I spoke with an originations guy who said one of the most successful investors he's worked with specialized in doing value added in tertiary markets. I'm not usually one to be sold on an idea in a two minute pitch but when I heard this, I literally interpreted it as a license to print money. The gist of it is:
Focus on tertiary markets that are often over looked by institutional players (e.g. cities with 150,000 people and a decent distance away from any primary market)
Target cities have low rents as a % of income and a stable and/or growing economy. (I'm guessing relatively young demographics would be helpful too but that was not mentioned).
Even though income levels in these cities are going to be nowhere near what they would be in NYC or San Francisco, people are still spending a much smaller % of their income on rent. A large number of these people wouldn't mind spending ~20% more per month on rent because in a lot of these areas, that's a very small number in absolute terms (e.g. $100-$200). The reason why this demand goes unmet is because most developers have never heard of these cities and the projects are too small for them to consider investing in.
Does anyone know of firms that specialize in doing this sort of thing? Or can someone point out why this isn't as easy as it sounds? I guess the biggest downside I see with this strategy is that it lacks scalability. I also imagine that small cities are very susceptible to downturns in one industry and/or company.
As someone from one of those smaller town growing up, your biggest challenge is a shadow rental market in SF homes as well as relatively low for sale housing prices. If you start pricing too aggressively, people will just buy or rent actual homes. I think a really interesting space is investing in redevelopments in these cities "urban core" (I feel stupid writing that), as people in these towns want big city amenities. You'll run up against construction costs as well as avg. household income issues.
Also, as a follow on to my previous comment, another opportunity in these markets is to bring institutional grade mgmt. to these markets, trim expenses, and generally murder mom and pop.
In my experience, the challenge with this strategy (assuming you achieve proforma rents) is exit liquidity. It is much harder to find groups to buy these assets in tertiary markets.. Many of the institutional groups will only go after new construction in these markets rather than 70's rehab product.
This was basically how Zell approached the industry when he started investing with limited capital. The problem with it is as CRE said it can be hard to exit and is harder to get financing. Basically if you get large the only exit may be through public markets but the difference between too large to exit and large enough to IPO effectively isn't small. And with these assets you'll be exposed to much more volatility in pricing which cuts both ways.
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