Article

Why some investors are choosing America’s secondary markets over coastal cities

High prices in gateway markets are forcing investors to look beyond cities like New York and San Francisco - to cities like Houston, Phoenix and Charlotte.

March 09, 2018

Traditionally the first-stop for real estate investors, high prices in gateway markets around the world are forcing investors to look beyond the bright lights of the Big Apple and the rolling hills of San Francisco to cities like Houston, Phoenix and Charlotte.

These so-called secondary markets accounted for 50 percent of all U.S. office transactions in 2017, up from 45.9 percent in 2016, according to JLL’s latest U.S. Investment Outlook report.

“Investors have robust levels of active value-add capital and are moving it into new geographies, with a greater focus on secondary markets,” says Lauro Ferroni, Director of Investor Research at JLL, who co-authored the report.

Secondary gains

Houston, for example, saw investment into the office sector increase by a significant 193.3 percent to US$4.9 billion in 2017.

Portfolio acquisitions made by Canadian Pension Plan Investment Board and Brookfield drove the activity. Deals like Brookfield’s roughly US$900 million acquisition of the downtown Houston Center Complex shepherded the market out of a period of lows.

Detroit saw office transaction volumes more than double, and Charlotte, Orlando, Raleigh-Durham, St. Louis, Kansas City, Las Vegas, Milwaukee and Cleveland all marked significant increases. Meanwhile, Tempe, Arizona posted a near-record year, driven by the sale-leaseback of the State Farm Insurance campus by Transwestern Investment Group for approximately US$928 million.

All of these deals closed at a time when many primary markets saw office investment volumes soften – New York, Chicago and San Francisco among them.

Foreign interest

Secondary office markets are also proving increasingly appealing to foreign investors, according to Ferroni.

Although foreign investment in both primary and secondary markets softened slightly in 2017, the percentage share “remains near an all-time high in secondary markets, as investors broaden their purview to achieve yield,” he says.

Singapore-based Mapletree, for example, purchased an office asset in Minneapolis for approximately US$259 million.

“We expect off-shore investors’ diversification into secondary office markets to increase and represent a sustained trend,” Ferroni says. “Off-shore capital sources will continue to pursue higher-yielding investments and gain deeper understanding of markets outside of the key gateways.”

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