Table of Contents

What Are Real Estate Market Tiers? Defining Characteristics

By

James Chen

Updated May 14, 2024

Reviewed by

Charlene Rhinehart

Fact checked by

Hans Daniel Jasperson

What Are Real Estate Market Tiers?

Real estate market tiers are categories used by the real estate industry to divide cities. The categories for the real estate market tiers are tier I, tier II, and tier III. Each real estate market tier has a distinct defining characteristic. Major cities fall into the first tier while the second tier provides opportunities for new investment. The third tier has lower populations and the chance for growth if there is room for development. Real estate companies and investors use this tier system to determine market conditions and investment opportunities.

Key Takeaways

Real estate market tiers are broken down into three levels, representing how well-developed the markets are in the underlying cities.
Tier I cities are highly developed, tier II cities are still developing their real estate markets, and Tier III cities have underdeveloped markets.
The higher the tier of the city, the more desirable it is seen for development by businesses looking to expand.
When the economy is poor, businesses mostly stick to tier I cities, but when it is thriving, they may consider tier II and tier III cities.

Understanding Real Estate Market Tiers

As noted above, real estate markets are divided into three different categories. These levels are made up of cities based on growth in the real estate market, populations, and the potential for real estate investment. These tiers help guide investors and real estate firms, such as real estate investment trusts (REITs) in their investment decisions.

The three tiers are:

Tier I: This level represents cities with a developed and established real estate market. These cities tend to be densely populated and highly developed with desirable schools, facilities, and businesses. These cities have the most expensive real estate. New York, Los Angeles, Chicago, and Boston are some common Tier I cities.
Tier II: Cities in this tier are 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. But if growth continues, prices will rise. Populations tend to be between one and five million. Examples include Denver, Atlanta, Nashville, and Austin.
Tier III: The third category is made up of cities with lower populations—usually lower than one million people. 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. Detroit, Las Vegas, Orlando, and St. Louis are considered Tier III cities.

The cost to operate in prime tier I real estate is expensive even with the potential for high returns. 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. Although they are expensive, these cities also feature the most desirable facilities and social programs.

Many investors and real estate investment firms turn to underdeveloped areas to expand and invest in future growth, which is why Tier II and Tier III cities are considered desirable destinations. This is especially true during periods of economic strength. That's because there is the potential for growth and development for businesses. As businesses expand, they can provide employment opportunities for residents.

The variation in home values between tiers is very pronounced. For instance, the typical home value in New York is $748,012. Meanwhile, the average home prices in Atlanta and Detroit were $400,699 and $73,843, respectively.

Risks Associated with 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.

Are Tier I Cities Better Than Cities in the Other Tiers?

Tier I cities aren't necessarily better than those in the other tiers. Tiers are used to classify cities based on their populations, real estate markets, growth (and growth potential), and other factors like infrastructure.

Tier I cities tend to be densely populated with high growth and development as well as established infrastructure and social programs. Although this means there is a great deal of real estate investment in tier I cities, it doesn't mean they are better. These cities are often expensive and can experience slow growth when the economy thrives. This is why many businesses turn to tier II and tier III areas when the economy slows down, as they often present opportunities for development and growth.

What Are Some Common Examples of Cities in Each Real Estate Tier in the U.S.?

Tier I cities are highly populated with extensive growth, and are often very expensive. New York, Los Angeles, Chicago, and Boston are common examples of tier I cities. Tier II cities include those with mid-level growth and populations between one and five million, such as Denver, Atlanta, and Nashville. The third tier consists of cities like Detroit and Orlando—cities with smaller populations. Although they aren't as developed as cities in the other two tiers, there is still opportunity for growth in tier III locations.

How Can I Invest in Real Estate?

There are different ways you can invest in real estate. You can invest directly by purchasing investment properties. You can also invest in this market indirectly by buying shares of real estate investment trusts. These are firms that own or provide financing to income-producing properties. They trade on stock exchanges and generate income from renting out properties. As a shareholder, you receive dividends. You can also invest online through investment platforms, which connect you with developers. Flipping homes has become a popular way to invest in the market. This allows you to purchase a home, renovate it, and sell it (hopefully for a profit) within a short timeframe.

The Bottom Line

Real estate investing can be both rewarding and risky. That's why it's important to understand all the nuances involved in this market. Researching real estate market tiers is one way you can stay ahead of the game. Knowing how each category is defined and their growth potential can help you choose the right properties, companies, and/or REITs before you dive in with your money.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.

NAIOP. "Second-Tier Cities Thrive in the Post-Pandemic World."
Caliber. "Picking the Right Real Estate Market to Invest in: Comparing Tier I, II, and III Markets."
Zillow. "New York, NY Housing Market."
Zillow. "Atlanta, GA Housing Market."
Zillow. "Detroit, MI Housing Market."

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