What are Third City Markets?
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Episode Transcript:
So today, uh, we're talking a little bit about third city markets. We recently released a white paper called 33rd City Markets, the Emergent Trend in Third City Markets. And the idea here was why don't we take the same methodology that we use to identify the next secondary and tertiary markets in the Western US that we're expanding into where the greatest opportunities are.
Let's take that same methodology. And bite-size it down to populations of a hundred to 200,000. Mm-hmm. Now we operate anywhere from 100,000 all the way up to 5 million square, or, I'm sorry, population. Yeah. Uh, metropolitan population. But we decided with this white paper, let's take that same methodology and let's just look at these small, the smallest of the small markets, the, the almost beyond tertiary.
And, and what is it? What does it yield? What are some gems along the way? Mm-hmm. And, uh, so that, that was kind of the exercise. And would, would love to you maybe talk a little bit about how we went about doing this. Let's start
with the idea that what's, uh, an interesting thing is that for our style of investing in secondary and tertiary markets, you have to earn your way into tertiary markets.
You have to earn your way into the smallest markets. Those are often the hardest markets to enter. They're, they tend to be the least liquid, which is the downside. Mm-hmm. Um, and to buy at great pricing in those markets is difficult. They're just dominated by local players. And those local players tend to hold 10 years, 15 years, they tend to not sell.
And to earn your way into tertiary markets, you have to, uh, be active in the secondary, uh, create traction in, in, in those around it and work your way into those best. Tertiary markets and this idea of third cities, it, it started, it, frankly, it started in Colorado. And it, it's interesting to note that this third city idea is an r and d idea.
This was our applying a methodology that we have put on secondary, tertiary mar tertiary markets. And, and, and, and we tried to put it on the smallest markets. But this idea originated with Pueblo, Colorado. And if you ask Coloradans about Pueblo, um, I've gotten very mixed responses, but they have to remember that we live in Modesto and
frankly, when, and we like Bakersfield and we like Bakersfield.
So when I got to Puelo, I thought, this is heaven. Like Puelo, Colorado, they have a river. The Arkansas River goes to the middle of this place. It's a nice downtown. I thought, this is great. I've since talked to other Coloradans. They're like Pueblo. But the, but the point is this, you've got Denver, which is um, A dominant secondary market.
It is a well, uh, ranked and well received secondary market throughout the us. Um, and then you've got Colorado Springs often ranked as the third best place in America to live. And then 45 minutes outside, you have Pueblo. Um, it, the, the question was, especially in multifamily, um, what drives Pueblo? And the answer is, it's, it's in the vein of what drives Modesto.
It's, uh, It, it it's value and it's proximity and it's quality of life. Um, to back up a step, the way we invest is we look for, uh, tight vacancy, reasonable rents and value relative to replacement cost. And the reason Pueblo popped up was vacancy of 1.3%, uh, rents that were about a thousand dollars a unit.
Uh, and, and. Replacement cost at about 50%. Like that showed up that those are three green lights. You don't see those lights in Colorado Springs that way. Yeah. And it's a, you, you don't see 'em them in, in Denver Metro as much either.
Well, and I think even just stepping back a little bit, um, like you were referring, we are, by our very nature, we're contrarian investors.
We're, we're investing in geographies that are historically, you know, non-institutional geographies. And, um, to do that, we have to clear away the clutter because you take a market like Bakersfield, if you talk to anyone from the greater LA area, Bakersfield is the armpit of the world, and yet I. By many quality of life measures, by affordability measures, uh, by climate.
There, there are a lot of benefits to Bakersfield. It just happens to be shadowed by a much larger major market. And so when you have that kind of echo effect, where it's like, Colorado Springs is an amazing market, so compared to that, Pueblo doesn't look so great. You have the, what we use is we use qualitative or quantitative measures.
To clear away the noise mm-hmm. And be able to really distill down what drives a market and what are the, the, what are the key attributes of markets that we look for, regardless of, you know, perception and that sort of thing. Because, uh, that, that's subject to, to whim and its subject to, you know, qualitative, uh, factors.
Yeah, it's interesting. If you have tight vacancy and reasonable rents, you will see rent growth. There is a list of people looking to rent those units. Yeah. And if you have positive population growth, you will see continual demand in those markets.
The markets are, are punished because of liquidity.
Especially in down-times like we're in now, it's a, a good time to buy, a bad time to, uh, sell. Mm-hmm. Um, they're, they're more cyclical, but the population's very sticky. Uh, another piece we added into this was, um, median home price, uh, average income rent compared to income. Mm-hmm. Um, and ARP score.
ARPs got this great score oriented towards seniors, but it's oriented towards quality of life. It's oriented towards affordability, and there's, there's a lot of markets that are in the middle there that because of value and proximity, uh, score well than the most attractive markets. The famous markets.
And a, a big part of our job is to not run with the herd. Uh, I'd say use analogy, dance with the herd a little bit. Mm-hmm. We're in proximity. We're, we're not in that, in the same, uh, strategies, but we are very careful of where our proximity is. And these, uh, tertiary markets, these third city markets are a good example of how we, how we dance.
Does that mean we're, uh, are, we're gonna be very focused only on this? No. Um, we will buy in some of these cities. We certainly won't buy in all, we'll probably buy in a few of these cities, and it will happen over time as we build out our clusters in such a way that our, uh, management capability and our conviction and our thesis align, uh, with the right opportunity at the right time.
