JLL: Opportunities in Secondary Markets

Secondary markets present opportunities for significant rent growth, with some of the lowest vacancies and in many cases historically low office development, reported JLL, Chicago.

JLL said nine of the 10 lowest-vacancy metros are secondary markets.  

“High pricing and limited offerings may make primary market office acquisitions challenging, but secondary markets garner plenty of institutional level investment interest on their own merit,” said the JLL special report, Why Investors are Targeting Secondary U.S. Skylines.

The report cited three driving factors behind the momentum, led by job growth. “The low cost of conducting business, high quality of life and low cost of living for the employee base is driving employers to enter or expand in secondary markets,” JLL said. The biggest winners include cities with a tech presence as well as broad service industry opportunities.

Next, population growth. “Jobs are following workers this cycle and many secondary markets are experiencing significant population growth, particularly among Millennials,” the report said. “Top secondary cities offer a walkable urban core and unique touches ranging from hip restaurants to cultural attractions, good public transit options and bike-friendly infrastructures.”

JLL also said secondary markets have more “room to run” than primary markets, noting that many investors view secondary market asset pricing as a comparative bargain to larger markets and an opportunity to secure yield. “In addition, there are simply less available properties in primary markets,” the report said. “In response, investors are casting a wider net for value, growth-oriented acquisitions.”

Two secondary markets, Atlanta and Portland, Ore., share many common characteristics and attract significant investor and tenant interest, JLL said. 

“Atlanta office fundamentals are as strong as they’ve been in more than three decades,” said JLL Managing Director David Tennery. “Atlanta has experienced positive net absorption for the past four years and growing tenant demand due to modest rental rates, which are still 10-plus percent below peak pricing.” 

In most cases, Class A rents are still 12 to 25 percent below lease rates required to drive new speculative development, JLL said. 

“There continues to be a significant and likely ongoing pause in office development and that has aggressively shifted the dynamics in favor of office owners,” Tennery said. “The clear winners are submarkets and buildings that can offer the ‘live, work, play’ dynamic or the ability to adapt and rebrand with a mixed-use, transit focus.” 

Tennery added whether or not an investor is currently active in Atlanta, the office investment climate over the next several years is “undeniably favorable” and should be driving investors to the table. “Anyone not digging beneath the surface is missing key opportunities in this rapidly transitioning market,” he said.

There is “room to run” in Portland as well, said JLL Senior Vice President Paige Morgan. Nearby West Coast office markets such as San Francisco and Seattle average $677 and $458 per square foot respectively, while Portland’s remains under $325 per square foot. 

JLL pegged Portland’s new high-water mark at more than $400 per square foot but said the market remains “a bargain” compared to more actively traded markets.

“Portland’s fundamentals are strong and while we’re starting to see pricing and rents rise, the yields look good on a relative basis and investors believe the market will see more growth compared to other West Coast cities,” Morgan said. “Historically, Portland is a less actively traded market and investors are vetting how they can gain exposure. Plus it has the cool factor–at the end of the day, businesses and people want to be here.” 

JLL called Portland’s job growth and in-migration significant. “The base of companies has increased and major tech giants who acquire Portland-based companies are opting to keep business there,” the report said. 

Portland’s population could grow by 5 percent between 2015 and 2020 and the millennial cohort increased more than 10 percent over the past five years, JLL reported.

“There’s capital for all types of office product. Institutional investors are increasingly taking a larger position in the market, primarily targeting large trophy and core assets,” the report said. “At the same time, creative office space caters to the city’s tech workforce and investors are considering value-add, re-positioning strategies with these buildings.”