3 Reasons to Invest in Multifamily Secondary and Tertiary Markets

News headlines typically focus on major multifamily investments in primary markets.  And, cities like New York, Chicago, and San Francisco certainly deserve this attention, as they remain reliable markets that provide predictable returns. 

However, more and more real estate investors have begun pursuing multifamily deals in secondary and tertiary markets, a strategy with greater risk - but also the potential for greater returns. 

In this article, I’ll outline some of the considerations behind this multifamily investment shift and three reasons why it makes sense. 

Secondary and Tertiary Market Characteristics

Whereas primary markets appeal to commercial real estate investors for their stability, secondary and tertiary markets tend to share the following characteristics:

• Increased volatility (relative to primary markets)

• Lower commercial real estate barriers to entry

• Lower job growth rates

All of these characteristics represent an increased level of risk for multifamily investments in these markets, but this increased risk also offers investors significant upside potential. 

Of note, these second- and third-tier markets tend to include major job centers with large growth and innovation potential, typically consisting of populations from one to three million people.  In other words, even if job growth rates may not meet the same level as primary markets, growth – and potential – remain extremely high.

Accordingly, secondary and tertiary markets offer unique opportunities for expansion resulting from both infrastructure investment and continued growth of educated workforces, largely the result of the millennial drive to urbanization.

Commercial real estate professionals can help you identify multifamily investment opportunities for your unique situation.  Need help connecting with reliable ones in a new market? Drop us a note!

Reason 1: Opportunities for Higher Multifamily Returns

In analyzing commercial real estate deals – and deals, in general – investors must balance their risk appetites with desired returns.  As stated above, secondary and tertiary markets have characteristics that increase risk, but this risk offers investors the potential for higher associated rewards. 

Recent Wall Street Journal analysis noted that, in these markets, multifamily owners of Class A properties are realizing higher yield returns and larger cap rates relative to comparable properties in primary markets.  Typically, this cap rate spread hovers between 150 and 200 basis points, offering higher returns for multifamily investors in secondary and tertiary markets.

And, moving forward, this trend remains likely to continue.  In an era of historically low interest rates, there has been a massive flow of capital into commercial real estate as investors chase yields.  As competition to invest this capital remains high, multifamily properties in secondary and tertiary markets will continue to offer stable – and higher yielding – investment opportunities. 

Feel free to drop us a note if you need help analyzing multifamily investment returns in a new market.  This analysis can seem challenging, and we’re happy to help!

Reason 2: Less New Multifamily Supply to Compete Against

As the traditional targets for multifamily investments, supply in primary markets has more consistently grown in anticipation of demand, leading to increased competition between existing and new properties.

Conversely, due to the relatively lower job and population growth rates, there tends to be fewer new multifamily properties entering secondary and tertiary markets.  This prevents oversaturation and allows existing multifamily properties to avoid consistent competition from new properties entering the market.  Put simply, institutional-grade investors are less likely to accept development risk in these second- and third-tier markets. 

For investors willing to accept the increased risk in these markets, local commercial real estate brokers can provide key insight into existing multifamily supplies. 

Reason 3: Less Competition for Existing Multifamily Properties

For smaller-scale commercial investors, barriers to enter the multifamily markets in primary cities proves extremely high.  In addition to the typically far higher valuations, investors face massive amounts of competition in primary markets. In search of stable returns, institutional investors focus their capital in these markets, leaving little opportunity for non-institutional investors. 

Fortunately, this tremendous competition in primary markets means less competition exists in secondary and tertiary markets, providing opportunities for investors willing to move into these markets.  While adding a Manhattan multifamily property to your portfolio may not be realistic, investing in cities like Atlanta, Baltimore, Indianapolis, Milwaukee, Sacramento, and San Diego remains feasible. 

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We recognize that, even after outlining the above information, finding multifamily investments in new markets can seem daunting.

That’s why we’re here to help.  The Pocket Broker team lives and breathes commercial real estate, so drop us a note to see how we can help you achieve your unique objectives!