Admit it. The bright lights of big cities can be enticing to anyone, including travelers, those seeking to start new lives, and commercial real estate investors. The hustle and bustle tend to convey a sense of opportunity, whether it’s access to amenities or higher incomes. For investors, the commercial real estate landscape is plentiful, with a visible population to support even more expansion.
However, secondary markets, often defined as cities with populations between 500,000 and one million, can offer advantages that primary markets can’t. There’s the potential for higher returns, less competition, and lower entry barriers. These are a few reasons commercial real estate investors should look beyond major cities for their next portfolio addition. Let’s get into those motivations and more below.
Better Returns
In real estate, capitalization rates signal a property’s profitability. The higher the capitalization or cap rate, the higher the potential return. Broken down, a cap rate is the net operating income of a piece of real estate divided by its market value. It’s like looking at the return rate for a stock or bond.
While cap rates can indicate more risk, higher rates also suggest a property’s stronger cash flow. Take a property with a net operating income of $50,000 and a market value of $300,000. The cap rate would be roughly 16.7%. Say the net operating income is $100,000 with the same market value. Your cap rate increases to approximately 33.4%
Steady cash flow is one of the key benefits of investing in commercial real estate properties, such as mobile home parks. You typically won’t find these investment opportunities in major metropolitan areas. But you are likely to see them in less densely populated markets.
Regarding return potential and mobile home parks, Lifestyle Investing expert Justin Donald says that “Even though they’re a completely overlooked form of real estate, they provide the least amount of hassle and some of the biggest returns in any industry.” Justin notes that these investments are his favorites due to their high return and cash flow potential.
Mobile home residents tend to stay put, and the parks don’t require as much maintenance when all you own are the lots. Your operating costs are more limited compared to those of a high-rise office building. And you’re not constantly chasing a revolving door of tenants. As a result, your marketing expenses and vacancy rates will be lower.
Fewer Competitors
2024 was a record year for real estate investments in New York City. The metro area finalized more than $28 billion in investment sales for the year. Those deals represented a 23% increase from 2023, exceeding the national market. Additionally, multifamily, development, and office assets accounted for 70% of the sales volume.
While these numbers look promising, the figures also spell out an omitted factor: stiff competition. If you’ve ever gotten into a bidding war over your dream house, you’ve experienced what competition does. It drives up prices, reducing potential returns. Stiff competition also increases the chance you’ll be edged out of the market. Once another investor outbids you, you’re back to square one.
In secondary markets, there are fewer competitors to try to outmaneuver. Less competition helps prevent prices from overinflating and gives you a better chance of closing deals. You can secure the properties you deem most advantageous to your investment goals. There’s also less pressure to act, meaning you can take the time to do a thorough analysis.
Properties in secondary markets may not attract the attention of larger investment firms and real estate investment trusts (REITs). These markets have lower entry barriers for individual investors seeking their first property. Because of fewer competitors armed with big bank accounts, individual investors also have an easier time expanding their portfolios. Simply put, you’ll make smarter investment decisions that you won’t regret later.
Long-Term Growth
Undoubtedly, living and investing in a top metro area come with perks. There’s accessibility to resources that smaller areas may not yet have. The keyword here is “yet.” While major cities may have an overabundance of resources now, these areas can also be oversaturated. An oversaturated market means there’s less potential for long-term growth compared to up-and-coming locations.
Secondary markets, on the other hand, have room for growth. When you invest in commercial property in these areas, long-term growth leads to appreciation. The market value of your investments may increase more than that of properties in primary markets. As secondary markets attract additional residents and businesses, the demand for facilities increases.
If growth is rapid, the supply may not initially be able to keep up with demand. If you’ve invested in the market before the growth spurt occurs, you can increase your return potential. Say you decide to sell or tap into the property’s equity down the line. Since property values may have been substantially lower when you invested, you’ll reap greater rewards.
While not all secondary markets will become another Los Angeles, growth opportunities are less constrained. There’s only so much more a top city can expand. In some cases, growth may shrink as these areas become less affordable for the average person. People will be looking for places where they won’t break the bank. And the secondary markets you’ve invested in could be on their list of top contenders, adding to long-term growth.
Reasons to Invest in Smaller Markets
Affordability combined with higher returns and growth potential makes investing in smaller markets attractive. The economies of major metros also tend to be more volatile. When national or global economic factors aren’t as favorable, the vulnerability of top cities’ economies increases. Increased vulnerability to recessions means higher risks and possibly even negative returns for commercial investors.
In contrast, secondary markets can be more resilient as these areas tend to be more influenced by local economic factors. Fewer competitors are bidding on the same properties, and operating costs can be lower as a result. Individual investors have a leg up in less populated cities with long-term growth potential. Let the large investment conglomerates fight over the prime office building in Chicago. You could already be earning cash flow on a property in suburbia instead.
