Investors Are Chasing Rent Growth in Secondary Markets

Investors are chasing rent growth in secondary or emerging markets, but where affordability issues haven’t become a burden on residents. The combination creates strong longevity, according to speakers on the Transaction Talks: The Art of Multifamily Dealmaking panel at RealShare Apartments this week. The panel—which we covered earlier—featured Tim Hennessey, managing director at PGIM Real Estate; David Schwartz, CEO and chairman at Waterton Associates; Gary Goodman, SVP of acquisitions at Passco Companies; Marc D. Renard, executive vice chairman of the capital markets Group at Cushman & Wakefield; Mark Deason, managing director and head of U.S. asset management at Starwood Capital Group; and Richard Boynton, SVP of acquisitions at Fairfield Residential, and covered the geographic markets where investors are finding opportunities today.

Goodman looks for assets in markets where rents are growing but are still 25% of average income. He believes those are markets with the best opportunity to absorb rising rents in the long term. “We are buying in markets where the rents are only 25% of income, so we are able to see sustainable rent growth for residents in those units,” he said on the panel. This strategy has led him to secondary and even tertiary markets. The firm has bought apartment properties in places like Jackson, Mississippi, which Goodman describes as a rent by choice market, and Asheville, North Carolina. “People are moving into these areas and a lot of people want to rent,” he added. “The in-migration into these communities is strong.”

Renard asked if there is more rent growth potential in more primary markets, and Goodman said that it is really location specific. If you look at a market like Downtown Los Angeles, there is no or even negative rent growth, he said, adding that secondary markets may have more sustained rent growth at this point in the cycle. In addition to rent-to-income ratios, he also looks at markets where the jobs to permits ratio is high, at a three or four, and that generally rules out urban infill locations. “Urban infill locations are generally over built,” he explained. And, in markets like San Francisco, homeowners are putting restrictions on new apartment construction.

Still, there are higher risks to buying in secondary markets. Boynton said that secondary markets are typically more cyclical, using Dallas as an example. The market has seen substantial growth and has nearly 40,000 apartment units under construction. At the moment, in a strong economy, Dallas is absorbing those units with flat rent growth; however, in a weaker economic market, those units might not be absorbed or owners will have to give substantial concessions and lower rents. “The question is if we go into a recession, what is going to happen to their 40,000 units,” he asked. “I wouldn’t want to be in that market. I would rather be in a market like Inland Empire. I think that is a market that will hold up a lot better.”

Boynton also said that investment decisions in secondary markets would also depend on the business plan. At this point in the cycle, it might be riskier to invest in a secondary market, like Dallas, that would suffer more severely than a primary market. “If I was a short-term holder, you might worry about getting out of the market at the right time in a secondary market.”