Secondary Cities: Rise of the Rest

Steve Case (co-founder of AOL) wrote that in 2014, three quarters of all venture dollars flowed to just three states: California, New York, and Massachusetts. Case mentions that during the second wave of the Internet, which spanned from 2000 to 2015 and was defined by search engines, social media, and ecommerce, capital and talent rushed to primary cities across the nation (specifically San Francisco, New York, and Boston) with advantageous environments to launch the next big tech startup. Case believes that as we enter the third wave of the Internet, in which we’ll see technology integrated into all industries, all of this will change. New technological advances allow people to conduct business from anyplace with Internet access. Because of this, and the high cost of doing business in major hub cities due to their competitive business environment, entrepreneurs and technical experts are seeking lower cost basis environments to start their businesses. The next wave of talented, innovative entrepreneurs are seeking secondary cities throughout the country for their start-ups, and investors are following them.

The question is, how do these innovation trends relate to multi-family real estate investing? One trend we are seeing is that we are in the early stages of a similar shift in real estate investing. In addition, as investors, we are continuously monitoring the environment we are investing in, so how does the continuous evolution of technology affect our investment strategy?

Since the recession subsided in 2009, institutional investors have been pouring money into luxury apartment complexes in primary cities, mostly on the east and west coasts. Foreign investors have also been seeking a safe haven in the historically stable US commercial real estate market, targeting high-end assets in major cities as well. With these two major investment groups pouring money into the same asset classes in the same markets, cap rates have dropped significantly, increasing value but leaving limited opportunity in the high-end market.

With the high-end market becoming saturated, similar to how today’s entrepreneurs are seeking lower cost basis environments to start their businesses, institutional and foreign investors are beginning to see the value in secondary markets across the US. Abundant access to capital has allowed the large Institutional and the wealthy foreign investors to remain in the large primary markets as they mature. It may be a few years before they enter secondary markets, sacrificing yield for stable investments in markets they’re already in. In the meantime, we’re looking at secondary markets with the necessary infrastructure and leadership to support growth in the market. Through proper market due diligence, we are able to identify and invest in these emerging secondary markets now, and reap the benefits in the future when Institutional and foreign investments enter these markets and drive up prices.

When researching a new market it is important to analyze the local nuances of the market. In addition, from a big picture perspective, it is important to understand what drives growth in today’s world. As Case would argue, advances in technology and innovation continue to drive business and social growth. San Francisco, New York, and Boston have lead the field in using research, technology, and innovation to drive their local economies. Select secondary markets, specifically ones with universities and research centers, are starting to catch on. Case points to the North Carolina Research Triangle as an early adapter to this model as a hot secondary market. This area is using the research facilities provided by three large regional universities. That, along with its local educated workforce and great climate have enabled this region to attract business to the area rather than see talented natives flee north to New York or Boston. As technology continues to expand in various industries, additional secondary markets will become more attractive. We are especially attracted to regions with research universities, hospitals, and leading innovative companies. Local government leadership who are supporting innovation and seeking opportunities for rapid growth is also vital. Case uses many old industrial cities such as Hartford, CT, Buffalo, NY, and Cincinnati, OH, among others, as cities that fit this model.

As real estate investors, it is our job to identify these markets, and find undervalued properties in them. As innovation moves into secondary and tertiary markets, multi-family property values will continue to climb!