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Non-Gateway REITs Offer New Horizon for Investors

Many mid-sized markets offer attractive fundamentals, including above-average job and population growth.

The landscape of real estate investment trusts (REITs) is changing.

Or, more accurately, the cityscape.

While REITs in gateway markets have a strong historical record of growth and price performance, many REITs in non-gateway markets offer more attractive valuation and growth prospects and have recently outperformed gateway offerings. Secondary market strategies have the potential to produce exciting returns for shareholders.

In fact, since the spring of 2016, non-gateway REITs have pulled ahead in total return. 1

Gateway markets such as New York, Washington D.C., Boston, Seattle, San Francisco and Los Angeles – cities that benefit from the presence of finance, technology, or healthcare industries and are well-positioned for growth – have long been the standard when it comes to investing in REITs. But gateway market fundamentals have shifted, and these relatively pricey locations are no longer the only appealing option for real estate seekers – or investors.

Falling global interest rates have prompted foreign investors to pour capital into safe, positive-yielding investments such as gateway real estate, causing market values to increase and capitalization rates to compress. Gateway rent and net operating income (NOI) have not accelerated at a rate sufficient to compensate for the increased values.

Meanwhile, non-gateway markets offer different metrics. In the office sector, the average same store NOI growth of non-gateway REITs in Southern and Western markets has outpaced gateway REITs in each of the past four years, with not nearly as much cap-rate compression as the gateway sector.2

The result is higher yield in the short and long term.

Going smaller, thinking bigger

Many mid-sized metropolitan areas – Austin, Texas; Portland, Oregon; Nashville, Tennessee; Charlotte, North Carolina; and similar cities – offer attractive fundamentals, combining above-average job and population growth with low cost of living, especially in housing.

Job growth in gateway markets from June 2009 to June 2016 was 10.3%, slightly higher than overall U.S. growth of 10.1%. But job growth was substantially higher in the non-gateway markets of Tampa, Florida (15.6%); Denver, Colorado (20.0%); Orlando, Florida (21.3%); and Dallas, Texas (22.7%).3

Projected population growth from 2016 to 2021 favors those same mid-sized cities. Gateway market growth was projected at 3.6% and overall U.S. growth at 3.7%, but the projections were higher for Tampa (5.6%), Denver (7.7%), Dallas (7.7%) and Orlando (7.7%).4

In the office space sector, many top businesses are taking advantage of these more affordable locales. Companies such as Google, Apple, Oracle, Toyota, Deutsche Bank, Charles Schwab, Citi and UBS – to name a few – have combined to move thousands of jobs to Tennessee, Florida, Colorado and Texas.

PricewaterhouseCoopers, in its Emerging Trends in Real Estate® 2016 report, called 2016 the “year of the secondary and tertiary markets.” And for 2017, PwC’s top three U.S. real estate markets to watch are non-gateway locations: Austin, Dallas/Fort Worth and Portland, respectively.


Many REITs and large institutional investors have not typically focused on non-gateway markets, given investors’ preference for familiar markets and the industry’s tendency toward backward-looking 10-year arguments. Yet, given non-gateway markets’ attractive valuations and potential for growth – as well as the recent performances of non-gateway REITs – it’s time to view these cities in a new light.

Their skylines might be smaller, but their opportunities could be bigger.

2017 U.S. Markets to Watch: Overall Real Estate Prospects*

  1. Austin (3, 1)
  2. Dallas/Fort Worth (1, 5)
  3. Portland (8, 2)
  4. Seattle (2, 8)
  5. Los Angeles (6, 6)
  6. Nashville (9, 3)
  7. Raleigh/Durham, N.C. (13, 4)
  8. Orange County (5, 10)
  9. Charlotte (12, 7)
  10. San Francisco (7, 13)
  11. Denver (15, 9)
  12. Boston (10, 14)
  13. New York-Manhattan (4, 20)
  14. Oakland/East Bay (16, 12)
  15. Atlanta (11, 15)
  16. New York-Brooklyn (14, 19)
  17. San Jose (20, 11)
  18. Salt Lake City (18, 17)
  19. Chicago (17, 21)
  20. Tampa/St. Petersburg (23, 16)
SOURCE: Emerging Trends in Real Estate, PricewaterhouseCoopers
*NOTE: Numbers in parentheses are rankings for, in order, investment and development.

Sources: [1] S&P Global Market Intelligence. [2] Company filings. [3] U.S. Bureau of Labor; gateway markets represented by New York, Boston, Chicago, Los Angeles, San Francisco and Washington D.C. [4] S&P Global Market Intelligence.
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