SACRS Spring 2025: Challenging Misconceptions: Research Makes Compelling Case for Investing in Smaller Markets
Originally published in SACRS Spring 2025
by Ryan Swehla
Cities such as Bakersfield, Orem, or Loveland aren’t typically top-of-mind for institutional investors. But groups that once bypassed such secondary and tertiary markets in favor of major metros are now putting these smaller markets on their radar.
Institutions have traditionally viewed commercial real estate investment through a fairly narrow geographic scope with their sights firmly set on acquiring assets in primary markets. Even as competition and a search for better risk-adjusted yields pushed investors to expand their focus beyond the top 10 metros, they have typically moved cautiously and targeted large, fast-growing secondary markets.
That investment thesis is now changing, thanks in large part to greater transparency and historical data that presents a solid business case for strong performance of assets in smaller secondary and tertiary markets. Graceada Partners recently conducted an in-depth analysis of economic metrics and real estate fundamentals in workforce housing and industrial sectors in secondary and tertiary markets versus primary markets in the Western U.S. The findings uncovered surprising results on the vibrancy of local economies, outperformance in key real estate market fundamentals, and greater stability across the past 20 years.
When an institutional investor hears the term “secondary and tertiary markets,” several concerns automatically come to mind, including lack of liquidity, less economic diversity and overall slower growth, particularly during economic downturns. Data-driven research is debunking many of those long-held market misperceptions.
Vibrant Local Economies
Secondary and tertiary markets in the West are economically more robust, and importantly, less volatile than primary markets. Analysis of data from Oxford Economics and the U.S. Bureau of Economic Analysis of 12 secondary and tertiary markets found that the sample set exhibited stronger GDP growth, income growth and job growth compared to bigger primaries, such as San Francisco and Los Angeles, over the 20-year period from 2002 to 2022. Key highlights include:
Economic Growth: GDP growth averaged 5.05% in secondary and tertiary markets– 36 bps higher compared to primary markets. During the Great Financial Crisis, GDP growth in secondary and tertiary markets was 300 bps better than in primary markets, and GDP growth also outperformed primary markets during the COVID pandemic.
Job Growth: Employment was consistently better in secondary and tertiary markets, even during the GFC and during the pandemic. Annual average job growth at 1.76% over the 20-year period is almost double the 0.92% in primary markets. Secondary and tertiary markets also posted consistently lower unemployment, with an average of 6.04% that is 35 bps below primary markets.
Income Growth: Household income growth in secondary and tertiary markets is on par with primary markets. However, growth in the smaller markets tends to be more stable, with fewer peaks and valleys as compared to primary markets. During the GFC, primary markets had more severe income declines, and during the pandemic secondary and tertiary markets posted continued positive income growth whereas primary markets had negative income growth.
The purpose of this article is to present a data-grounded reexamination of outdated investment heuristics that reflexively favor primary markets. We aim to provide institutional investors with a framework to better understand and evaluate the evolving performance dynamics of smaller Western US cities—and why, in today’s climate, those dynamics may be better aligned with risk adjusted return goals than the traditional gateway cities.
People, Diverse Economies Fuel FGrowth
The perception that smaller metros are more likely to be so-called “one-mill” towns that are more prone to boom-and-bust cycles doesn’t hold up in the West. Two key reasons why secondary and tertiary markets are outperforming are their diverse economies and population growth, including net in-migration.
Among the dozen Western cities Graceada analyzed in California, Utah, Nevada and Colorado, all had broadly diversified economies with most having no single sector greater than 17% of GDP. The two exceptions are Sacramento and Colorado Springs, where the government represented 22% and 24%, respectively. In comparison, more than 50% of GDP in the San Francisco Bay Area is dependent on technology.
Fresno, for example, has a broad cross- section of industries ranging from manufacturing, transportation and agriculture to business & professional services and real estate. Among the top employers in Fresno County are major firms such as Cargill, Foster Farms, Pelco, Kaiser Permanente, and Amazon, among others.
Population growth is one of the biggest drivers of demand for real estate, and secondary and tertiary markets produce consistently higher net population growth with an annual average of 1.3% versus nearly flat growth in primaries at 0.2%. Primary market population growth exhibits almost twice the volatility of secondary and tertiary markets and registered declined in seven of the 20 years analyzed.
