Targeting your Investment
Glamourous Markets versus Dull Markets
Investing moderate sums in dull, steady markets is better than investing large sums in glamorous, volatile markets
Inbound USA Realty assists non-US investors in finding and evaluating real estate investment opportunities in the US which call for cash investments ranging from $200,000 to $20 million. In doing so, we suggest that non-US investors look for opportunities in medium-sized markets, that is, markets other than New York City, San Francisco, Los Angeles, Miami and Boston.
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Why do we focus on medium-sized markets, and why do we focus on the $200,000 to $20 million value increment?
Because that strategy offers a competitive advantage to a non-US investor who is not a full-time real estate professional.
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What is that competitive advantage?
There are a variety of ways to categorize real estate markets in the United States. One very useful way is to categorize them by risk over time, specifically, risk over time without consideration for whether the real estate is residential, office, warehouse or other.
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By that measure, real estate values in New York City, San Francisco and Boston (and, to a lesser extent, Miami and Los Angeles) are relatively volatile. In other words, the value of real estate in those markets will, compared to mid-sized markets, tend to increase more rapidly when times are good and tend to fall further when times are bad.
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While there are many theories why this is so, it is likely in part because these are so-called ‘gateway’ markets. Gateway markets means, in this sense, markets that are most attractive to large and/or institutional investors. This institutional category includes US and non-US pension funds, Wall Street sources and professional, full-time investors (whether based within or outside the United States).
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A point related to the long-term volatility question is that there tends to be less pressure on land prices in middle markets than in gateway markets. Consequently, the pricing of investment-grade real estate in these alternative locations more closely reflects actual costs of development and construction. As a result of that, these areas, although offering less opportunity for huge profits, also tend to be less vulnerable to market downturns.
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All of the foregoing supports the hypothesis that the search by large and/or institutional investors for yield has a greater impact on prices in gateway markets than in middle markets (let’s call this “Yield Pricing”). Conversely, steady, long-term user demand (i.e., the demand by tenants and prospective tenants for space) has a relatively greater impact on prices in middle markets than in gateway markets (let’s call this “Tenant Pricing”).
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Competition for yield drives yields down. Consequently, the return on cash invested in dull middle markets, where the influence of Tenant Pricing is greater, will tend to be (and, market data indicates, is in fact) higher than the return on cash invested in glamorous gateway markets, where Yield Pricing is more influential.
Suburban Markets vs. Central Business Districts
Investing in suburban markets is better than investing in central business districts
A comparison of the rent/asset price ratio in middle market central business districts and the rent/asset price in middle market suburban areas suggests that Yield Pricing is not only relatively stronger than Tenant Pricing in gateway markets, but it is also relatively stronger the central business districts of middle markets. That is, even in middle markets, the influence of Yield Pricing on the value of central business district properties means that returns on cash will tend be higher when the non-institutional investor, most importantly, a private non-US investor, invests in properties near but not in the center of urban areas.
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Based on the foregoing, the return on cash invested in middle market suburban properties will tend, for private, non-institutional investors, to be higher, all else being equal, than the return on cash invested in middle market central business district properties
Summary
Non-US investors who are either just beginning to enter the US market or who are interested in only one or a few real estate investments in the United States should consider, as a starting point, looking at direct and indirect investments in properties that are located in suburban areas, that is, outside central business districts.
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Within that framework, there are dozens of mid-sized US markets that justify serious consideration as a source of investment opportunities.
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Examples include Phoenix, Las Vegas and Salt Lake City in the west, Atlanta, Dallas, Houston, Charlotte and Orlando in the south, and Philadelphia, Washington DC, Hartford and Richmond in the mid-Atlantic and northeast.
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Overlapping with the above list, we also suggest considering investments in the so-called “95 Corridor,” which is the densely populated northeast part of the United States, from Boston in the north to Washington, D.C. in the south. The 95 Corridor is an example of a broader regional market that offers investment opportunities outside of urban areas (in the case of the 95 Corridor, that means between major cities) that are worthy of consideration.