Secondary Markets Are Now Front and Center


Ken Robertson

Not everybody can live in New York and Los Angeles. The Millennials — and the action — are gravitating toward secondary markets, and taking their skills (and college debt and foosball tables) with them.

What makes a market primary (gateway) or secondary (non-gateway)? Two factors: demographics and job growth. Of course, that impacts housing and demand. If you guess which markets are primary, you will most likely be correct: New York, Los Angeles, Chicago, San Francisco, DC. — in essence, major centers of long-established commerce and population. These are also markets in which foreign capital is being heavily invested and where you can most likely travel to with a nonstop flight.

Secondary cities used to be afterthoughts, but not anymore, by anybody’s standards. Think Houston, Portland, Raleigh-Durham, Salt Lake City, Atlanta, Charlotte, Dallas/Fort Worth, Nashville, Denver, Miami, Seattle, and Austin. Even Las Vegas.

“Secondary” does not at all mean less hot. Quite the contrary. It means a surging growth in population, a booming economy, and a cost of living that is livable. Many of these cities used to be embarrassed about their shabby, decaying downtowns, but the times they are a-changin’: restaurants, bars, green spaces, and mixed-use development have made these markets 18-hour cities; for Millennials, this is the missing link between expensive primary markets and the suburbs they mostly come from.

A key component to the success of secondary cities: light rail — an electrified fast tram with an exclusive right of way, usually complimenting a city’s larger public transportation system. An American Public Transportation Association study found that  light rail is the Millennials’ third most-favored transportation mode, after buses and bicycles. Next City says that light rail is about to get big consideration in secondary cities in 2018, with wide expansions in Seattle and Denver, among other markets.

Investors are increasingly interested because secondary markets are showing higher yields, moderate cap rates, and construction pricing below replacement costs. Foreign investors are still generally focused on primary markets, but the growth of these secondary cities are starting to turn heads. Secondary cities can expand in ways that gateway cities no longer can.

“It turns out that Millennials don’t necessarily prefer gateway cities; they prefer the amenities that cities offer”

It turns out that Millennials don’t necessarily prefer gateway cities; they prefer the amenities that cities offer: less driving, more walking, more reasons to commune and less reasons to commute. Call these spaces urban nodes.

The reason for the growth of secondary markets, of course, is not rocket science. They offer well-paying jobs combined with affordable apartments. It’s a no-brainer for Millennials, and a profitable destination for the industries that follow them.

For corporations, this could mean holding onto their main office in a gateway market and opening a satellite office in a secondary market, just to attract the right talent. And nobody’s mad at the increasingly strong trend of job creation.

Tech firms are taking strong notes and signing leases in secondary markets. These locations may not be considered go-to tech centers at first, but the cheaper prices for both office and living space are creating new meccas that nobody would have predicted only a few years ago.

According to Bloomberg Brief: Real Estate, Charlotte, North Carolina, saw a 449 percent jump in building permits for privately owned housing with two or more units between 2010 and 2013. In Raleigh, North Carolina, another non-gateway Millennial destination, permits jumped by a breathtaking 507 percent.

Non-gateway city Raleigh-Durham, with its local universities, is able to retain its educated workforce — a phenom noticed by national multifamily developers. Bloomberg reports that jobs there grew at more than a 3 percent pace as of 2014, well above the national average. That same year, new rental stock was delivered — more than 7,000 units, with another 3,500 expected to be completed the following year. Check out our local property, Captrust Tower, a 17-story, Class A office building with retail and restaurants as Exhibit A.

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Since 2010, Seattle’s job market expanded by 7 percent, surging ahead of the national average by 2 percent. Call Seattle a secondary market all you want, but remember that Google, MicroSoft and eBay have a strong presence there.

Amazon’s Seattle presence — with its world headquarters located there  — cannot be understated as a powerful magnet for tech professionals and Millennials. The revolutionary company employs 20,000 people in three million square feet of new space. That doesn’t include those whose local businesses have grown as a result of its presence. And Amazon is not just attracting one type of demographic — G.I Jobs magazine has named it a top military employer for both veterans and military spouses.

Salt Lake City may be a city that most people don’t think of as a Millennial magnet. However, according to Globe Street, Salt Lake City’s biggest driver is the growth of e-Commerce. Industrial properties make it easy for goods to be delivered more locally, which reduces transportation expenses and increases customer service and quality.

According to the Urban Land Institute Emerging Trends for 2018, the local market outlook for Portland increased 13% in 2017 and was better than the national average in every property sector. Check out how the iconic Commonwealth Building has kept up with the times and attracts creative talent.

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Some secondary cities are so up and coming that they haven’t yet made any official lists. The Real Deal reports that young people are flocking to Kansas City. Since 2000, its downtown population has increased by 50 percent, and developers added 6,130 apartments between 2000 and 2012, with residential occupancy above 95 percent.  The New York Times reported that creative-industry businesses are reconsidering the Downtown Kansas City area instead of competing submarkets. Click here to see how our Park Place captures the flavor of the old city with up-to-date amenities and features.

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Secondary markets may be considered a bit of a riskier investment, but they are increasingly being recognized as more of a “calculated risk.” As tech, healthcare, education and other industries move in — and mixed-use properties go up — the investment begins to look more and more stable, with the yields proving to be bigger. And there’s nothing secondary about that.

Click here to check out all the KBS properties in hot secondary markets.

 

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Ken Robertson oversees a team responsible for all acquisition, disposition, and asset management activities for his region on behalf of KBS REIT, pension fund and sovereign wealth fund clients. His portfolio consists of 32 assets containing 12M SF.