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Does Market Size Really Matter?

The Charlotte skyline

By Les Shaver

As supply fills up some major cities, secondary and tertiary markets are thriving.

As cap rates have fallen in the major metros over the past decade and more money has moved into the apartment sector, investors have begun looking to markets they wouldn’t have considered in the past.

“We have groups of investors who want to invest in secondary markets, and now they’re even looking at tertiary markets,” said Alexandra Jackiw, CAPS, COO at Hayes Gibson Property Services at the session “Does (Market) Size Really Matter?” at Apartmentalize this past June in Denver.

But these markets come with risk compared with larger cities. “Tier-one markets have great economic diversity and less exposure,” says Alan King, Managing Director and President, Property Operations, at Berkshire Residential Investments.

Many smaller markets often rely on one employer. If that company downsizes or closes shop, the ramifications can be felt throughout the area.

“One of my former employers bought a 324-unit property in Peoria [Ill.],” Jackiw says. “The day we took over, Caterpillar announced a reduction in workforce. We had 60 apartments occupied with their employees.”

But even with those cautionary tales, Jackiw sees why investors are clamoring for apartments in secondary and tertiary markets. “Secondary markets are less prone to big shifts [when the economy turns] than primary markets,” she says.

Secondary markets are also usually less prone to having huge amounts of supply. In contrast, King cites concessions of two and a half to three and a half months in Houston and South Florida.

“I’ve seen a lot of new construction in high-profile submarkets,” King says. “The absorption has been tough in some of them, such as Houston and Charlotte. In the worst of these [places], concessions have impacted the A-minus and B-plus markets.”

As that supply hits some large markets, a lot of smaller markets are posting staggering rent increases.

“In 2018, national rent growth was 3.3 percent,” Jackiw says. “The secondary markets had astronomical rent growth.” In Midland–Odessa, Texas, for example, rents rose 21 percent in 2018, according to Jackiw.

That market isn’t alone. “The secondary markets across Texas are doing well,” says Hugh Cobb, a Partner and one of the Owners of Alpha Barnes Real Estate Services

If these markets continue to thrive, developers will find their way in. Alpha Barnes recently opened a project in Frisco, Texas—roughly 30 miles north of Dallas—that’s renting 40 units a month.

“Building Class A products that are well located in small markets is a very strong business model,” King says.

When going into smaller markets, Cobb says investors and developers need to be on the lookout for permanent job drivers, such as Walmart distribution centers, prisons and colleges and universities.

But there are also hazards awaiting developers in these markets. “Secondary markets see developers with deep pockets as a way to add streetlights and other things,” Jackiw says.

Despite the concessions, there’s still a lot to like about big markets. “The tier-one markets are getting population growth,” says Jordan Brooks, Analytics Specialist at ALN Apartment Data. “The others are stabilizing or declining.”

The main reason for this is jobs. “Tier-one markets have diverse job drivers,” King says.

King adds that outside of some high-profile problems in markets such as Houston, Dallas and Charlotte, absorption has been strong in most large markets.

“In our revenue management system, we saw the best four-month lift through May that we’ve seen in any four months since 2013,” King says.