The 3 Different Tiers of Real Estate Markets
What Are They, How Do They Differ, and Where Should I Invest
As most of us are aware, real estate is all about location. More often than not, the where is going to outweigh the what. A single-family home situated in a growing and thriving market is going to appreciate and perform well in its own right, just as an apartment building or commercial store front will in that same market.
Compared to the city, state or region, the neighborhood and immediate area surrounding a property usually has a larger impact on the asset’s valuation. However, it’s equally important to understand the macro-environment of the markets in which you own and invest.
In this piece I’ll be breaking down the fundamental differences between Tier 1, Tier 2, and Tier 3 Cities; as well as sharing what emerging markets we’re keeping a close eye on.
Tier 1
Tier 1 Cities and Metros are your most established markets; such as New York, Los Angeles, San Francisco and Chicago. The exact metrics that firms and individual investors use to determine Tier 1 status, versus Tier 2 or 3 may differ; but population, median income, property values, and domestic GDP are often the top factors considered.
Tier 2
Tier 2, or Secondary Markets, are slightly less established than Tier 1 Markets and have a lower barrier to entry. But they still reflect material growth and clear signs of further upward movement.
Some examples would be the Seattle, Tampa, Denver, and San Diego MSA (Metropolitan Statistical Area). All of which have a population size between 2 - 5 million people, and property values and income levels within the major cities hover at or above the national average. However, they aren’t the largest hubs for business compared to some of the previously mentioned Tier 1 Markets.
Tier 3
Tier 3 Cities, also known as Tertiary Markets, are smaller with less robust economies than both Tier 1 and Tier 2 Markets. MSAs such as Memphis, Tennessee, Buffalo-Niagara Falls, and Oklahoma City would fall into this category. These areas have populations that are in the low millions, real estate trades for less than the national average, and they aren’t home to a diversified spectrum of major corporations. Investment opportunities within Tier 3 markets may provide the most room for long-term growth, but due to the suppressed social and economic dynamics of the area, they’re also viewed as the most risky.
What Emerging Markets Are On My Radar
Now that you have a better understanding of what differentiates the various market tiers from one another, here are a few areas that my team and I are keeping a close eye on:
St. Louis, Missouri MSA (#24, 2.8M): It has a population of around 2.8 million people and it’s ranked the 24th largest MSA by GDP. As cash-flow focused multi-family investors, what we like the most about this market are the unit economics and the surplus inventory. We currently own 3 small apartment buildings, all within the city of St. Louis, and our average price per door is around $50K. We’ve been able to lease our studio units for $700 and 2-bedroom units for $930. Albeit capex (capital expenditures) has been higher than normal, the rental income and appreciation have provided a great return on investment for all three acquisitions.
Raleigh, North Carolina (#39, 1.4M): Prior to purchasing in St. Louis, I traveled to Raleigh, Durham and Fayetteville to get a hands-on feel for the market and the investment opportunities that may be on the rise. Subjectively speaking, Fayetteville was a bit underwhelming, but I was highly impressed with both Raleigh and Durham. All throughout downtown and the surrounding area there was a healthy balance between new-built construction and older historical infrastructure; providing both the modern appeal of a larger city, and the small-town charm that brings most people to the South and East Coast.
The reason we chose not to dig into the Raleigh-Durham market is because it’s far less cash-flow friendly, and there aren’t as many small and midsized apartment buildings compared to St. Louis and other Midwest markets. However, although this market doesn’t fully align with our investment thesis, it’s a strong Tier 3 city that boasts all the signs of more growth to come.
Tampa, St. Petersburg, Clearwater, Florida (#23, 3.2M): The last market I’d place on this short list is the Tampa MSA. With a population just shy of 3.2 million, it lands just above St. Louis at #23 on the Top 50 List of the Largest U.S. Metros by GDP. Tampa and the surrounding cities that make up the metro area - Clearwater, St. Petersburg, and Sarasota to the South - have been somewhat overshadowed by the hyper-growth Miami has been experiencing over the past five years. However, we believe that the Tampa region is going to begin receiving a ton of attention as the housing market rebounds.
In closing, while the micro-level factors of the neighborhood and immediate area surrounding a property play a significant role with regard to it’s performance and appreciation, a comprehensive understanding of the broader macro-environment is an indispensable component of your long-term success as an investor, and or owner. Being familiar with the pros and cons that come along with each tier, and the evolving dynamics of both the established and emerging markets, will help reveal hidden potential and opportunities for growth that may be less apparent to others. Thorough due diligence, coupled with strategically positioning your portfolio within the forward path of progress, can provide outsized return on your investment(s).
Feel free to reach out for added insight into our preferred markets, as well as access to the resources of our team.
For expert advice and professional help with your next purchase or investment, feel free to reach out.