Real estate market tiers categorize cities as Tier I, Tier II, or Tier III depending on the stage of development of their real estate markets.
Each real estate tier has defining characteristics:
- Tier I cities have a developed established real estate market. These cities tend to be highly developed, with desirable schools, facilities, and businesses. These cities have the most expensive real estate.
- Tier II cities are in the process of developing their real estate markets. These cities tend to be up-and-coming, and many companies have invested in these areas, but they haven't yet reached their peak. Real estate is usually relatively inexpensive here; however, if growth continues, prices will rise.
- Tier III cities have undeveloped or nonexistent real estate markets. Real estate in these cities tends to be cheap, and there is an opportunity for growth if real estate companies decide to invest in developing the area.
Breaking Down Real Estate Market Tiers
Many businesses see Tier II and Tier III cities as desirable destinations, particularly in times of economic strength. These areas present an opportunity for growth and development and allow businesses to expand and provide employment to people in growing cities. Additionally, the cost to operate in prime Tier I real estate is expensive, and companies often see underdeveloped areas as a way to expand and invest in future growth.
In contrast, businesses tend to focus more on the established markets in Tier I cities when the economy is in distress, as these areas don't require the investment and risks associated with undeveloped areas. Though they are expensive, these cities feature the most desirable facilities and social programs.
U.S. cities often classified as Tier I cities include New York, Los Angeles, Chicago, Boston, San Francisco, and Washington D.C. On the other hand, Tier II cities may consist of Seattle, Baltimore, Pittsburgh, and Austin — although classifications may differ through time and based on certain criteria. Still, real estate prices often vary drastically from tier to tier. For example, real estate website Zillow estimates a median home value in Pittsburgh of $130,400, compared to $586,400 in New York City and $658,500 in Los Angeles, as of January 2018.
Risks Associated with Different Real Estate Market Tiers
Tier I cities are often in danger of experiencing a housing bubble, which occurs when prices surge due to high demand. However, when prices get too high, no one can afford to pay for real estate. When this happens, people move away, real estate demand decreases, and prices sharply drop. This means that the bubble has "burst."
Tier II and Tier III cities tend to be riskier places to develop real estate and businesses. These risks stem from the fact that the infrastructures in Tier II and Tier III cities are underdeveloped and don't have the resources to support new ventures. It's expensive to develop these infrastructures, and there's always the chance that the development won't succeed, and the real estate market will end up failing.