The Emergent Value of Third City Markets

American population trends and movement of people reflect many things, including values, affordability, and quality of life. There is a desire among people to pursue places where the grass is greener, and embedded in the American dream is the spirit of people on the move. From the Gold Rush to the Great Migration and the modern Work-and-Live-Anywhere Movement during the pandemic, groups of people have been on the move for various reasons.

Modern migration taking place in the U.S. is centered on affordability and perceived quality of life. People are looking for cities with relatively lower rent or mortgage payments where they can cultivate a better work/life balance. For some, that means moving out of primary and even secondary markets into tertiary ones. There is an interesting trend of people and growth in what can be considered “third city markets,” defined generally as a city with 100,000 to 200,000 residents within several hours’ drive or a short plane ride from a major hub. These third city markets—hereby referred to as TCMs—are paving the way for a more geographically diffused economy. There is some momentum toward certain TCMs and away from certain primary and secondary markets, particularly in the Heartland, the Southwest (the Cactus Belt), and portions of the Pacific Northwest and Mountain West (Western Interior).

The Gravitational Pull Towards Third City Markets

With the dispersion of remote and gig workers away from major metropolitan areas and the increasing interest in investments in non-primary markets, second and tertiary markets are primed for incredible growth given the trends of the past few years. Nathan Metheny, the co-founder of Wealth Rise Capital, said that “Healthcare and education are typical industries supporting tertiary markets, which can be viewed as a main factor to the stabilization.” He went on to say that these micro-economies were recession-resilient because of their financial growth and diversification.

In Graceada Partners’ first-ever ranking of third city markets, we looked at more than 65 target markets across the U.S. that broadly fit our definition of a TCM. From there, we compiled a list detailing the top 20 TCMs based on key criteria such as renter value, rent growth potential, and purchase value collected using CoStar, as well as quality-of-life measurement using AARP data. We also evaluated U.S. Census data to track population growth in regions. Our overall formula provides a comprehensive, unique measurement of the top 20 TCMs in the United States that may hold the most value for residents looking to move there and investors looking to build a portfolio in those areas.

While a handful of TCMs had higher-than-average vacancy rates compared to the national environment, El Centro and McMinnville had vacancy rates at 1.6% and 1.2%, respectively. Despite not ranking higher on the Top 20 List, they showed signs of growth that could position these tertiary markets for future expansion.

How an uptick in TCM growth could impact some secondary and primary markets

Given the rise of the concept of “Zoom towns,” TCMs will become increasingly appealing to those in proximity to a secondary or primary market. “By the end of 2020, 48% of Americans expressed an interest in living in small towns,” according to a recent Twingate study evaluating the “Zoom town” phenomenon, a reference to boomtowns of the 1800s that sprung up around newly discovered economic opportunities. Some of the growth of TCMs comes from working professionals moving there remotely, which in turn creates demand for housing. The influx of people also generates demand for consumer-facing businesses such as grocery stores, restaurants, and gyms, which then need to hire employees to support the growing population.

Several years removed from the start of the pandemic, Americans are still rethinking where they want to reside as more employers establish or make permanent remote work policies. As a result, some real estate investors may consider re-examining the markets where people are moving as viable investment opportunities. Secondary markets will remain valuable for homebuyers, renters, and investors, while TCMs will experience a similar, though less pronounced, trend in the coming years. Part of this shift will be driven by the expansion from secondary markets into TCMs, as well as the greater opportunity-to-cost ratio that tertiary markets offer compared to nearby larger markets.

Yuba City, for example, may become one of these “Zoom towns” as former Bay Area or Sacramento residents relocate to this tertiary market. As the gig economy continues to expand, cities like Yuba City and other locations in Northern California may attract increased interest from institutional investors seeking opportunistic, long-term investments outside of San Francisco or the state’s capital.

Competitive secondary markets are driving some people to TCMs

As noted in Graceada Partners’ Rise of the Outpost Economy report, office demand is increasing, financial rebirths are occurring in traditionally working-class cities, and the rise of untethered workers will propel professionals into less expensive geographic areas that still offer a competitive edge in terms of living standards. This trend has been evident among workers leaving primary markets for secondary markets and is now extending to those relocating from primary or secondary markets into tertiary markets. A more globalized world and interconnected financial community are decentralizing where untethered workers choose to live. Simply put, more people have the luxury of living and working wherever they want.

