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Secondary U.S. Cities Continue to Show Strong Investment Potential

Places like Seattle, Austin and Fort Lauderdale have positive economic growth and wide appeal

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Smaller secondary cities, such as Seattle, offer opportunities for investors to yield higher returns without taking on much more risk, experts say.

InfiniteThought / Pixabay
Smaller secondary cities, such as Seattle, offer opportunities for investors to yield higher returns without taking on much more risk, experts say.
InfiniteThought / Pixabay

Want to invest in U.S. real estate development? Forget 24-hour gateway cities, such as New York, San Francisco and Washington, D.C. that have been oversaturated with capital investment and development. Instead, smaller secondary cities, such as Seattle, Austin, Texas, and Raleigh/Durham, North Carolina, offer opportunities for investors to yield higher returns without taking on much more risk, experts say.

When he works with institutional investors looking for opportunities in real estate, financial adviser Paul Fried, who’s executive managing director of Greystone Bassuk Group, points to secondary cities, where he said they can expect annual returns in the mid-teens.

Would that be possible in primary markets that draw international interest? Not so much.

"For your typical institutional investor, getting these types of returns in the gateway cities is impossible," Mr. Fried said. "It’s not going to happen, which is why they’re willing to listen to a story about an investment opportunity in a secondary market."

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‘The small city is the new big city’  

Secondary cities can be broken into several categories, but are typically just smaller cities with populations from about 500,000 to 3 million. Many of them, including Charlotte, North Carolina; Nashville and Raleigh/Durham, are showing major population growth, as people move in the U.S. from major metropolises to smaller markets at an ever-quickening pace. In fact, Charlotte and Raleigh each get more than 100 new residents a day, according to developer Clay Grubb, the CEO of Charlotte-based Grubb Properties, while Austin gets 150, according to the 2017 Knight Frank Wealth Report.

Combine those positive demographic shifts with strong job growth, competitive living costs, top-notch healthcare systems and the appeal of being near intellectual capital and higher education institutions, and you’ve got a sustainable place to develop residential and commercial properties. It’s no wonder that real estate professionals are taking notice.

In the just-released, 39th annual Emerging Trends in Real Estate survey—co-published by global real estate and land use trade organization Urban Land Institute and global professional services firm PricewaterhouseCoopers—more than 1,600 real estate professionals, including homebuilders, architects, brokers and bankers, voted on where they think people can find the best investment and development prospects in 2018.

Seattle tops the 78-city list, followed by Austin; Salt Lake City, Utah; Raleigh/Durham; and Dallas/Fort Worth, Texas. The only primary markets in the top-10 are Los Angeles and Boston. San Francisco came in at 27, Washington, D.C. at 35 and Manhattan at 46.

"The story here is that the small city is the new big city," said Mitch Roschelle, a partner at PwC and co-publisher of the report.

If you look back to 2009—the last time that Seattle topped the Emerging Trends survey—the outcome was almost reversed. Back then, all the gateway cities were in the top-10, Mr. Roschelle said, which together, had a total population of about 60 million people. The total population of the top-10 on the new list is about 37 million.

"What happened is that real estate investors and developers came out of the financial crisis and looked to those big gateway markets because of their relative safety," he said.

"But now, as time has passed and those cities have gotten crowded, they’re saying, ‘where’s the safe place to be where not everyone else is?’"

Not all secondary cities are created equal

If you’re looking for a good city to invest in, not any secondary city will do, experts say. The places with real potential must have a confluence of positive economic factors, including local industry and job creation; quality-of-life features, including a walkable downtown core; access to higher education and an educated workforce; and established infrastructure, with access to quality healthcare and ideally, public transit.

The secondary cities with the most investment potential satisfy these criteria, and are also attracting a young and educated demographic. It’s for this reason that Charlotte, is red hot, as is Charleston, South Carolina, and Orlando, Florida, Mr. Roschelle said.

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These are among the areas where Mr. Grubb builds affordable rental properties for young residents—a niche that’s presented a "very attractive investment opportunity," with returns in the high-teens to low-20% annual range, he said.

"Coming right out of a recession, a gateway city will outperform these markets," Mr. Grubb said. "But the reality is that right now, these secondary markets will outperform the gateway cities."

And that makes good sense, he said.

"If you’re a millennial with $100,000 in student debt, good luck finding an apartment you can afford in New York, Boston or San Francisco," Mr. Grubb said. "If you want to be an entrepreneur or start up a business, you need to come to Charlotte where you can get an apartment for under $1,000 a month."

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Smaller secondary markets

Then you have some smaller secondary cities with populations under 500,000 that aren’t necessarily as ripe for investment, but still show potential, experts say.

Pittsburgh, Pennsylvania, and Cincinnati, Ohio, which Mr. Fried likes because they’re "micro-hubs that are New York-like for their region," with density, infrastructure and solid university systems and healthcare, are on that list. So is Salt Lake City, the smallest city to crack the Emerging Trends survey’s top 10. Like Denver, Mr. Roschelle said, Salt Lake City boasts a concentration of young people and a view of snowcapped mountains. But, it’s much more affordable.

Other secondary cities worth investing in lie adjacent to major gateway cities, often within about 50 miles. Larger cities that fit this classification include Fort Lauderdale, Florida, which is located about a half hour from Miami, and the uber-hip, San Francisco-adjacent Oakland, California.

Smaller cities, with about 100,000 residents or less, including White Plains, New York, and Stamford, Connecticut, are attractive because they have their own economies and industry with an urban core and some population density, but they’re also less than an hour train ride from midtown Manhattan.

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Steve Schwartz, a real estate developer who lives in the San Francisco Bay Area, just completed a self-storage facility in Norwalk, Connecticut, near where he grew up. He picked that location to cater to people living in multi-family spaces, where they don’t have basements or garages, but knew from experience that it’d also mean a significantly higher return on investment than if he built in Manhattan.

"Some investors see being in the major markets as risk mitigation," he said, "but true secondary markets didn’t really get hurt much more badly in 2008."

Overall, he added, "the returns in a secondary market are potentially higher, and there’s really not much more risk."

Almost outgrowing their secondary status

The final type of secondary city includes a handful of markets, such as Atlanta, Dallas/Fort Worth, Seattle and Austin that have had the attention of developers and investors for years.

Austin has even gotten some national attention, and even showed up in Knight Frank’s 2017 Wealth Report—in a section highlighting global hotspots, including Melbourne, Australia; Mexico City and Berlin—that present, "exciting opportunities for private investors in 2017 and beyond."

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"Austin is fast becoming a global model for forward-thinking cities," the report states, "and it’s not hard to see why: Its innovative mindset, enterprise-friendly environment, entrepreneurial focus and unique culture have transformed it from a government-dominated economy into a technology leader."

So, when do these cities lose their secondary status? That doesn’t really matter, Mr. Roschelle said. "The real question is, have these cities become so popular with investment capital that they’re no longer among the best kept secrets?"

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