The time-honored mantra of real estate – “location, location, location” – drives everything from a property’s purchase price to the rental rate. It can even dictate how much or little you should invest in improvements.
Real estate markets are classified by location type. There are primary, secondary, and tertiary markets, sometimes called Tier I, Tier I, and Tier III. The market classification for your rental property will be a crucial consideration as you set its rental rate.
An area’s population and state of real estate market development determine its classification as a primary, secondary, or tertiary market.
Primary, Tier I markets are typically larger cities of 5 million people or more, with well-established rental markets. Examples include Chicago, New York City, Boston, San Francisco, Los Angeles, Washington, D.C., and Dallas-Fort Worth.
These large metro areas are usually more expensive than other metro areas – for both buyers and renters – due to consistent demand for housing.
Growing cities are considered secondary markets; their growth creates demand as new people move into the area, supporting new business development and job creation.
These Tier 2 locations demonstrate more real estate market flux, creating attractive opportunities for real estate investors.
Secondary markets tend to be a population of 2 to 5 million people. They are usually less expensive than primary markets but still in demand. Examples include Philadelphia, San Antonio, Phoenix, San Diego, and San Jose.
Tertiary markets involve a lower population density of fewer than 2 million people. The population is spread out across a bigger geographic area.
There is typically less reliable job growth. In a strong economy, tertiary markets can provide attractive investment opportunities as property prices are typically lower.
These areas may be more expensive to develop as many are rural or outside of secondary market cities.
But can be prime markets for real estate investors as the properties cost less.
Whether you invest in a secondary market, tertiary, or primary market, it is essential to consider market-relevant data to price your rental correctly.
The key to pricing rentals in a primary vs. secondary market
The whole real estate cycle – from the purchase price to rental rate and eventual selling price relies on intelligence gleaned from current, comparable sales data for properties in the same price range.
When you review these comparables, you will get a good sense of amenities and the property improvements for other properties in the price range. As you determine your target rental rate, the purchase price is one factor but not the whole story.
You may be able to invest a small amount in fixing up the property, add or improve its amenities, and charge a higher rental rate than similar unimproved properties sold in the past year.
How you need to look at properties in secondary and primary markets differently.
Demand for rental property is always a local story. You can’t take an apartment in New York City and compare it to a similar apartment in Des Moines. Even if both cities are the largest in their respective states, large is relative –Des Moines has a population of 210,000, and New York City’s population is 8.175 million.
Even within Iowa and New York, you have the full range of markets to consider. So how do you determine the rent?
In real estate, comparing neighborhood properties wins out.
While you need to be aware of overall rates in the city where you plan to buy, your rental rate should be based on going rates in the immediate neighborhood. Each neighborhood will have a range that extends across unimproved and improved properties.
High-demand primary markets are top dogs because they have low turnover and can command higher rents. Secondary markets can present many growth opportunities. You can still improve a property in a secondary market to make it more attractive to tenants.
This will also allow you to raise rents accordingly. Tertiary markets also offer good opportunities, especially when the primary and secondary market values seem overblown.
Comparing apples to apples
In any market, you want to rely on current, accurate information to complete your analysis. Rentometer pulls rental rates from all online sources for current listings to provide you with accurate rental rates for any area. You can search within any state, city, or neighborhood to get the most up-to-date picture of rental rates.
Let’s compare rates for 2-bedroom, 1 1/2 bath rental units in Des Moines. The city’s average rent for this property type is $1,186 per month, but rates range from $943 to as high as $1,429. This range tells you that the right purchase price and a few property improvements could create a nice cash flow.
Comparing similar properties in a secondary market
Going a bit deeper, let’s compare three different neighborhoods in Des Moines: Downtown Des Moines, Bloomfield-Allen, and Merle Hay. Downtown has the highest average rents at $1,482 per month, while Bloomfield-Allen and Merle Hay show average rents of $890 and $891. Looking more closely at each area, you’ll find that Downtown has an entirely different culture and amenities from both the Merle Hay and Bloomfield-Allen neighborhoods. And while the two other neighborhoods are similarly priced, they have different amenities, culture, and crime levels.