Can Secondary Cities Ever Surpass Gateway Cities?

One of the most significant megatrends in the real estate market is property investment in gateway cities. Today’s smart investors are looking for opportunities that translate to long-term returns and, as has been demonstrated in the past, investing in gateway cities can be ideal investment opportunity.

Gateway markets are highly-coveted destinations, such as New York, San Francisco, and Los Angeles in the U.S. and Beijing and Tokyo in the Asia Pacific. However, some wonder whether secondary cities (like those that are showing a resurgence in the Midwest, such as Kansas City) deserve equal attention, and investment, since many are located so close to a gateway city and may promise high-value real estate investments.

Can secondary cities ever surpass gateway cities? Here’s a closer look:

The Problem with Secondary Cities

While there may indeed be many cities outside of gateway markets with attractive real estate investment opportunities, it can be difficult to determine whether these opportunities will provide long-term returns. For instance, the market may not be receptive to renters, which could affect your income. Investing in a property in a city that doesn’t have a diverse or large tenant market can make it difficult to earn rental income year after year. You may need to work harder to keep your property occupied or run into problems with tenants more frequently.

Another downside of secondary cities is that they may not be attractive to other investors in the event you decide to sell. Even if the property has increased in value, and is occupied by renters most of the time, it won’t necessarily be attractive to a foreign investor or even American investors if there is no sign of growth and economic development in and around the city. At most, you might find an investor who wants to own the property as a vacation home or secondary property. Even then, there may not be a fierce bidding war or high demand for the property.

Perhaps one of the biggest pitfalls of investing in a secondary city is the low barrier to entry. This may seem like a benefit at first, but when you consider there may soon be an influx of new properties built in the same area (or any other major shifts in the local economy), rents may start to fall leading to a much lower return on your investment than anticipated. This can be even more problematic if the property becomes harder to sell, as noted above. You would experience less liquidity in this type of market and may end up losing money in the long-term.

The Long-Term Value of Gateway Market Investments

While some secondary cities may be appealing in the short-term, gateway markets are still the better option for investors that are looking for long-term returns. Even though gateway markets are often near-saturated markets, and prices can be higher than the national average, there are still plenty of high-value investment opportunities in these markets. These are ‘stabilized assets’ because they tend to provide generous returns consistently and have little need for major property renovations.

Those who are willing to put some work into updating and renovating a property, that otherwise may not quite be ready for the market, can do especially well in a gateway market. Investments here can pay off rather quickly because demand for properties in these cities stays strong and there are fewer market fluctuations that could create a situation where you would get a very poor return.

While many secondary cities have some appeal, they are currently, rarely, a wise investment. Low liquidity, sensitivity to market turbulence, and a low barrier to entry can make it difficult to turn a viable profit from any investments in a secondary city. The risk of loss is much higher than in a gateway city, no matter how fast a secondary city may be growing or how much new development in the area is occurring — both of which, can in fact reduce average rental rates. Gateway markets continue to be a better option for investors looking for long-term returns.

By | 2017-09-27T20:00:40+00:00 September 27th, 2017|Blog, Gateway markets, Real Estate|0 Comments

About the Author:

Sonny Kalsi is an accomplished real estate investor with more than 20 years of experience that spans a range of areas, including: investment management, real estate financing and hedge funds. Since 2010, Sonny Kalsi has worked as a partner-owner of GreenOak Real Estate, the independent real estate merchant banking platform where he is also a founder. Sonny's professional career also includes almost two decades of experience at Morgan Stanley, where he served as Managing Director and Global Head of Real Estate Investing in parts of Asia and in New York City. In an effort to share this wealth of knowledge and experience, Sonny Kalsi teaches at Columbia University as an adjunct professor in the university's Real Estate Development program. Connect with Sonny on Twitter at @SonnyKalsi_

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