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Apartment Investment -
Secondary Markets Show Upside for Investors

For several years, primary markets like Chicago, Boston, New York and Los Angeles have been the focus of multifamily investors. These markets are attractive because they are considered high barrier to entry markets, creating security and stability for investors.

But, competition in these major markets is fierce, pushing pricing up and returns down. That's why many investors are seeking multifamily opportunities in so-called secondary markets - those with smaller populations and fewer real estate investors chasing the same apartment deals.


"Sometimes it seems like 90 percent of the capital is chasing deals in 10 percent of the markets," says Frank Marro, managing director of multifamily investments for GE Real Estate's joint venture group. "We would love to invest in markets like Chicago, Boston, New York and L.A., but so would everyone else. The real key for us is teaming with the right local partner who has the operating expertise to add value as price appreciation will no longer come from cap rate compression."

In many secondary markets, investors are finding quality assets at more favorable pricing and higher cap rates. Many of these secondary markets have expanding populations, strong job growth, and limited new apartment development. As a result, investors in many secondary markets are benefiting from strong apartment occupancies and rental rate increases.

GREM evaluated several secondary markets across the U.S. and discovered the top five secondary markets that show high growth potential for multifamily investors. The markets are: Baltimore, Md.; Birmingham, Ala.; San Antonio, Texas; Tacoma, Wash.; and Tucson, Ariz.

Baltimore, Md.
Investors with a five to 10-year holding period who are looking for a sleeper market with tremendous growth potential will not be disappointed by Baltimore.

"Baltimore is a special market that shows numerous signs of being the 'it' place for the individual investor to buy apartments now before prices begin to escalate - sort of the calm before the storm," says Tim Phillips, an associate with Marcus & Millichap Real Estate Investment Services in Baltimore. "Much of this excitement stems from the projected impact of Base Relocations and Closure (BRAC) process and the emerging biotech industry."

Over the next five years, BRAC alone will bring 45,000 new jobs to the area and is expected to have a $5 billion economic impact annually on the region. Baltimore is also emerging as a biotech hub with numerous hospitals and medical facilities currently under development. This growth will create a multifamily housing need for healthcare personnel including nurses, interns and residents.

Strong demand and robust absorption are expected to push the vacancy rate below the current six percent mark, while rental rates will increase more than three percent annually.

Historically, Baltimore has had negative population growth which dates back to the 1950s. But in 2006, the exodus slowed and the city had a net gain of approximately 100 people - a change that many believe will be the first of many years of population growth.

"The population growth can partially be attributed to residents moving from costly Washington D.C. to a place more affordable, while only being a 45 minute drive to their job," Phillips says.

Baltimore city officials are also working hard to bring new businesses to the area. With projects like Harbor East, a 38-acre mixed-use development, and Harbor Pointe, a 1.8 million square-foot mixed-use project, they are hoping to create a live, work, play environment in Baltimore for years to come.

"We agree that Baltimore is an excellent market for multifamily investments," Marro says. "It is actually one of our primary markets and we are actively seeking investments there."

Birmingham, Ala.
Unlike many apartments markets that have severe peaks and valleys, the Birmingham, Ala. multifamily market is consistently strong.

GE Real Estate's Marro agrees that Birmingham should be a solid market, although liquidity may be an issue. "Birmingham is one of those solid, growing markets that has not yet hit the radar screen of many institutional investors. We are watching it carefully and would be interested in doing business there with the right partner," he says.

Over the past five years, rents have steadily increased approximately 3.5 percent with 25 quarters of rent growth, according to a recent report by Rock Apartment Advisors, a Birmingham-based multifamily brokerage firm specializing in Alabama and the Southeast.

Meanwhile, occupancy has averaged 95 percent, and new development has averaged 700 new units per year - a paltry amount compared to other Alabama markets such as Mobile and Montgomery with 2,399 units and 1,034 units under construction, respectively.

"With few units being developed and entitlements difficult to obtain, many investors are eager to invest in Birmingham's multifamily market," says Michael Murphy, chief operating officer for Rock Apartment Advisors.

