Monday Morning Scoop - Investment Capital Continues Its March Toward America's Smaller Cities

Investment Capital Continues Its March Toward America’s Smaller Cities

Investment sales activity has been in a “long steady migration” from big cities to small ones, with a greater amount of capital flowing into tertiary markets from primary ones.

In the early 2000s, 60% of all CRE deals were in gateway cities like Los Angeles, New York and Chicago. But by 2004, “the money started to move,” says Marcus & Millichap’s John Chang. “By 2007, major metros constituted half of the market. It shrunk to 40% by 2018 and primary markets now constitute just 33.8% of total deals.

“Now granted, there’s a lot more money coming into real estate today than there was 20 years ago,” Chang notes. Specifically, in 2002 there were about 20,000 CRE transactions over $1 million, for a total of about $120 billion in activity. In 2021, there were more than 90,000 such deals, accounting for $734 billion in volume. And while Chang says the total activity in primary markets is still up by more than three times, their share of the total market has shrunk.

“The big lift has been in tertiary metros, the smaller cities across America, and that momentum surged during the pandemic,” Chang says. In the early 2000s, less than 20% of the deals were in those cities, and the figure hit 40% by 2018. It’s now around 47%.

“Part of the equation is likely tied to the greater availability of assets in smaller cities. There has generally been less competition for those properties,” Chang says. “Part of it is probably tied to higher yields. The average cap rate in tertiary metros runs about 100 to 150 bps higher than primary markets.”

But the biggest component is likely tied to price point: properties in tertiary metros trade at 30% to 50% lower than in primary markets, which appeals to smaller investors, allowing them to get into larger assets with professional management at a lower price point. And this is especially the case for the multifamily asset class: tertiary apartment revenues are also up 81% compared to 60% in primary markets, with a lot of the lift again coming from the pandemic.

“As an investor, the big question on my mind is whether this trend will hold,” Chang says. “The two factors I think will have the most bearing on this are demographics and whether a significant portion of the labor force continues to work from home.”

By: Lynn Pollack
Source: GlobeStreet