Yeah. So, uh, I, I'm curious, uh, obviously I've seen the white paper, but, uh, maybe you could talk a little bit about. Some of the, uh, results that we found and some surprises, and, uh, when, when we apply a more quantitative approach to evaluating.
Yeah, so we, we sorted first for vacancy rate. Uh, these, the vacancy rate in these, uh, markets, uh, are somewhere between one and 3%.
The tightest, uh, in the country. Very hard to find that, um, rents that were, uh, very reasonable, uh, 800 to $1,400, especially relative to average income. Um, above average annual rent growth, uh, um, median home prices that were, uh, fair, but also, uh, made it, uh, make more sense to rent or, or certainly there was a, it didn't, uh, favor towards owning and most importantly, an ARP score.
I won't say most importantly. But an ARP score. A score, a quality of life score that said, uh, this is a, this is a place where you can live. This is a place where you can raise a family. This is a place where your kids can go to school. Yeah. Where you're near nature, where you can probably have a, a garage if you want, where you can Yeah.
Park your car and walk to a store. So it's, it's quality of life relative to affordability, essentially. Yeah. Because we're not looking at. You know, the cities that score the highest on the quality of life are often the least affordable. Right. And so one of the, the key filters for us is because we want that ability to, for rent, to grow.
Yeah. We want that ability for property values to grow and, and so being in an affordable market that also has quality of life, there's value there. Well,
these markets are the most open to institutionalization. Because there's the least amount of institutionals there. Yeah. Yeah. It, these are, uh, hard mark markets to enter and require.
They're, they're higher, they're, it's, it's, uh, contrary to what you might think, but they're high barrier to entry markets. Um, both because it's hard to find the right deals there and because it's hard for firms to make sense of investing there unless they've earned the way to it by building out the clusters that support their management teams and their, uh, effort.
It is a longer term strategy, not a short term strategy. Um, but when we apply our techniques and when we, uh, run properties professionally in these markets, there's tremendous upside because, um, They, they've been run by mom and
pops. Yeah. What city was, uh, most surprising on the list? Cheyenne, Wyoming, 1.3%
vacancy.
Um, also red in California. Bakersfield, California. Yakima, Washington, um, Las Cruces, New Mexico based on this report. I went to Las Cruces not too long ago and, um, a lovely place. So, uh, but you know, I met with local firms there. I, I surveyed the market. Um, very tough market to enter. It's very tight, entrenched market with local players that are, that, that, uh, you know, with local players, so to, um, a larger market.
In fact, the largest market that might fit this is El Paso. 45 minutes away. Yeah. And there will be a day, I think, where you can combine those two markets in a cluster.
I think. Uh, something to mention about this white paper, much like our prior white papers. It's, it's a mix of tactical, real world experience, investing experience with, uh, kind of maybe our more academic analytical approach of how we view the world.
Going back to the whole contrarian investing, it requires a discipline. And a, and a quantitative approach that kind of working with a herd doesn't necessarily require,
I mean, you, you work, uh, primarily on the capital side or, or yeah. You lead that side. How this, how does this strategy resonate, uh, as you see it on the capital side?
Yeah. Oh, absolutely. It must be an interesting, uh, pitch. Yeah,
it, it is fascinating because, um, you know, the conversations are pretty. Binary and like, I totally resonate. I get it. This is an opportunity or I don't get it. This is not something that we're interested in. Yeah. Um, and I would say on the, on the get it side, it really is around, I mean, candidly, everybody is searching for Alpha.
Everybody is searching for the next niche strategy. They're, they're looking for where they can find pockets of opportunity in the market. And I think as we have seen, there's this large, mature existing segment of the market that is there and has yet to be institutionalized. So this isn't, you know, I I would say with life science, it's a little bit of, uh, maturing a category, but also inventing a category, uh, right.
Because this, that it's a new field. Data centers even more so, you know, it's a. It's a new category, right? Yeah. And so people are learning how to operate in those categories, but secondary and tertiary markets, like a lot like self storage or mobile home parks. It's just an existing mature se segment of the market that that hasn't been institutionalized.
But when you do that, uh, it requires a more methodical, quantitative approach to, to entering these markets because, You are doing, you, you're by, by your very nature, you're going into highly inefficient Yeah. Markets the most inefficient that, that have, uh, you know, lot, not a lot of information flow, and you're creating the systems to build that information
flow when you, when you're just talking about a, an individual market or two.
It's easy to see that as, uh, not the strategy, but when you speak to the greater Western us, uh, that there's 85, uh, secondary and tertiary markets, 1.8 trillion, uh, dollars worth of value in the type, in the, in the multi-tenant industrial and, uh, value add multifamily that we invest in the aggregate value, uh, the aggregate opportunity is what's extremely powerful.
Yeah. So what on our side becomes the most powerful thing is the way we develop new markets, the way we build clusters, the way we, uh, develop over time and into, uh, lots of smaller markets that historically have been untouched, uh, because it was inefficient to go there. We are putting in the groundwork, uh, and the capital and human capital to develop into those, those places.
Yeah. So, um, I just close by saying, uh, What's next for us? What's next is we'll continue to do this sort of r and d. We will continue to build out the clusters in the, uh, seven markets we're currently in. We will likely add one or two markets or sub-markets per year. And, um, we'll do this for a long period of time and, uh, we expect to create a lot of value.
Summary
Joe and Ryan discuss Third City Markets, what they are, and the advantages and disadvantages with working in them