Another Sign Investors Looking Beyond Gateway Cities

WASHINGTON, DC-The way trends are moving, 2014 could well be the year that secondary and tertiary markets come into their own with commercial real estate investors. That, of course, doesn't mean that primary cities such as Washington DC will see an exodus of investors. But clearly the competitive landscape is changing and high property valuations in these markets can expect to undergo more scrutiny by investors aware they have a growing number of options.

Lawrence Yun, chief economist of the National Association of Realtors, was the most recent industry watcher to note the trend to smaller markets by investors, in the NAR's quarterly forecast. "Investors have been looking for better yields, and have found good potential in smaller commercial properties, notably in secondary and tertiary markets," he said. "Sales of commercial properties costing less than $2.5 million in the third quarter were 11% above a year ago, while prices for smaller properties were 4% above the third quarter of 2012."

The quarterly report also noted that commercial investment in properties costing more than $2.5 million rose 26% from a year ago, while prices for large properties were 9% above the third quarter of 2012. Also, national vacancy rates over the coming year are forecast to decline 0.2 percentage point in the office market, 0.6 point in industrial, and 0.5 point for retail real estate. The average multifamily vacancy rate will edge up 0.1 percent.

One factor in DC's favor is that it has among the lowest office vacancy rates in the nation at 9.9%. Only New York City's is lower, in fact, at 9.8%. The bad news, possibly? Some of those aforementioned secondary and tertiary markets are also posting low vacancy rates: Little Rock is 12% and Nashville is 12.9%.

A report co-published by PwC US and the Urban Land Institute earlier this month also came to similar conclusions about the growing allure of secondary markets.

"The anticipated interest in secondary markets is indicative of how the US real estate recovery is expanding beyond the traditional investment hubs," says ULI Chief Executive Officer Patrick L. Phillips. "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."

DC, meanwhile, has suddenly become very unappealing to some investors, in no small part because of dysfunction in the federal government. Washington, DC slipped from eighth place in the 2013 report to 22nd in the 2014 investment rankings, positioning it close to the middle of the 50 markets ranked in the report.

The city was number one as recently as 2011.