Primary, Secondary and Tertiary Markets: How They Play a Role in Your Investment Strategy.
There is no set industry consensus on the definition of a primary, secondary or tertiary market. Aside from the overall ambiguity of the terms, there are a broadly recognized set of characteristics that help investors define a market. It is important to understand how your strategy fits within a particular market because not all strategies are optimal for a market and not all markets are germane to your strategy. Being able to identify specific market characteristics will enable you to subjectively categorize a market type and in turn efficiently execute your strategy.
Defining the markets:
At the most basic level, there are four principal variables that are fundamental to categorizing a market: Historical property investment, size of the real estate market (inventory), population size and economic size. We have to be able to measure the four principal variables if we want to differentiate between primary, secondary and tertiary markets since all markets are defined by the same variables.
From the most conservative perspective, Primary markets are defined as the top 5 metro areas in the U.S, such as: New York, Los Angeles, San Francisco, D.C, and Chicago. A less conservative interpretation would utilize specific characteristics in order to help measure the principal variables. If these characteristics are well represented, then the market may be considered primary. These characteristics can include but are not limited to:
The location with respect to trade routes, highway access, and international airports
Strong university presence
Markets large enough to support major sports teams
Domestic flow of capital as well as the flow of foreign capital
Characteristics are indicative of the four principal variables. Being able to measure these different variables will help you identify the market type.
Secondary markets tend to be driven by the desire for consumers to find a better standard of living and less expensive rent. Secondary markets are often associated with smaller cities and the surrounding areas of major metropolitan cities. Simply stated, secondary markets will measure lower on the four principal variables. These markets may be lacking in one or two of the principal variables, but most would agree that growth potential is the differentiating factor between secondary and tertiary markets. With respect to this methodology, we can assume that tertiary markets will measure the lowest on the four principal variables. We can also assume that the market has low growth potential with regard to the four variables.
Whether you are a highly sophisticated investor or a novice, understanding your investments market will help you better determine your investment strategy. Investment performance can be attributed to how an investment develops throughout its lifecycle and how it reacts given certain market frictions. These frictions can include events such as interest rate hikes, population trends and the tax environment.
Understanding your investments market will help you better forecast your investments performance. For example, Primary markets are often times associated with lower cap rate investments, which are akin to strategies that involve medium to long term appreciation holds vs a cash flow specific strategy. Given this scenario, if your investment strategy focuses on cash flow, you would not target a low cap, primary market property (not to say that these opportunities do not exist). Optimal investment strategies with respect to secondary markets can be more diverse. A higher growth factor in the market may allow an investor to implement a cash flow specific or an appreciation specific strategy depending on the investment property. Tertiary markets tend to lag behind primary markets by a year or two when market adjustments take place. They are also considered by many to be less volatile markets that can weather the storm better than primary or secondary markets. With tertiary markets, we tend to observe the optimal investment strategies shift away from appreciation specific strategies that rely on growth within the market to a more value-add strategy. Tertiary markets excel in value add strategies; they reward investors for improving commercial real estate properties with a higher ROI.
It is important for us to reiterate the ambiguity of these market definitions. It is common to see secondary and tertiary market characteristics within primary markets. An obvious example would be Los Angeles, California. Most consider Los Angeles a primary market but would consider Palmdale and Lancaster to be tertiary, although they are a component of the broader Los Angeles market. Therefore, it is always important to have a good understanding of the submarkets within a larger, broader market. Once an investor has a sufficient understanding of a market, he/she now not only has the ability to identify if their specific investment strategy is feasible, but also has the ability to identify the types of investment strategies well-suited for the particular market in question.
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