A TALE OF TWO TYPES OF CITIES

This article by EDR Insight’s Principal Analyst Dianne Crocker appears in the Commercial Real Estate Direct’s The Mid-Year 2015 magazine. Her article appears alongside articles by authors from Trepp, Real Capital Analytics, Markit, BuildFax and the CRE Finance Council. The publication is being distributed at this week’s CREFC conference in New York City.  It is being republished here with permission by the publisher. Gratitude to Sarah Quirk and the rest of the Trepp team. 

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A TALE OF TWO TYPES OF CITIES: Are Secondary Markets Still Secondary?

Over the past several years, the nation’s gateway markets have dominated commercial real estate headlines. Peel back the layers to look at what is happening in property due diligence, a harbinger of where commercial real estate deals are shifting, and an interesting trend emerges: secondary and even tertiary markets are the real story of growth.

Moderate, Sustainable Growth in CRE

Transaction activity continues to be the highlight of this commercial real estate recovery, with solid growth in both large and small property sales. It is hard to ignore the slower-than-expected first quarter, which was attributable largely to record-low temperatures and a tough winter in the northern United States and New England.

Despite the disappointing start to the year, market indicators that include job growth, construction activity and the housing market continue to point to moderate and sustainable growth in lending and transactions. In fact, by most accounts, market conditions are starting to look more and more like the days of 2005 and 2006—and in some cases,
even better.

Migration to Secondary Markets Evident

While the story of the past several years has been one of steady growth in commercial property deal-making, another exciting trend for the market is taking root. For the first time in this protracted recovery, secondary markets are seeing more investor and lending activity. The latest results from EDR’s ScoreKeeper model, the industry barometer for Phase I environmental site-assessment activity, show that environmental due-diligence activity (measured in terms of the volume of Phase I environmental site assessments) was up strongly in smaller metropolitan areas across the U.S. in the first quarter.

This metro trend aligns very closely with what is happening in commercial real estate. Primary markets were responsible for much of the double-digit growth thus far since the recession. Only very recently have investors shown a willingness to go further out on the risk curve in search of higher yields and less competition.

ScoreKeeper data for the first quarter reflects a slow migration away from the safe primary metro areas, like New York City and Los Angeles, into smaller secondary metros. The 10 metros in the table to the left had Phase I growth rates in the first quarter that ranged from 13 percent to 52 percent, well above the overall U.S. growth rate of 4 percent. The increasing popularity of cities such as Las Vegas, Columbia, S.C., San Antonio and Charleston, S.C., is the result of peaking prices and stiff competition, especially from foreign capital, in primary metros.

Investor attention is shifting to cities with strong growth profiles like Portland, Ore., Seattle, Denver, Austin, Atlanta and Tampa, Fla., that did not have access to capital just a few years ago. Common denominators among the economies in these metros include growing—in some cases, burgeoning—technology sectors, healthcare and financial services industries. They also tend to have aboveaverage job growth, strong population growth (especially for millennials), low vacancy rates in office and apartment buildings and rising property values.

As the mid-year mark approaches, anyone whose business relies on a healthy flow of commercial real estate transactions can be reasonably optimistic about the near-term, and take solace in the fact that conditions are steady and holding their own. The increasing popularity of smaller metros is likely to become more transparent as the year plays out, a trend that will only gain steam as the overall economy strengthens. In coming quarters, ScoreKeeper output will point to the next stars of the commercial real estate recovery, those that show robust and consistent growth.

TreppTableNOTE TO READERS: This article appeared in Commercial Real Estate Direct’s The Mid-Year 2015 magazine, published June 8, 2015. To view Crocker’s article as it appeared in the magazine, along with the complete edition, click here: CRED-The-Mid-Year-2015.