Yuma, Arizona—a border city equidistant from San Diego and Phoenix—is an example of this shift. Yuma is a TCM that shows considerable potential in a state projected to grow by 12% between now and 2030 and is included in our list of the top 20 TCMs. Except for a few outliers, the average rent for many TCMs is in the $900s. The states of New Mexico, Arizona, and Washington are expected to experience population growth of over 10% throughout the 2020s. As more people move to these states and recognize the value within their TCMs, demand is expected to continue rising.

More competitive tertiary markets may catch the eye of investors who have traditionally overlooked such areas. According to Wealth Management, “Traditionally, larger institutional investors have been wary of the greater risk and reduced liquidity in smaller metros, as well as the challenge of being able to place capital at scale. However, many smaller metros are posting strong growth, which has been further fueled by the pandemic and remote working.”

Some major markets are witnessing a surge in population and increasing housing or development costs, making them unattainable for many people with smaller budgets. Take Seattle as an example. The average rent in Seattle is $2,334, according to RentCafe, which is more than $1,000 above the national average. However, Yakima, Washington, is geographically close to Seattle while being far more affordable, with rent costs roughly half those in the Emerald City. This affordability makes Yakima appealing to workers who are fully remote or only need to commute to Seattle a few times a week.

Money speaks volumes, but quality of life is also quite relevant

Trend 1: Third City Markets are becoming an increasingly popular place to live and will grow as a place to live and invest in the next decade

Echoing the success and growth of fast-growing larger markets like Atlanta, Salt Lake City, and Austin, TCMs will experience spillover from primary and secondary markets, leading to accelerated prosperity and population growth in top TCMs with a higher quality of life. As seen in primary markets like San Francisco during the pandemic, many individuals began relocating inland to areas in and around Sacramento. This migration has fueled the rise of outpost economies in Northern California, increasing the attractiveness of cities like Redding, California—ranked No. 3 on our list of top TCMs.

The Milken Institute’s 2022 Best-Performing Cities list ranked Redding as the fourth-best economic small city in the United States, a significant leap from its 2021 ranking of 63rd. Idaho Falls, another city on our Top 20 TCM list, followed closely behind Redding, ranking fifth in Milken’s 2022 analysis and sixth in our assessment.

With these trends in mind, niche real estate investors may begin considering investment opportunities in attractive TCMs that would not have been on their radar just a few years ago. Our analysis reveals three major regions of the U.S. that contain many of the top 20 TCMs: the Heartland, the Cactus Belt, and the Western Interior. Colloquially, these regions correspond to the Midwest, Southwest, and Western U.S., respectively. TCMs in these areas are well-positioned for growth and resident attraction, potentially outpacing other American regions such as New England or the Deep South.

While primary markets will continue to thrive, these emerging third-city markets could become increasingly competitive within their respective regions. Some of the top 20 TCMs may even witness rapid expansion that elevates their status on the national stage. For example, Raleigh, North Carolina, had a population of roughly 200,000 in 1990, and in just 30 years, it has more than doubled to over 450,000. With relative affordability and a booming tech industry, Raleigh has attracted significant real estate investment, a trend that could be mirrored in some of today’s top TCMs.

Trend 2: Third City Markets offer increasingly more value to residents compared to some secondary markets

One of the primary appeals of TCMs for residents is their generally lower cost of living compared to larger markets in the U.S. Monthly rent and mortgage costs relative to average income in these markets make them particularly attractive for people seeking value.

Three of the top five TCMs have an average rent price below $1,000. In contrast, Austin, Texas—one of the fastest-growing secondary markets in the nation—has seen its cost of living skyrocket, with the average apartment now renting for over $1,800 per month. While some residents may justify the higher cost of living with higher salaries, the reality is that wages in many primary and secondary markets often do not keep pace with rising housing costs. Meanwhile, TCMs offer a much lower housing cost-to-income ratio.

For example, the rent-to-income ratio in Bloomington, Illinois, is just 13%, and in eight of the top 20 TCMs, it remains below 20%. This means that renters and homeowners in these communities have greater purchasing power, making TCMs more enticing than nearby secondary markets with significantly higher rent costs. This enhanced affordability, coupled with increasing demand for more budget-friendly rentals, could lead to long-term rent growth in cities such as Cheyenne, Wyoming; Rapid City, South Dakota; and Redding, California.

Trend 3: