The success of a commercial real estate investment is closely correlated to the market in which the property is located. While most investors are aware of this fact, choosing a market in which to invest can be a much more complicated decision because they have different sizes, needs, growth rates, and costs.
In this article, we are going to discuss one very specific type of market known as a “gateway market.” We will describe what they are, how they are defined, and the risks and benefits of investing in one. By the end, readers will have the information needed to determine if a gateway market investment is a good fit for their risk tolerance and real estate return objectives.
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What is a Gateway Market?
For potential commercial real estate investors, there are two ways to think about gateway markets.
The first is that a gateway market is the best. These are markets that are considered to be top tier by commercial real estate professionals and investors and they offer the best of everything, from restaurants to hotels, nightlife, shopping, entertainment, and business opportunities.
The second way to think about a gateway market is as a major, international city that is often the first that travelers will experience upon arrival.
In the United States, gateway markets include cities like: Miami, New York, Boston, Chicago, Seattle, San Francisco, Washington D.C., Denver, Atlanta, Houston, Dallas, and Los Angeles. Around the world, gateway markets are cities like: London, Tokyo, Madrid, Paris, Hong Kong, Buenos Aires, or Sydney.
What Defines a Gateway Market?
Gateway markets in commercial real estate are typically defined by the following characteristics:
- Growth: They are places where both population growth and industrial growth are high. Think technology in San Francisco or Finance in New York.
- Transport Hubs: Gateway cities have a world class, multimodal, transportation infrastructure. Think airports, rail stations, subways, cruise terminals, and cargo ports. For example, New York has 3 major airports, a world class subway system, and a major port within the metro area.
- Diversification: Gateway markets have a highly diversified economic base, with multiple influential industries. For example, Houston is a global hub for the energy industry, but it also has significant medical, finance, and agriculture industries.
- Arts & Culture: Aside from their business and commerce leadership, gateway markets are also global hubs for arts, culture, film, fashion, and music. For example, think about Miami which has an incredibly vibrant fashion and arts scene. Art Basel alone is one of the most important art shows in the world and it takes place annually in Miami Beach.
- Headquarters: Gateway markets are home to a disproportionate share of corporate headquarters for major companies. In the US, just a handful of gateway cities account for a large number of Fortune 500 company headquarters: New York City has 64, Chicago has 35, Houston has 24, and Dallas has 22.
- Liquidity: From a real estate perspective, the size, diversity, growth, and demand in gateway markets means that they offer a high degree of liquidity when owners go to sell their properties. Of course, liquidity is a function of property type, demand, and a number of other factors. But, the important point is that gateway markets tend to offer more liquidity than secondary markets or tertiary markets.
Gateway markets are some of the most important and consequential cities in the US and they typically come with potentially attractive opportunities for CRE investors.
Gateway Market vs. Gateway City
The difference between a gateway market and a gateway city is a slight, but important one and it has to do with city boundaries. To illustrate this point, consider Houston, TX – a gateway city with a population of ~2.4M people within its official city boundaries. However, Houston is also home to a much larger market that spills far beyond city boundaries.
The Houston – Woodlands – Sugar Land Metropolitan Statistical Area (MSA) is the fifth largest in the US and has a total population of 7.1M people. This MSA represents the broader Houston gateway market, which is much larger than its official city boundaries suggest. Within this broader market, there may be many attractive investment opportunities.
The point is this, investors interested in gateway cities may also find attractive opportunities outside city limits, but within the boundaries of the broader gateway market.
Benefits and Risks of Investing in a Gateway City/Market
Like any commercial real estate investment opportunity, there are benefits and risks that investors should consider before investing in a gateway city/market.
Benefits of Investing in a Gateway Market
Benefits of a investing in a gateway market include:
- Diversity of Opportunity: Because of their size and scale, there are opportunities for real estate investors in all price points, property types, and building sizes. These could range from a 3-unit multifamily apartment building to a 50-story high rise office building. There is something for everyone.
