In NYC, hotels are one of the property sectors that respondents feel offer the best opportunities.

NEW YORK CITY-The US real estate recovery is set to continue along the path of recovery this year, with investors increasingly looking beyond some of the traditionally popular markets to secondary markets in search of higher yields, according to Emerging Trends in Real Estate 2014, co-published by PwC and the Urban Land Institute.

The predicted growth in secondary markets will stem from investors searching for returns as opportunities in core markets become harder to find and the best assets become more expensive, according to the report’s findings, which stem from an industry survey. As a result, it’s anticipated that 2014 may be the year that many investors who have traditionally focused mainly on large established markets such as Boston, Chicago, Los Angeles, New York City, San Francisco and Washington, DC will expand their focus to other cities in order to protect capital. This trend, first noted in last year’s Emerging Trends report, is likely to build substantial momentum this year given the steady pace of improvement in market fundamentals in secondary markets and with more investments in those markets meeting investors’ risk/return metrics.

The movement into secondary markets will be aided by the expected increase of both debt and equity capital this year. Survey respondents were particularly positive about the prospects for equity capital from foreign investors, institutional investors and private equity funds, as well as debt from insurance companies, mezzanine lenders and issuers of commercial mortgage-backed securities.

“Real optimism has emerged as a key theme in the real estate market for 2014 as trends are progressing significantly through the economic and real estate recovery cycles,” says Mitch Roschelle, partner, US real estate advisory practice leader, PwC. “The steady economic recovery and job creation has created ‘tailwinds’ that have propelled the commercial real estate market forward, and momentum of this recovery seems powerful enough to weather spikes in interest rates that may be inevitable.”

Adds ULI CEO Patrick Phillips, “The anticipated interest in secondary markets is indicative of how the US real estate recovery is expanding beyond the traditional investment hubs. Access to greater amounts of both debt and equity financing, combined with a sustained improvement in the underlying economic fundamentals, means that the opportunities and returns offered in smaller markets are potentially very appealing.”

The report notes that, of course, the key threat to market recovery is the timing and pace of any interest rate increases. The report forecasts a modest increase in the short term, but does not expect a small increase to cause a major disruption to the recovery. If higher interest rates are a function of the Federal Reserve Board’s response to an improving economy in 2014, the increased borrowing cost will be offset by greater demand and therefore higher rents. However, the report cautions that faster-than-anticipated rises or rates growing faster than the underlying economy could undermine the recovery.

In terms of “markets to watch,” New York City came in at fourth place. The city’s investment and development components are still rated as “good,” the report states, however there is a growing concern that pricing is once again becoming too high. Rental apartments and hotels are the property sectors that respondents feel offer the best opportunities in 2014.

The most significant example of the shift by investors from some core markets and into alternate markets is seen in the findings for Washington DC. Highly ranked by Emerging Trends prior to and during the recession, and ranked number one in 2011, the District slipped from eighth place in the 2013 report to 22nd in the 2014 investment rankings. The report notes that “fed [federal government] fatigue” appears to be diminishing the investment appeal of the nation’s capital. “What was once viewed as an asset is now seen as a liability.”

In terms of market sectors, industrial tops the ranking in this year’s report, while multifamily housing remains popular. And in a sign of investor optimism, the report signals that in 2014 there may be an increase in new development activity in subsectors such as central business district office and limited service hotels that have not seen new construction in several years.