It’s no secret that investing in real estate is one of the best ways to build wealth. People from all over the country look to hold and rent out real estate to build equity and generate income. Unfortunately, many people buy single-family homes or condos or invest in larger projects like syndications without understanding the fundamentals of the different kinds of real estate markets. Finding your ideal market that fits your criteria and investment strategy is crucial to find a successful real estate investment.
Here’s what you need to know about the levels of real estate investing, including gateway markets, secondary markets, and tertiary ones!
The Problem with Categorizing Real Estate Markets
If you were to ask the average person how they would differentiate real estate markets, the answer you’d likely get would revolve around population density. A rural market consisting of farms and small businesses would be much different than a market like San Jose, CA.
And they would be right. Those are very different markets.
But to go solely based on population is an oversimplification. What’s happening in San Jose might be different from what’s happening in Houston. Even though both are large cities, they have entirely different demographics and job prospects. For example, a tech crash might obliterate the San Jose market, and an oil boom might bolster Houston. Other dimensions, like immigration, look very different in these two cities.
That’s why investors have come up with three broad market classifications to try and compare different real estate markets with each other. Indeed, there are three overall types of markets: gateway markets (the primary real estate markets), secondary markets, and tertiary markets.
Gateway Markets (Primary Real Estate Markets)
What are gateway markets? Gateway markets are the biggest metropolitan areas in the United States. They are highly sought-after markets both by the public (moving there) and by equity investors seeking to buy apartment buildings, commercial office towers, etc. When you think of gateway markets, think of places like New York, LA, San Francisco, Boston, DC, and Miami. These are markets that have long-established population histories and long-established commerce.
Gateway markets typically have the following characteristics:
- High rent, high demand
- Lower cap rate (stable, less-risky income and high investment activity means lower cap rates)
- Tend to be more stable investments
If you want a stable investment with a decent ROI, you’ll want to put your money into a gateway market.
These markets are all the other “non-gateway” cities. They’re well-known cities in the United States but might not make the top of an international tourist list.
Examples of secondary markets include Charlotte, Denver, Atlanta, Seattle, Atlanta, Minneapolis, etc. Within the United States, everyone knows about Atlanta.
Secondary markets usually have undergone a period of high growth to get to where they are now. For example, the Seattle area has seen a big tech boom recently. That boom has brought many people to the area, thereby raising rents and property valuations.
Secondary markets tend to have the following characteristics:
- High rent, high demand
- Medium cap rate (stable income but not attracting the same levels of cap rate compression that the gateway markets have)
- Stable investments, as these are usually mature economies
Secondary markets are often a fantastic place to look for real estate investments because they offer higher cash flow and sale prices than gateway markets.
These are cities that are emerging in growth. Populations are typically below one million, but they could become the next secondary market if they keep their same growth trajectory. In most cases tertiary markets are on the outskirts of primary markets, and usually, there’s something specific fuelling the underlying growth (like bountiful natural resources or a budding tech scene).
Tertiary markets fluctuate quite a bit, so quickly listing them out would be out-of-date. However, tertiary markets typically share these characteristics:
- Lower rent, high demand
- Higher cap rate (high growth means high potential ROI, but also higher risk)
- Less stable investments but a more significant payoff opportunity
Are the Gateway Markets Right for You?
If you were brand-new to real estate investing and tried to figure out where to start, you’d probably pick a gateway market. After all, buying a property in LA, for example, should be reasonably safe. Or, investing in a syndication in LA should be reasonably straightforward.
The problem is that these markets aren’t often the best bet. The high-growth markets, the secondary and tertiary ones, are where people flock in downturns. Everyone escapes the primary real estate markets seeking lower rent costs and leases, benefiting the lower cost-of-living areas.
So, the gateway markets have a lower cap rate overall, and they can also run into some issues in a downturn, with people leaving those high cost-of-living places.
Sure it’s a stable, sought-after area, but wouldn’t you prefer to benefit from the high growth? Wouldn’t it be better to take advantage of the lower upfront costs and instead enjoy the rising rent prices, giving you progressively better rents and, ultimately, a much better future sales price?
The gateway markets don’t provide the best returns for most people – the secondary and tertiary markets do!
Know What Your Goals Are
Ultimately, it all comes down to investing with strategy. As an investor, it’s important to nail down the cash flow and appreciation you are looking for and your investment strategy. This will play a significant role in determining the markets you should be pursuing for your next real estate investment. For example, are you an investor focused on cash flow (aka. passive income?)? If so, secondary or tertiary markets may be your best bet! If you are looking for long-term appreciation, gateway markets will better fit your investment criteria.
The moral of the story, know your goals and your strategy, and that will help you pick your next real estate market for investment!