Over the past few years, many out-of-state investors from California, Florida and New York have invested in Birmingham's apartment market because of its value-added opportunities, says Steve Ankenbrandt, president of Rock Apartment Advisors, adding that investors realize there is a great opportunity in this market to improve the quality of the property and to increase their net operating income through rehabilitation and repositioning - without the worry of a saturation of new units coming on line.

San Antonio, Texas
For investors seeking both stability and growth, San Antonio has plenty of appeal. With occupancy rates ranging from 90 to 95 percent over the past 17 years and rental increases of about three percent every year, this market is one of the best performing in the nation and has investors eyeing it from all over the world.

"If 20 years of history is any indication, the San Antonio multifamily investment market will continue to appreciate in value because of its stability and traction," says Will Balthrope, senior director with Marcus & Millichap's Dallas office. Of the last five San Antonio properties that Balthrope brokered, four were to buyers located outside of Texas, including one offshore investment group.

San Antonio's economy strongly supports the multifamily markets future growth. The city, well known as a tourist destination because of the River Walk, boasts a diverse economy that is unusual for many secondary markets. As the home of the University of Texas Health Science Center at San Antonio and several other hospitals, the medical industry is leading the way with job growth. In fact, San Antonio is projected to be the fourth fastest job growth and population growth city in the U.S. over the next five years, according to Marcus & Millichap Research Services and Economy.com.

"San Antonio continues to be a target market for us," says GE Real Estate's Marro. "We have had a very successful track record there with several local partners such as CWS, Venterra Realty, and The Lynd Company among others and look to continue that in the future."

Tacoma, Wash.
The rebirth of downtown Tacoma has made many residents eager to call this secondary market home, and multifamily investors are following. The city's focused urban revitalization effort, which includes the University of Washington campus, Tacoma Art Museum and Tacoma Convention and Trade Center, has transformed it from a blighted urban core into a vibrant 24-hour environment that overlooks Commencement Bay with views of Mt. Rainier in the background.

"The city wants to make the area appealing to residents, and residents want to be downtown," says Josh Blake, senior advisor for Hendricks & Partners' Seattle office. "City officials have done a good job in improving the quality of life in this formerly blighted area."

While Tacoma's downtown continues to improve, the city's local economy also is expanding. Approximately 43,000 new jobs have been added during the past 12 months, with The Port of Tacoma continuing expansion and Fort Lewis' defense initiatives adding $2.5 billion to the local economy.

Tacoma's multifamily fundamentals continue to be strong, with vacancy dropping from 7.4 percent in September 2006 to 3.6 percent in September 2007. Even with low vacancy, development remains in check with only 749 units completed in 2007 and 649 units currently under construction. In 2007, rental rates increased 3.8 percent.

"The combination of the Port of Tacoma expansion, supply constraints and increased demand, all as reflected in the strong operating fundamentals, make this a very attractive market for GE," Marro notes.

Tucson, Ariz.
With extremely strong fundamentals, one could argue that Tucson is the hottest multifamily market in the Southwest, if not the United States.

"Over the past few years, demand for multifamily housing in the Tucson market has significantly outpaced new supply, resulting in decreasing vacancy rates and strong rental penetration, thus effectively increasing rental rates," says Michael Sauter, CEO of S-J Management LLC, a Seattle-based firm that is actively buying class A apartments in Tucson. The company, which started investing in Tucson in 2006, owns about 1,000 units in the city.

Tucson's median home price jumped 21.4 percent over the 12 months ending March of 2007, resulting in fewer renters qualifying for homeownership. Today, the vacancy rate is approximately six percent. Low vacancy, combined with rental upside, has generated a 14 percent increase in net income since 2000.

With fewer than 100 units under construction, and 133 units in the planning process, Tucson's future looks bright (although several recent sales of land zoned for multifamily development could allow for 1,000 apartments units to be built over the next few years.)

Nonetheless, the horizon continues to look good for Tucson. In 2008, the trends that have been in effect since the 1st quarter of 2003 (improving occupancy, rental growth, lack of substantial new product, increased profitability for owners, strong investor demand and increasing valuations of properties) will continue.

"The underlying fundamentals are strong and the Tucson market will continue its steady climb," Sauter contends.

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