Investors are increasingly moving from large U.S. cities to smaller ones
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Investment volumes have been in a significant phase of migration from major U.S. cities to smaller cities and from primary to secondary and tertiary markets in recent years.
In the early 2000s, the majority of real estate investments were in cities like Los Angeles, New York and Chicago. But in 2004, capital began to shift. By 2007, major U.S. cities accounted for roughly half of the market. A figure that has shrunk to 40% in 2018, and today represents only 33.8% of the number of investment projects completed.
"It's worth noting, however, that there is a lot more money coming into the U.S. real estate market than there was 20 years ago," said John Chang, director of research at Marcus & Millichap. Specifically, in 2002 there were about 20,000 commercial transactions that exceeded $1 million, for a total of about $120 billion. By 2021, there were over 90,000, representing $734 billion in volume. While the volume in primary markets is still three times what it was 20 years ago, the share it represents has shrunk significantly.
"The biggest impact is on tertiary, smaller cities across the U.S. and this momentum accelerated during the health crisis," Chang explains. In the early 2000s less than 20% of transactions took place in these types of cities, a figure that rose to 40% in 2018 and is now around 47%!
This phenomenon can be explained by several factors, such as the greater supply of properties available in smaller cities, which are also less competitive. But also by the observed yields which are generally between 1% and 1.5% higher than those of the primary cities.
But perhaps the most significant component is real estate prices: properties in tertiary markets sell for 30% to 50% less than their primary market counterparts. In addition to being attractive to investors, this mismatch allows them to acquire larger properties that allow them to smooth out rental risk and set up professional management. This is especially true for the multifamily sector, with revenues in tertiary cities up 81% compared to 60% in the primary market, a gap that widened during the pandemic.
"As an investor, the question is whether this trend will hold over the long term," Chang says. "The two factors that will have the most impact will probably be demographic trends and the share of telecommuting in businesses."
Source: Marcus & Millichap, GlobeSt
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