Real Estate Market Tiers

Dec 24, 2023 By Triston Martin

Real estate market tiers are used to categorize properties according to the place's maturity level. Tier 1 cities, such as New York City, have highly developed marketplaces that may not see much more expansion in the foreseeable future. Tier 3 cities are less developed and have fewer populations than Tier 2 and Tier 1 cities, and they may not have the necessary infrastructure or demographic backing for substantial real estate projects. Cities that fall into the Tier 2 category, such as Denver, are in the middle.

Working

Companies that do investment research and businesses that deal in real estate utilize the tiers to segment investments. Some real estate investment trusts will promote the fact that they exclusively invest in Tier 1 markets. This is essential information for investors who are searching for consistent income. There is a greater likelihood of a supply of new tenants searching for space in Tier 1 markets.

The levels may also be used for growth purposes by businesses. Tier 2 cities will have the capacity to host a sizable back-office operation. Since their general quality of living is lower than in Tier 1 cities, premium salaries will not be required to be paid in these towns. Despite this, companies can concentrate their efforts on Tier 1 cities to maintain a cautious stance if there is a downturn in the economy.

Tier 1

Every investment firm has its rating methodology, although most major metropolitan areas like New York City, Los Angeles, and Boston are in Tier 1 of their rankings. These cities have large populations, significant real estate expansion over the last few decades, and prospering markets.

Tier 2

Most investors believe that Tier 2 cities provide the greatest investment opportunities. The infrastructure for future investments already exists, but the market is not yet fully developed. Cities within the Tier 2 category can include Salt Lake City, Denver, and Kansas City, amongst others. The populations of cities classified as Tier 2 typically vary anywhere from one million to five million people.

Tier 3

The population in Tier 3 markets is often rather small. Some individuals consider all cities with a population of less than one million to be secondary, while others set the population threshold as less than one hundred thousand. If there is a compelling rationale for population expansion in the region, Tier 3 markets may provide an excellent business opportunity.

Alternatives to the Different Market Tiers

The current market tier structure is not even close to being flawless. When it comes to classifying cities into different tiers, the vast majority of practitioners rely on their very own unique models. Because of this, tiering is often determined with the target audience in mind rather than based on predetermined, objective criteria. In addition, Tier 1 cities are often marketed as the finest places to invest, despite the reality that these areas are already intrinsically oversaturated with investment opportunities.

This method does not improve the designation of a city as a Tier 2 city. Depending on the information you look at, Salt Lake City, Dallas, and Baltimore are all examples of cities that may be classified as Tier 2 cities. Each place has a unique set of possibilities and problems for individuals interested in real estate investing.

The National Association of Industrial and Office Parks (NAIOP) proposed a method with many dimensions, similar to how the Morningstar Style Box compares mutual funds on two dimensions. This would make it possible for investors and developers to categorize markets according to size and the potential risk vs. return ratio. Instead of just analyzing markets in terms of their size and grouping the majority of markets into Tier 2, investors might examine which markets provide the most favorable opportunity in light of their particular objectives.

The Implications of Real Estate Market Tiers for Private Investors

Individual investors looking to participate in REITs or other commercial real estate products might benefit from knowing the many levels of the real estate industry. If you want to be able to read the prospectuses and make informed judgments about your investments, you need to be familiar with the terminology.

You shouldn't be shocked if the real estate market in Tier 1 cities performs badly over the next ten years or so. An increase in people working from home due to the epidemic has contributed to migrating away from large, costly cities. If this pattern continues, there may be little need for businesses to pay the increased costs associated with leasing space in Tier 1 locations.

Investing in commercial real estate also enables you to construct your unique tiers in geographically near regions. Which suburbs are considered Tier 2 and Tier 3 if the large city most convenient to you is your Tier 1 city? How would all of them fit on a system that has several dimensions? Going through this procedure might be useful when looking for new possibilities.

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