A decade ago, Austin was a quirky college town perhaps best known for its slate of annual music festivals. Today, it is the heart of private real estate investment in the US.
The Texas state capital is the number one US destination for international investors in 2021, according to two surveys released this month. Along with it, several other second- and third-tier metros have shot up institutional wish lists this year, with markets across the southern US outpacing traditional coastal gateways in terms of investor demand.
This proverbial ‘rise of the rest’ is cyclical. Investors tend to go searching for yield late in real estate cycles when property values in traditional markets get prohibitively high, according to Will McIntosh, head of global research for USAA Real Estate.
“With competition in primary markets, [investors] see secondary markets as a place to get returns,” McIntosh said during a webinar that the Association of Foreign Investors in Real Estate hosted about its survey findings. “They ask, ‘Where can I go to get my yields up?’ And these secondary markets all of a sudden get more popular.”
There are secular trends at play, too. Companies and people have been fleeing traditional real estate hubs for less costly alternatives for years. Enthusiasm for markets in Texas, Florida and the Carolinas rides on an expectation of that migratory pattern continuing to drive economic expansion. But the question is whether real estate investment will remain in line with that growth.
“We have to watch carefully,” McIntosh said. “These markets are only so deep, so they could get overheated… Developers will keep on building until someone makes them stop.”
Thirty percent of respondents in AFIRE’s survey said they plan to invest in Austin this year, making it the first tertiary city to top the association’s annual ranking. It also topped the wish list of the real estate executives surveyed by the UK law firm DLA Piper, with 53 percent saying it would be the top investment market in the year ahead.
Austin is a unique case study. Within the top 50 metropolitan statistical areas in the US, it saw the fastest growth between 2010 and 2019, increasing its population by 30 percent during that stretch, according to US Census data. On average, it has added about 32,000 residents annually from domestic migration, a trend that seems to have accelerated during the pandemic. That population growth paired with the state’s friendly tax regime has attracted major commitments from companies such as Apple, Tesla and Oracle.
Yet, Austin is not the only second – or third – tier US city to have captured the eye of global capital. Atlanta and Dallas were both top-five cities in the AFIRE survey. Additionally, roughly 80 percent of respondents said they plan to grow their exposure to secondary markets (cities between 1 million and 5 million residents) more broadly, while 60 percent said the same of tertiary markets (cities with less than 1 million residents). In DLA Piper’s survey, Denver, Nashville, Charlotte and Raleigh-Durham were favored over traditional gateways such as New York, San Francisco, Los Angeles, Chicago, Boston and Washington, DC.
Matt Bear, founder of Bear Real Estate Advisors, a Las Vegas brokerage that serves institutional buyers, said the rising second- and third-tier cities represent the nexus between good schools, growing job markets and affordable housing. But he noted that the broadening spectrum of institutional-grade property types has expanded the investable map for many investors.
“If you’re going to be in the logistics business, that means being in multiple nodes all throughout the country, and in that sense, Des Moines, Iowa is probably as important as metro Atlanta,” Bear said. “I’m doing a lot of work in cold storage and that tends to be in some pretty remote areas because of cost or proximity to where food is actually being produced or packaged.”
Following the money
In winning over the hearts and minds of international investors, next-tier cities are securing significant investment dollars. Seattle overtook Manhattan as the biggest landing spot for cross-border investment for the 12-month period ending on March 31, absorbing more than $2.5 billion, according to the transactions house Real Capital Analytics. It was the first time Manhattan was knocked from the top spot since the global financial crisis, the firm noted.
On the construction front, Dallas – a booming secondary city that some feel has reached primary market status – remained the top market for new starts. Nearly $18 billion-worth of commercial projects commenced there from Q2 2020 through Q1 2021, according to RCA, more than double that of second-ranked Los Angeles. Manhattan, which had already seen activity waning pre-covid, slid from the eighth-busiest construction market to the 14th. Likewise, Boston fell from three to 11.
Meanwhile, Seattle climbed from seventh to fourth on the list, Austin from 12th to sixth and Nashville, one of the few cities to see year-over-year growth in volume during the pandemic, shot up from 18th to ninth. Raleigh-Durham was another market to experience a construction boom, seeing new start volumes climb 75 percent from 2019 to 2020, helping it jump from the 34th biggest construction market to the 15th.
Despite the hefty influx of capital into these relatively small metros, Zeb Bradford, chief investment officer for Seattle-based investment firm Metzler Real Estate, said the demographic trends are poised to support it.
“One mitigating factor to this wall of capital is that the secondary cities are attractive because of strong growth economically and demographically,” Bradford said during AFIRE’s webinar. “Even if cap rates go low, they should grow to a good yield over time, if growth continues.”
Ultimately, how those growth patterns play out will dictate whether the shift toward Austin, Atlanta, Dallas and other recently popular markets is a permanent one, or if the likes of New York, San Francisco and Los Angeles return to prominence for global investors.