Read the following two paragraphs from a recent real estate brokerage house white paper and tell me which real estate markets seem riskier to you, primary (gateway cities like New York or Los Angeles) or secondary (smaller cities like St. Louis or Phoenix):
“Notable shift back to primary markets indicating a current resistance to market risk. After the continued expansion into secondary markets over the last two years, volumes are moving back toward primary markets. In the second quarter of 2016, 70.1% of total transaction volume took place in primary markets. This represents only the second occurrence of the last eight quarters in which primary volumes exceeded 70.0%.
Pull back in risk evident on submarket level as well with investment clustering increasing. Office investment ‘sprawl’ is declining as investors adopt a heightened focus on lower risk submarkets amidst market jitters and cycle longevity concerns.”
Did you say secondary markets? Why?
The word “risk” is mentioned three times in those two paragraphs, while the word “price” doesn’t get a single mention. How is that possible? Price is the number one determinant of risk. Without knowing the price of something, how can you reasonably assess the risk? Hint: you can’t.
There’s a price for everything. Value investors understand this, while others choose to ignore it. Is New York City a more dynamic market than St. Louis? Of course. Would you pay one price for a building in St. Louis and double that price for the same building in New York City? How about triple that price? The answer may differ for different investors, but one thing is for sure: price matters.
Eliot Bencuya is the co-founder and CEO of Streitwise. Eliot has extensive experience identifying, underwriting, and executing value-add real estate investments.
Prior to forming Streitwise, he was a Vice President of Acquisitions for Canyon Capital Realty Advisors and the Canyon-Johnson Urban Funds, where he was responsible for originating, underwriting, structuring and executing transactions in the Pacific Northwest, Northern California and Midwest regions. Mr. Bencuya also held positions at Sovereign Investment Company (a subsidiary of the Marcus and Millichap Company) and the investment banking division of Merrill Lynch & Co. He holds a Bachelor of Arts degree in Economics and International Studies from Yale University, and a Masters of Business Administration degree from the Haas School of Business at the University of California, Berkeley. Mr. Bencuya is a member of ULI.