“IT’s amazing how complete is the delusion that beauty is

goodness,” Leo Tolstoy once opined.

But when it comes to the apartment market, beauty is as beauty does.

The multifamily industry’s recovery was led by the “Sexy Six,” also known as New York, Los Angeles, San Francisco, Boston, Washington, D.C., and Seattle. Acquisition and development attention was squarely fixed on those hot-to-trot markets, which provide high occupancies, high rents, and, not coincidentally, the highest barriers to entry.

But for many investors, any window of opportunity that the Great Recession presented in these high-octane markets is now firmly shut. Ever-shrinking cap rates have left this A-list to only the most well-heeled developers, owners, and financiers, once again. In September, pricing in all six markets reached and, in some cases, exceeded the peaks last seen in December 2007, according to New York–based market research firm Real Capital Analytics.

And development yields in these overheated cores also seem to be shrinking violets. The scurry among developers to build more units in places like Washington, D.C., has led to concerns of too much too soon—that the industry may be overdoing it in select pockets.

But some owners instead spent the recovery staking a claim far from the honking horns and caffeinated sidewalk bustle of our nation’s largest cities. And right now, those companies are being rewarded handsomely for their foresight.

Markets like Charlotte and Raleigh–Durham, N.C.; Austin, Texas; and Portland, Ore., for instance, have gone from second-tier cities to multifamily celebrities in the past two years.

“There is no doubt the six top metros are the biggest money makers, but the markets on the second tier right behind them are looking very attractive as well,” says Greg Willett, vice president of research and analysis at Carrollton, Texas–based MPF Research. “Just because they’re not included among the Sexy Six doesn’t mean they’re not sexy. They still look pretty attractive, but just in a darker room.”


But are secondary markets like Charlotte and Raleigh–Durham starting to behave like mini-Manhattans? Cap rates have been falling just as fast in those secondary markets, and many first-time ­investors and developers are flooding the region.

Will these and other jewels of the Southeast wilt from all of this attention? Not if you ask Al Campbell, CFO for Memphis, Tenn.–based MAA.

“There are a lot of jobs expected to come into the Southeast region of the country in the next few years,” says Campbell, whose company has a strong foothold in the Midwest and Southeast. “There are many changes going on in manufacturing, shifting of distribution. There are a lot of markets in this area that fit our strategy very well.”

MAA’s strategy is to allocate about 60 percent of its capital to primary markets, and 40 percent to secondary markets, a scheme that sets it apart from many of its REIT brethren. Some of the markets MAA is targeting include Birmingham, Ala.; Jacksonville, Fla.; Charleston, S.C.; and Kansas City, Mo. In fact, the company recently ­expanded into Kansas City with its acquisition of the 323-unit Market Station apartments, built in 2010.

“We believe over the long term that that’s a very important component of our strategy to produce stable cash flows,” Campbell says. “Those markets, like Kansas City, tend to have pretty stable job growth over time, and the really big peak supply doesn’t come, since there isn’t as much competition. We see that as a competitive advantage.”

The company is hoping to expand its presence in Kansas City to 1,500 units in the coming years, he adds.


MAA isn’t the only major REIT fixating on secondary markets, however. Richmond Heights, Ohio–based Associated Estates has also created a footprint in submarkets across the Southeast region. The company has made inroads this year into North Carolina’s Triangle apartment market, consisting of the Raleigh–Durham and Chapel Hill areas. Since May, Associated Estates has acquired three assets in the region, totaling 760 units, at a price tag close to $110 million. And John Hinkle, the company’s vice president of acquisitions, isn’t ready to buy into the hype that markets like these will become oversupplied anytime soon.

“There has been talk of oversupply and robust pipelines, but we have to take these figures with a grain of salt,” says Hinkle. “There is lots of talk of a flood of new deals getting done, but in some cases only half of the units being discussed will ever actually get done in many markets.”