Another important point to highlight is that while the pandemic may have accelerated population growth out of primary markets and into smaller metros, data shows a consistent and positive trendline for Western U.S. secondary and tertiary markets over the last 20 years with no pandemic-induced spike. That suggests that these are long-term expansion markets that are receiving in-migration from other parts of the U.S. and not just from neighboring primary markets such as San Francisco or Los Angeles.
Solid Foundation for Real Estate
That strong economic base, and growth – in people, jobs, and incomes – drives demand for commercial real estate. The other side of the equation is supply. Another common misperception for secondary and tertiary markets is that there is abundant land and fewer barriers to entry for developers, which creates greater risk of oversupply.
Analysis of CoStar data clearly shows greater volatility in supply and demand in primary markets when looking at net absorption. The likely reason for that is that there is more availability of capital for development in primary markets, whereas in secondary and tertiary markets, development tends to be limited to private capital. The relatively good balance between supply and demand dynamics is another factor contributing to outperformance in market fundamentals.
Workforce Housing Highlights
◼ Rent growth: Secondary and tertiary markets average annual asking rent growth at 3.02% is roughly 40 basis points higher than primary markets.
◼ Net absorption: Secondary and tertiary markets have consistently better net absorption, with an annual average of 0.73%, more than double that of primary markets.
◼ Vacancy: While primary markets tend to have lower vacancy (4.75% on average versus 5.79%), data shows that vacancies have been converging.
◼ Cap rates: On average, cap rates are still higher in secondary and tertiary markets by about 45+ bps. In addition, the gap in cap rates between primary and secondary and tertiary markets has been narrowing since 2008, which underscores the broader acceptance of multifamily investment in these markets.
Industrial Market Highlights
◼ Rent growth: Overall, primary markets lead in average annual rent growth at a rate of 4.31% versus 3.81%. However, secondary and tertiary markets outperformed during the GFC, and have posted stronger rent growth since 2017.
◼ Net absorption: Secondary and tertiary markets have consistently outperformed with annual net absorption of 1.59% versus -0.03% for primary markets, which likely underscores the greater risk of boom/ bust development cycles in primary markets.
◼ Vacancy rate: Although vacancies trend higher in secondary and tertiary markets at 6.40% versus 4.91%, data shows that vacancies have been converging, especially over the past several years.
◼ Cap rates: Secondary and tertiary markets average cap rates that are 160 bps higher than primary markets. However, there is no convergence between cap rates (unlike in workforce multifamily), which potentially creates an opportunity for convergence in the future.
A snapshot of current market research shows that secondary and tertiary markets are continuing to follow historical trend lines. For example, a Q3 2024 research report on Sacramento’s multifamily markets published by Colliers showed a strong recovery in 2024. Demand outpaced supply by 1,000 units during the first three quarters, with vacancies at 5% and effective rents growing at an annual rate of 1.4%, pushing average rental rates past $2,000 for the first time ever.
Despite softening in many national industrial markets, vacancies in Colorado Springs dipped lower to 4.6% during the third quarter with newer class A space in particular that is in short supply. Asking rents grew at a modest 1.2%, while cap rates averaged between 6.5 and 7%, according to NAI Highland.
Expanding Investment Box
Targeting secondary and tertiary markets fits into what has been an ongoing trend in strategy for many institutional investors. Over time, institutions have been expanding their traditional view of what is considered to be the accepted “investable universe” and are continuing to move into new property types and sub-types, as well as new geographies.
A number of factors are opening pathways into new markets. The markets themselves are maturing and there is more data and transparency. Institutions also have developed their own processes for overcoming misperceptions, identifying opportunities, underwriting investment assets, and building the infrastructure and expertise to successfully execute investments in new areas.
A clear example of that expansion is the move beyond the traditional core property types and heavy concentrations in office into a variety of alternatives, such as self-storage, manufactured housing and single-family rentals, among others. In the early days for each of these new sub-sectors, there was a litany of reasons (and misconceptions) why such strategies or focus areas were “non-institutional” or not investable. Each time, those objections were ultimately overcome and the first investors into the space benefited from lack of institutional competition. That same trend is now underway in secondary and tertiary markets, and institutions have the potential to capture similar first-move advantages.
Ryan Swehla is Co-CEO and Co-Founder at Graceada Partners, a value-add real estate investor focused on institutionalizing secondary & tertiary markets of the Western U.S. with a combination of entrenched market knowledge and institutional expertise. Ryan provides strategic direction for the firm and serves on Graceada Partners’ investment committee. His insights on the real estate investing climate have been cited in Institutional Real Estate Americas, The New York Times, Forbes, Barron’s, and REIT Magazine.