Understanding Primary, Secondary and Territory Real Estate Markets
This article is part of our passive investors guide on real estate syndications, available here.
Understanding markets is the key to success in real estate investing, as they help you formulate your investment strategies. Choosing what market or markets you want to put your capital to work in requires a great deal of knowledge, even for experienced real estate investors. To simplify things, we use three types of real estate market classifications to bucket a market into. Classifying a market as primary, secondary, or tertiary helps us understand the density of population that a market has, what type of infrastructure and amenities it possesses, and how each real estate market functions.
In this guide, we will break down the difference between the three classifications and what opportunities lie within each.
The 3 Main Types of Real Estate Markets
The following are the 3 main real estate market classifications.
- Primary Markets
- Secondary Markets
- Tertiary Markets
1.) Primary Markets
Primary real estate markets are sometimes referred to as gateway markets and are the largest housing markets in the United States. These markets are highly densely populated, with over five-plus million people. They are centers containing long-established commerce, which have the extensive infrastructure and are heavily invested by larger institutions and private equity firms.
These markets offer the lowest CAP rates or yield compared to secondary and tertiary markets. They have the most substantial economic drivers, making real estate investing in one of these markets very low risk.
What are the primary real estate markets
Large cities such as the following are examples of primary markets
- Los Angeles
- New York
- San Francisco
- And more
2.) Secondary Markets
Secondary real estate markets have many of the same amenities as a primary market, except they tend to be a little less densely populated, with around 1 to 5 million people. These markets generally have substantial population and economic growth but are not quite the size of a primary market.
Secondary market example
The following are examples of secondary markets.
- And more
3.) Tertiary Markets
Tertiary real estate markets are also sometimes referred to as emerging markets with a steady growth trend. These markets are much less densely populated, with under 1 million people, and are much more spread out than primary and secondary markets.
These markets usually offer the highest CAP rates or yield compared to primary and secondary markets, as they tend to lag the faster CAP compression that larger markets have.
Tertiary market example
The following are examples of tertiary markets.
- Las Vegas
- And more
The growing importance of tertiary markets for real estate investors
Historically, the biggest investor for large properties had its best sights on the secondary markets. Class A properties in a primary market often will be rated with lower rates than similar commercial buildings in a Tier II market. Smaller Tier 3 metro areas like Las Vegas, Nashville, Charleston, and Richmond, offer many attractive qualities for investors.
This can also mean investors earn higher returns since these funds can buy properties at higher cap rates in Tier III markets that may have larger rental rates than the US average. Las Vegas and Nashville offer attractive characteristics like above-average population and employment growth which can help investors earn more than double the average rental rate.
What real estate investors should look for in a tertiary market?
Austin has snowballed to a more desirable location for real estate investors in recent years. Austin’s consistently higher-than-average population and jobs have fueled impressive rental growth. A city that’s earlier in its growth cycle but has a similar upside profile may offer a tremendous tertiary market for a real estate investor.
Austin is an excellent example, as it has consistently exceeded the average growth in numbers, job creation, and constant rental development. Austin is an example of a city with a similar growth profile, making it an Ideal Market for investors to invest in.
Tertiary markets are not as large or stable as primary/secondary markets. However, these metros offer investors more growth potency and higher cap rates. And that’s why the local government has no excuse not to consider these major metropolises.
Related Read: Multifamily Market Research, What You Need To Know
What is the difference between primary and secondary markets?
Primary and secondary real estate markets are often confused with one another. At first glance, some secondary markets, like Miami, might be mistaken for a primary market based on the city’s popularity rather than its characteristics. Both markets have high rental demand and more expensively priced real estate. The following are the three main differences between primary and secondary real estate markets.
- Return on Investment
- Population Growth
Competition in secondary markets is still fierce but not as crazy as in primary markets. These investors, who are either investing as individuals or on behalf of a large group, elect to invest in primary markets because of the cache and low risk relative to the demand and liquidity of these markets.
As a result, deals are harder to come by as you’re competing against massive firms who are willing to often overpay for an asset. Secondary markets offer a little less competition which makes these markets more attractive to less institutional groups. But institutional groups and their investors are savvy investors who invest as limited partners (LP) for a living, so they also recognize this and often play in both ponds.
2.) Return on Investment
Secondary markets offer a little less competition, allowing real estate investors to get better returns as they don’t have to overpay to win the bidding process on a deal. Higher CAP rate deals or higher in-place yielding deals allow investors to have strong cash flow on day 1.
Primary markets generally have the highest rents, but secondary markets still have relatively high rents with solid upside for more growth. What’s made secondary markets even more attractive as of the start of the pandemic has been what we’ve learned from migration trends of people living in the big primary markets like New York.
Some of these people transitioned to remote work and realized they didn’t need to live close to their job in the heart of the city any longer. Rather, instead of moving outside the city and enjoying a more suburban lifestyle.
3.) Population Growth
Population growth can be an excellent indication of what to expect in future property prices. Population growth is what brings investors and what leads investors to make their decisions on what property market they will invest in. It’s essential to be aware of what has been happening and what will happen next with population growth rates because knowing what your population is doing will help you decide what property market would best suit your investment needs.
Although primary markets have a much higher population than secondary markets, they don’t tend to have as high a growth rate as that a secondary market. This means that rental pricing and real estate values in secondary markets are still on their way up. Job growth is also intertwined with population growth, as strong migration comes with a spike in the job growth of new settlers.
If a market has a higher growth rate, it will take less time to achieve that large growth in property value. The longer you expect to own the real estate, the more comfortable you will need to be with the property market you choose. If a city doesn’t have a high enough growth rate, it could become stagnant, which means there will not be any development in the future and puts constraints on increased demand for properties.
Frequently Asked Questions About Primary Secondary Tertiary Markets
Places like Austin, Texas; Tampa, Florida, Raleigh, North Carolina; and Atlanta, Georgia, to name a few, have seen massive appreciation over the past two years. In commercial real estate, CAP rates have continued to compress, significantly increasing asset valuations. Competition from buyers to acquire assets has continued to strengthen, causing further supply issues.
An example of tertiary real estate would be a property in Charleston, South Carolina, which is a little bit of a smaller market, with less than 1 million people that is not densely populated.
Primary Secondary Tertiary Markets - Conclusion
Choosing the right real estate market to invest in is a decision not taken lightly. The information you have just read should help simplify your search by giving you an overview of what each type of market classification means and how it might impact your investment decisions.
If your co-investing then whomever the sponsor is of the real estate project, they’ll have already chosen the market. So as a limited partner (LP) it’s your job to understand what market classification the property is located in and what that means for exiting the deal in 5-10 years.
All 3 real estate market classifications have their own unique advantages and disadvantages and should be at the top of your list when it comes to your real estate investment strategy analysis. Now that you understand the difference between primary, secondary, and tertiary real estate markets, you can make an educated decision as to what market type provides the best risk vs return profile for your comfort level.
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