Who doesn’t like a prize? It’s fair to say that the majority of those in the commercial property game wouldn’t hesitate to jump at the chance for that signature high-rise or high-profile luxury apartment project if it provides sufficient value. It’s akin to a medal for investors, developers, and capital providers. Those noteworthy prizes can attract a lot of attention. Middle-market opportunities? Not so much.
Middle-market investments don’t often generate headlines or make for a great centerpiece in slick, glossy marketing collateral. To draw an analogy, they fall in between single-tenant retail and large multi-tenant centers. Therefore, they often aren’t the focus of those who specialize in the low-end or high-end properties, who tend to gravitate towards the margins.
While there are challenges and myths about investing in market-rate properties, it can be a great value and provide a solid base that provides its own reward. One such challenge of middle-market assets is that they can be perceived as an inefficient market segmentation. Middle-market assets with a total capitalization of $10 million to $50 million face the dilemma of being too small for global and institutional investors but also being too big for private investors.
Despite this predicament, developing properties in areas not considered “gateway” markets has its advantages. Developers and institutional investors will often focus on trendier and more affluent submarkets. This creates a beneficial side effect on secondary and tertiary submarkets as sole focus on affluent areas ends up creating high demand, strong rent growth and results in higher yields in the more affordable and peripheral areas. Additionally, prices in small-cap developments aren’t as volatile with the highs and lows of the larger CRE market.
Furthermore, some of the market’s attractiveness can be attributed to a lack of new construction projects, as middle market assets will continue to wall off institutional investors from entry. This is based on the idea that it takes similar time and proportional cost to process and underwrite a particular deal. Consequently, their time would instead be better spent on the larger opportunities. This in turn, keeps the supply of potential value-add investments or development opportunities ripe for savvy investors.
Of course, rising interest rates and geo-political impacts present potential risks to commercial real estate as a whole and middle-market acquisitions are no exception. Until those potential risks become reality, middle-market investments will maintain attractive for investors looking for durable income-producing assets.
Jonathan Genton is founder & CEO of Genton Property Group.