Expanding economies and higher yields are driving multifamily investors to look into and invest in smaller cities.
As of December 2019, Multifamily investors are now more likely to spend their money on properties in secondary and tertiary markets as opposed to investing in primary markets.
After decades of expansion, investors are starting to run out of attractive places to invest their capital, especially when it comes to multifamily properties. In secondary and tertiary markets, the yields are usually only slightly better than in primary markets; however, what makes these markets more attractive is the local economies are strong enough to keep bringing more investors.
The majority (more than half) of the apartment properties bought in 2019 were located in secondary and tertiary markets, according to DLP Capital Partners data. That’s up from 43 percent a decade ago.
Consistent demand for apartments has helped make investors looking into multifamily properties feel secure enough to spend the majority of their money on properties in smaller cities and towns.
Although the apartment vacancy rate in prime markets has shrunk to just 3.4 percent in 2019 (which is down from 5.4% back in 2010), the change has been even significant in secondary markets, where the vacancy rate fell to 3.8 percent from 6.6 percent over that same time period. The most pronounced change has been in tertiary markets, where the vacancy rate has fallen to 4.8 percent from 7.2 percent, according to DLP Capital Partners.
Many smaller markets have become more effective in attracting millenials. These secondary markets often have ample job opportunities and the cost of housing is relatively affordable compared to more prime markets.
When investors buy properties in prime markets the average cap rate is around 4.1%, but in tertiary markets, the cap rates average 7.0 percent, which is higher than the 5.3 percent average achieved in secondary markets.
However, there is still some risk when investing in smaller markets. New construction projects can have a negative effect. Also, smaller markets are easier to enter so there is likely more room for competition from a variety of players.