CRE Investment Continues To Heat Up In 18-Hour Cities

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Includes: IYR
by: Hightower

By Billy Fink

Gateway cities - such as New York City, Los Angeles, and Chicago - have been magnets for investment capital in the wake of the recession. But the inflow of capital also brought immense competition and skyrocketing prices.

As a result, more investors are looking to deploy their capital outside of the frothy competition in the major US metros. They are turning to the buying opportunities that exist across a wider pool of up-and-coming secondary markets and "18-hour" cities.

Philadelphia, Atlanta, and Phoenix are just a few examples of the 18-hour cities that have seen their stock rising among real estate investors. And that interest is well deserved. These metros typically offer compelling growth and more attractive yields. Given the fierce competition in gateway markets, which has been spurred by record foreign investments, it is no surprise that investment activity is on the rise in 18-hour cities.

In the office sector, for example, sale prices for properties in primary metros rose 23.4% during the first three quarters of 2015 compared to an 11.0% price increase in secondary markets, according to JLL. Cap rates in the office sector also are higher in secondary markets at 5.3% compared to 4.5 percent in primary markets, according to JLL.

Although 18-hour cities are somewhat loosely defined, some of the metros that top the list generally include the likes of Dallas, Austin, Charlotte, Atlanta, Denver, Nashville, Portland, and Raleigh/Durham, according to an Emerging Trends 2016 report published by PwC and ULI. These and other 18-hour cities tend to share a number of key attributes, such as:

  • Strong economic and population growth
  • Revitalization and new development
  • Attractive yields and improving real estate fundamentals.
  • A trendy, cool vibe or unique cultural scene that is attracting millennials.

One need not look far to see examples of population and business growth occurring in these 18-hour cities. Atlanta, for example, is expected to see its population jump 59% between 2010 and 2030, while Raleigh is forecast to grow by 50.4%, according to the Urban Institute. Many of these metros also are experiencing a wave of urbanization and revitalization. Cities such as Indianapolis, Pittsburgh, and Minneapolis each have in excess of $1 billion in public and private development underway ranging from light rail transit and sports stadiums to high-rise housing projects.

Yet, while the 18-hour metros are hotspots for growth, they also come with more investment risk. There is a reason that the bulk of investment capital tends to flow to major metros first. Gateway cities are a safe investment play. Potential risks to investors in secondary markets include lower NOI growth and smaller economies, which can translate to weak job growth and tenant demand. In the past, secondary markets also have had a reputation for being less liquid, making exit strategies problematic in a down market.

Investors are well aware of the downside risks that exist in secondary markets. However, the current economy and recovery of the real estate market may be giving buyers more confidence to take on the added risk - and hopefully higher returns - that comes with buying in 18-hour cities. Investment volumes are clearly on the rise in these metros, and that is likely to continue as capital continues to pour into the U.S. commercial real estate market.