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An Investment Resurgence: Properties In Secondary Markets

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An Investment Resurgence: Properties In Secondary Markets

By: Steve Sadler, CEO, Allegiancy

June 22, 2015

Sheboygan or San Francisco?

When looking to invest in real estate in secondary markets such as Sheboygan, what should investors consider and how should they compare their options to properties in primary markets, such as San Francisco?

That’s not only a question investors nationwide are considering today, but it’s also the key theme during a panel discussion I led Tuesday morning in New York City at the Information Management Network’s 16th Annual U.S. Real Estate Opportunity & Private Fund Investing Forum – “How Do You Determine Your Price? Income vs. Replacement Cost vs. Comps.”

Specifically, we discussed these key, and frequently considered questions, when looking at secondary markets:

-What are the risks and how can I gauge them when determining the prices of commercial real estate assets in secondary markets as the primary, gateway markets such as San Francisco, New York City, Los Angeles and elsewhere have experienced a major influx of cash and investors?

-What are the best methods to evaluate pricing potential before the deal and buying opportunistically in an environment where sellers are receiving record prices?

-How do you determine what the right price is for an asset?

-How do you make it make sense?

-What are the risks of being in Sheboygan versus San Francisco and how do you account for those?”

The answers came thanks to the panel, well stocked with esteemed management and investment executives from across the country – Daniel Kwon, Principal at Apollo Global Management; Jon-Paul Momsen, Senior Managing Director at Harbert Management Corporation; Aditya (Adi) Bhoopathy, Principal & Executive Vice President at Noble Investment Group; and Douglas O’Donnell, CEO of The O’Donnell Group.

These are really smart guys and they were talking about one of the biggest risks in the secondary market is that your buyer pool is thin. So when you’re ready to sell, you don’t have very many people go to. Which is true, but for me personally, all you need is one buyer.

All told, the group represented large institutions that move big blocks of capital. Meaningful blocks of capital. Like, change the landscape blocks of capital.

If they drop $100 million or $200 million in a city like Richmond, Va., it will move the market. Period.

Why? As they said repeatedly during the session, they’re drawn to these secondary markets as real estate has heated up in the primary markets thanks in part to infusions of foreign cash, low interest rates and other factors.

Effective Management

Once you invest in properties, what’s next? According to Paul Momsen, whose focus at Harbert Management is on hotel properties, it’s vital to then invest in efficient and effective operations to make sure the investment is going to work.

As an example, say you pick up hotels in Cincinnati looking for a 20 percent return on your investment. You have to actively manage the property so even if you can’t sell it quickly, you make money along the way.

He’s speaks the language of Allegiancy.

It’s exactly what we say at Allegiancy in the commercial properties (office buildings) we manage.

Getting a good `buy’ price is helpful and important, but if you don’t run the asset well it won’t matter. The tenants go away and you risk entering what we call the death spiral. There’s less money coming in. Less money results in an inability to make upgrades to the building. No upgrades equals fewer tenants, which equals even less money.

Looking For Balance

No doubt about it. There’s real value in the secondary markets beyond the buildings and properties themselves. There’s real value in how secondary markets operate as an entity within themselves.

If you go into the Houston market (a primary market) and buy office space, for instance, you know that if the oil and gas economy hits the skids vacancies will take a sharp uptick. Fewer tenants and, well, the death spiral could come into play.

Contrast that with a secondary market like Raleigh-Durham in North Carolina. It has state government, universities and the huge education complex that goes with it, major medical research and on top of that all the technology firms.

That’s a town that’s firing on all cylinders and it has exactly what you’re looking for – balance.

A Resurgence

Conclusion? There’s certainly a resurgence in these secondary markets. There’s a lot of money coming in from overseas into the U.S., the stability of the economy is attractive and secondary cities are taking a bigger piece of the investment pie.

While you might be priced out of New York, Los Angeles, Dallas or San Francisco, there’s always Sheboygan. Or Raleigh. Or Charleston. Or some other place I’ve got my eye on.

Want to listen to the complete panel? Click here.

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