In recent years, direct investment in commercial real estate has been heavily concentrated in a few cities such as New York, Washington and Los Angeles, which are considered safe havens during times of market uncertainty. 2013 saw a big jump in U.S. property investment, with much of the new money coming from foreign sources most comfortable with these “gateway” cities. As cap rates in those cities fell, many investors looked to secondary cities, as well as some smaller markets with good growth prospects.
While it's true that up-and-coming cities can offer higher going-in yields than investors can expect to get in Manhattan, a broader geographic strategy can also hold additional risks. The key to investment success is maintaining a disciplined approach in markets that demonstrate strength.
Commercial property markets were hit harder by the recession in some cities than others, and some cities have recovered more quickly. In fact, our analysis shows the cities with the lowest rate of job loss during the recession have also outpaced most other cities in terms of job gains in the recovery. In other words, some cities are expanding again while others are still well below the previous peak, in terms of rent and occupancy.
So a secondary-market strategy has a potential reward in the form of higher going-in cap rates, but there is also greater downside risk. By understanding the factors that can affect financial performance, investors can make decisions that best meet their risk and yield tolerance.