clear: We’re discussing secondary real estate markets, not secondary mortgage markets. In the United States, the primary metropolitan areas for real estate deals include New York City, Washington, D.C. and Boston on the East Coast; Los Angeles and San Francisco on the West Coast; and Chicago in between. Depending on whom you ask, you might add Philadelphia, Miami, Houston and Dallas-Fort Worth to the mix. The definition of primary market is a little loose because it takes into account both total population and population density, with density being a bit more critical. That’s why San Diego and San Antonio aren’t generally considered primary markets despite the reach of their local mass media. By the same token, there are plenty of densely packed pockets of greater Pittsburgh or Louisville, but there just aren’t enough people there to credibly promote them to primary.

One other nuance to the primary designation is the turnover of multi-family units in an area. “Instead of focusing on a single indicator” to make these distinctions, Drew Dolan of Titan Fund Management wrote in Forbes.com,  “we create a matrix of information, including population, job growth, traditional and alternative economic drivers, and cap rate analysis.” Dolan, by the way, eschews the term “secondary” and considers “gateway” more apt. But we’ll stick with convention for now.

Reasons why

The question then is, why? Why pour money into a less populous, less cosmopolitan town when you could be investing the same money in a city that’s always going to draw young, educated strivers and, by extension, the firms that want to hire them?

The first reason is obvious: There’s nothing wrong with the city life in San Diego, San Antonio or Pittsburgh. They’ve got contending professional sports franchises, homegrown industries, international airports and otherwise great standards of living. “Secondary markets are generally mid-sized cities that have begun to experience an uptick in growth—and as a result, they begin to capture people’s attention,” according to Robin Young, a blogger for property management software vendor Buildium. “In the rental market, occupancy rates begin to rise; but because the supply of apartments is relatively unconstrained, rent prices stay affordable for most residents.”

That uptick is the lower boundary that makes a mid-sized city a secondary rather than a tertiary market. Is there anything lower than tertiary? Maybe, but let’s turn the question around: Would you ever invest in it? “The housing market steadily gains strength but remains less competitive than primary markets,” Young notes, “resulting in lower prices for homebuyers and higher returns for investors.”

Another reason, though, for investing in secondary markets as opposed to primary markets is that the metro areas that comprise these categories are subject to change. Detroit was a primary market once. Now you can buy a detached home there with a credit card. Alternately, Dolan points out that what he terms gateway markets “are less volatile in downturns, which makes them particularly attractive late in the investment cycle. Deals in these markets are not overvalued and offer higher returns. They also offer stronger growth potential due to a lower cost of living and less supply.” Data analytics from Trepp back him up. According to their findings published in National Real Estate Investor, secondary markets’ aggregate cap rate stands at 6.8% as opposed to 3.68% in top-tier markets.

Secondary markets worth a second glance (U.S.)

  • Austin: fastest-growing population overall and fastest-growing population under age 35
  • Charlotte: top 5 in population growth overall and for population under age 35
  • Minneapolis: fastest job growth
  • Orlando: fastest growth in number of households
  • Raleigh: top 5 in population growth overall and for population under age 35
  • San Diego: top 5 in median home sale price and home sale price growth
  • San Jose: highest median home sale price

Source: Buildium