Perhaps contrary to the conventional wisdom, most of the major multi-market apartment lenders will actively look to place plenty of debt in secondary and tertiary markets in 2007.

Many top-tier lenders actually prefer smaller markets with growing and diversified employment bases due to the generally higher average capitalization rates relative to major markets, explained R. Lee Harris, president of NAI Cohen-Esrey Real Estate Services, Inc.

Major apartment lenders see the higher cap rates and somewhat wider interest rate spreads in smaller markets and feel quite safe lending against sizable well-positioned properties, Harris said.

Mortgage rate spreads in secondary and tertiary markets tend to be between 10 and 20 basis points wider than comparables in top-tier multifamily markets, Harris said. But the spread between cap rates in large and small markets tends to be even wider. Add it up, and small market buyers are much more likely to achieve positive leverage—that is, a going-in return on investment that’s higher than debt costs.

“We talk to the government-sponsored enterprises (Fannie Mae and Freddie Mac) and conduit lenders, and they love those kinds of deals in Wichita or Tulsa or Chattanooga,” where cap rates might get to 8 percent or even higher, Harris continued. “If they’re lending at 6 percent or 6.5 percent, they can feel good about the borrower’s positive leverage.”

NAI Cohen-Esrey, in fact, just formed a new unit chartered to invest in value plays in secondary and tertiary markets, Harris said.

However, the large national lenders won’t look quite as favorably on small transactions including value-added elements in tertiary markets, cautioned veteran investment banker Andy Little at John B. Levy & Co.

“Anything below $10 million that has some value-added risk element is probably going to generate a lot more interest from local community banks, who know the market and borrower, than from the out-of-town lenders,” he said.

And due to regulatory concerns about community bank exposure to commercial real estate, entrepreneurs targeting value-added plays in small markets might see the new year ushering in a daunting development.

Community banks appear disproportionately vulnerable to regulators’ concerns about that exposure, said Sam Chandan, chief economist at Reis, Inc. That may mean that they won’t be the most lucrative sources of apartment debt for small-market borrowers to tap in 2007, he said.