Secondary Markets Present Strong Opportunities

Investing in markets outside the core presents an opportunity to capitalize on the demand for downtown assets without the downtown address. Stephen Catarinella of CAPREIT discusses what factors to consider when acquiring communities in these areas.
Stephen Catarinella

Stephen Catarinella

Many aspire to be in the center of the urban core and amidst all the action, but that doesn’t mean they can afford to be there. Others crave the benefits of the city, but don’t necessarily want the nonstop hustle and bustle to be a part of their everyday lives.

This presents a prime opportunity for apartment owners to capitalize on the demand of downtown without the downtown address. Many of the tertiary markets surrounding these cores are often overlooked, but apartment communities in these neighborhoods can provide significant returns and strong investment opportunities.

Considering that most new construction in urban core markets is Class A, a market remains for quality housing that offers many luxury-like conveniences without the astronomical price tag.

Solid returns have surfaced in many of these markets, both on the management side and for investors. St. Charles in suburban St. Louis is an example of where to find success. Another is Louisville—on both the Kentucky and Indiana sides—and the Southfield/Ann Arbor areas near Detroit. Value-add has produced strong returns in Durham, N.C., with its research-focused demographic.  

These are a few examples of many lucrative tertiary markets across the nation, but uncovering success is more than just discovering a market that makes sense. Here is a look at many of the factors to consider when acquiring one of these communities.

Demand drivers, replacement costs

Of course, you’ll want to look for economic drivers in areas like healthcare and education. It’s advisable to research where local government is putting its dollars and research what types of infrastructure investments are happening. Planned or current investment in commercial, retail or office is a good sign of growth opportunity. Determine what types of development funds, if any, are available and whether there is venture capital in the area. When looking at the cost of an acquisition, look at replacement costs per unit. Buying at a per-unit number versus the cost of new construction in the area should be the first checkbox.

Keep in mind that another advantage to tertiary markets is ownership profile. In these markets, you’re more likely to find a family-owned/operated community than you would downtown. That typically means less institutional money and less foreign capital, which equates to increased opportunities for management upside. That family connection often leads to assets that are well preserved, but not necessarily managed or priced optimally. That means a national owner/operator can continue the good things the family-owned company has done and take things to the next level.

One less-often considered location trait is the proximity of an airport. We want an airport that’s easily accessible for management efficiencies, one that allows our associates to travel via direct flights or with one changeover. Time is an important commodity in the acquisition business, meaning a four-stop flight plan is simply inefficient.

Creating appeal

Once you’ve acquired a secondary-market community, you have to demonstrate why living there makes sense for someone still craving the city experience. We implement our typical value-add program that improves the curb appeal, amenities and community in general. But if you’re on the outskirts, you want to create demand drivers to give people another option from renting downtown.

One natural advantage is that all the new Class-A construction comes with a hefty price tag. So these markets allow an opportunity to create an attractive community with updated amenities, renovated units at a lower price than downtown—but still at a price that yields a strong ROI. You want to offer amenities that make the resident comfortable with not leaving the property—such as a gym comparable to a Class A product or a concierge service—in addition to a welcoming atmosphere and regular events at your renovated clubhouse.

For marketing purposes, partnering with a preferred employer is recommended. If the area has a high population of employees from a certain company, offer transportation to the site and discounts for preferred-employer residents. It could be a hospital, Amazon warehouse, Toyota plant, or anywhere that’s driving the economy or the desired resident profile from an economic standpoint.

Challenges

Being anywhere near downtown means there is plenty of competition. There’s only so much a company can do with a 1987-built community opposed to a new Class-A luxury development downtown. And now, there’s competition even when attempting to acquire that 1987 community. Foreign capital and institutional money that usually stays in the big city centers have moved to the secondary markets to find stronger returns. Owner/operators who have built their profile in tertiary markets are now struggling to acquire these assets.

It has become more difficult to keep rents down because there’s so much competition in the acquisition space. If you want to make your numbers work, you often have to underwrite aggressive rent increases. You don’t want it to trend like that of luxury housing, but rental rates aren’t staying flat, either.

Despite the challenges, it is very important to continue to invest in new development and preservation projects in these secondary and suburban markets. Not everyone wants to live in the city and not everyone can afford to live in the city. That includes many of our nation’s first responders and blue-collar workers, who need the option of a quality apartment community that does not break the budget.

Stephen A. Catarinella is the vice president of acquisitions & business development manager for CAPREIT.