Invested in tertiary markets - big fish in a small pond
What would you prefer?
1. Acquiring a core plus asset in a tertiary market.
2. Acquiring a comparable asset (just at a smaller scale) in a primary market.
Ceteris paribus for everything else on a risk adjusted basis. Curious about your thoughts.
This isn't a fair comparison, though. The dollar amount is highly unlikely to be the same in a tertiary market.
You can make a really nice living doing deals in a small market. You just won't ever be raising a $500mm fund to deploy there. This is why, generally speaking, yields are higher in those places - you cannot deploy capital at scale and you're putting in a lot more work for every dollar you earn.
And most people who are thinking about this in a conscious manner are probably not interested in that. They're looking for a big success, and it's hard to blame someone for thinking that it they're going to take entrepreneurial risk, they may as well go the route that offers the most upside.
I guess more to the hypothetical... most people who work in tertiary markets seem to justify their position after the fact as preferring to be a big fish in a small pond. I don't know that many of those people consciously set out to do that.
Let's keep in mind raising a $500mm+ fund isn't a big success, being able to deploy it and return solid returns to investor is.
Many groups that raise funds can do very well or get crushed while someone doing these smaller deals can do well regardless of the cycle if they're conservative and take calculated risks.
I mean, your point is well taken, but I'd venture that anyone raising a half a billion dollar fund has a very strong track record to point to. Either a previous fund that was a big success or years of experience and a number of highly successful deals behind them
This is just a risk/reward analysis. The tertiary market is a riskier market, but has higher reward. The submarket is less risky, but also seems to provide less return. Pretty difficult to answer without having more specifics on the risks/return i.e. what are the returns for each project, vacancy rates for each, types of tenants you'd be renting to in each market etc...Without more information, if I HAD to give an answer, I would probably choose the larger submarket because the first 3 rules of real estate are 1.) Location, 2.) Location, 3.) Location and I currently operate in a safe Tier 1 market with complicated zoning laws and a severe housing shortage so there is a large knowledge gap and high barriers to entry which allows for arbitrage opportunities. But once again, can't give a definitive answer without knowing specifics
For sure, it will be case by case.
I guess I’m curious about the general risk appetite of people here when it comes to placing capital within real estate. You can assume the risk-adjusted returns are comparable for the two cases.
I would wonder what the fully funded basis looks like relative to (diligenced) comps for each asset. If the smaller market asset can be tied up at a proportionately larger discount to recent trades of similar vintage and quality, and rents are below market, that’s great (versus the asset in the more established market). If the same is true of the asset in the larger market you described, I’d lean that way. Depends what kind of risk you want to take and ultimately how the deal is structured but that’s pretty in-the-weeds for the purposes of this discussion. Otherwise I don’t think any of us have enough info to answer your hypothetical.
Make it interesting, what is the difference between the two deals? What return profile am I after? What is the structure? Can’t just say “all else being equal” and expect anyone to have good insight unless they base their decision on exit liquidity and want to execute different business plans.
That said, if “all else is equal”, but both pencil to the same returns, and I can rely on more conservative rent growth assumptions in the smaller market (again assuming both markets are performing adequately and ideally the basis tied up presents a larger discount to comps in the smaller market because it’s unproven) and it’s a unique asset, I would lean that way. More risk, but ultimately hypothetically easier to lease up assuming in place rents are further below market, and as such, the ability to underwrite lower rents (relative to market) presents itself, and ideally exit more quickly and leave more meat on the bone for the next buyer
Small fish in bigger pond all day… the other opens up a lot of liabilities with little growth
Curious on what you mean, can you expand on the additional liabilities?
Not realizing this was under a real estate thread, I was thinking more in the sense that a small market limits growth opportunities for an operating company organically.
Something not mentioned is your exit. In a major market there will usually be a greater assortment of players to sell to vs. investing in a tertiary market where that may not be the case. Huge consideration on my end at least.
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