- High Growth: Gateway cities/markets are high demand, high growth places. So, the odds of being able to increase rents/property values are better than a low growth market.
- Liquidity: Again, demand for properties in these real estate markets is high so there is usually someone interested in buying a property when it goes up for sale.
- Support Infrastructure: By definition, the support infrastructure in gateway markets is fantastic, which can make commercial properties more attractive. For example, in New York, the subway system and abundance of taxis make accessing properties easy.
- Demand: Demand drives prices and the right commercial real estate properties in gateway markets can be highly sought after. This is good for investment returns.
When these benefits are combined, the net result for gateway markets is that investors have an opportunity to earn excellent returns from investing in commercial real estate assets located within them.
Risks of a Gateway Market
Risks of gateway market investing include:
- Cost: Given their high demand, the valuation of gateway properties can be significant relative to their lower cost counterparts in secondary or tertiary markets. There are two risks with regard to cost. First, it means that acquiring a gateway property can be extraordinarily expensive so they require a lot of capital. Second, because they are so expensive, returns may be somewhat capped.
- Complexity: Navigating the tenant and zoning laws in a place like Los Angeles or New York can be extremely complex and time consuming. This can add to the cost to manage a real estate investment, which can also limit returns.
- Competition: Again, demand for properties in gateway markets can make acquiring one (at a good price) incredibly competitive. Real estate investors must be disciplined to avoid overpaying, which could also limit returns.
- Red Tape: In a value-add strategy, getting the permitting and licenses necessary to perform renovations can be frustrating and time consuming. And, once a contractor has it, the renovation itself can be a logistical nightmare. Imagine a concrete truck on the busy streets of New York City or trying to hoist materials safely 30 stories above street level. The cost of the added red tape can limit returns.
- Security: Given the population density surrounding gateway properties, security is always a concern. So, it is common to have to employ full time security professionals and/or systems to ensure that only authorized personnel are allowed inside a property. For example, office buildings in Chicago or Los Angeles have multiple security checkpoints before a worker is allowed in. The cost for this is high, which can limit returns.
Of course, investors must weigh the risks of investing in a gateway market against the benefits to determine if doing so is in their own best interests.
Gateway Markets & Private Equity Real Estate
Given the discussion above, it may seem like investing in a gateway real estate market is a no-brainer way of making a profit. This is not necessarily true. Finding the right property in the right commercial real estate market and buying it at the right price is far more difficult than it may seem. For individual investors, this task can be overwhelming. It takes a tremendous amount of resources, time, and expertise, things that not all individual investors have.
For these reasons, it can be helpful for individual investors to partner with a private equity firm in pursuit of a commercial property investment in a gateway market (or non-gateway markets). With this structure, the private equity firm does all of the hard work to find the property, analyze the fundamentals, close the deal and manage the property once it is acquired. All an individual, accredited investor, has to do is to provide capital.
For most individuals with the desire to invest in commercial real estate, but not the time, expertise, or relationships to manage the property, a private equity partnership can be a strong option to consider.
Summary & Conclusion
A gateway real estate market is one that is widely recognized by commercial real estate professionals as top tier. Or, another way to think about it is as a major, international city that has a large, diverse, growing population.
Gateway markets are defined by a number of characteristics including: rent growth, population growth, world class transportation infrastructure, a vibrant arts & cultural scene, and a diversified economic base.
Benefits of investing in a gateway market include: a diversity of opportunities, high growth, liquidity, support infrastructure, and strong demand.
Potential risks of investing in a gateway market include the high cost (low cap rates), the competition for acquiring them, and the complexity of complying with zoning laws. These can all make gateway properties more expensive to manage and can put a cap on returns.
Finding gateway properties and purchasing them at a reasonable price can be a difficult task for an individual real estate investor to complete on their own. In some cases, it may be beneficial to partner with a private equity firm who has the time, resources, and expertise to complete these tasks.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you would like to learn more about our commercial real estate investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.