Hinkle says Associated Estates targets infill locations with a high level of walkability, access to transportation, and proximity to retail and commercial buildings. But perhaps more importantly, the region must be poised for job growth, have a diverse economy, and have strong household formation trends. And the Raleigh–Durham market, with its strong job market in the tech sector, universities, research facilities, and hospitals, fits the bill perfectly.

“We’re still looking to expand our presence through strategic acquisitions and developments; there is still plenty of room for new units to hit the market,” he says. “The most important thing is that our assets are very well insulated from the new supply,” since they’re located far from the submarkets with the most construction, he says.

MAA is likewise still scouring the Southeast for new deals with little fear of a slowdown in demand. Campbell cites Savannah, Ga., and Charleston, S.C., as prime secondary markets in which the REIT is hoping to expand. MAA also recently broke ground on the second phase of a 312-unit community in Little Rock, Ark., adding to its portfolio of more than 1,000 units there. The firm likes north Florida, too.

“Jacksonville has seen a lot of negative press, but it’s a dynamic market and has a diverse economic base, and it got a lot of supply in a tough period in the market,” Campbell says. “But job growth is now coming back, and really nothing is being built. It’s a good, solid secondary market.”

Beauty Contest

According to MPF’s Willett, secondary and tertiary markets are not all that far behind the Sexy Six in terms of growth potential. Willett named South Florida, Houston, Dallas, and Chicago as the regions that round out the top 10 markets so far in 2012 in terms of transaction volume. While some of the markets might start to look flat, there are critical factors like liquidity that point to the fact that there’s still plenty of private capital available in these areas.

MPF Research classifies a tertiary market as one with less than 100,000 units, and Willett says that areas like Denver; Nashville, Tenn.; and San Antonio are on the rise with institutional investors.

Willett says that despite talk of some secondary markets becoming overbuilt, there’s still safety and room to grow. He points to markets such as Denver, Charlotte, and South Florida as being among those where inventory is pretty well spaced out and the opportunity to be more aggressive with rents still exists, as the pipelines are not too overbuilt.

Willett also warns against buying into the myth that Gen Y renters are only attracted to urban cores. He believes we may be surprised by how many still cling to the American Dream—just a slightly different one. “Gen Y still wants to raise a family in the suburbs like their parents did. And I think they’re happy to just have the feel of an urban lifestyle,” says Willett. “This doesn’t necessarily mean they need to live in a city to get that.”

But not all secondary markets are created equal. The MPF Research also shows that several metros were on the decline during the third quarter. Some of the cities that dropped out of the top 50 were Honolulu; Richmond, Va.; and Salt Lake City.

But Campbell and MAA plan to continue pursuing opportunities in smaller markets and are even willing to bet on new markets moving forward.

“We’ve added several new markets to our footprint over the last few years. San Antonio, Charlotte, and Fredericksburg and Richmond, Va., are good examples,” says Campbell.

Inner Charm

If these bullish outlooks weren’t enough to convince you that small markets have the ability to bring big-time returns, just take a look at the third-quarter data from Dallas-based market research firm Axiometrics.

Some of the cities that averaged more than 4 percent annual ­effective-rent growth this year include Montgomery, Ala.; Nashville; Louisville, Ky.; Columbus, Ohio; and Oklahoma City. While that may not sound overly impressive, consider this: New York City; Washington, D.C.; Chicago; Los Angeles; San ­Diego; and Minneapolis each failed to break the 4 percent mark.

MAA classifies a city such as Kansas City as a secondary market by looking at both the size of the market and the amount of REIT capital there. And since there isn’t really any competition to speak of from his peers in this market, Kansas City is a promising, and likely profitable, place to be.

“I would call this an opportunity,” says Campbell. “This is an area of our strategy where we can take our REIT platform, our investments in pricing systems, our bulk-buying contract, all the things we bring in terms of overhead platform, and hopefully be able to outperform the competition, which is really a true competitive advantage.”

Those markets, like Kansas City, tend to have pretty stable job growth over time, and the really big peak supply doesn’t come, since there isn’t as much competition.

—Al Campbell, CFO, MAA