What it means
Tier 1 markets are the big, internationally known cities with deep pools of buyers, tenants and capital. Properties there are expensive and easy to sell, but the yield (the annual income as a share of the price) is usually the lowest.
Tier 3 sits at the other end, with cheaper properties, thinner demand and higher potential returns. Tier 2 sits between them and often attracts investors who want higher income than the major cities without taking on the full risk of a small market.
These cities are typically growing, often because of lower costs, expanding industry or population moving in. Over time, a successful Tier 2 city can be promoted to Tier 1 status.
The labels are used differently around the world, and the exact boundaries are a judgement call. In some countries the government or a research firm publishes an official ranking by population or economic output.
In others the tiers are an informal market convention that shifts depending on who is speaking. Be careful not to confuse market tiers with property grades.
Letters such as Class A, B and C describe the quality and age of an individual building, while Tier 1, 2 and 3 describe the location and market. A top-quality building in a Tier 3 town and a tired building in a Tier 1 city show how the two ideas differ.
Finance teams use the bands when setting expansion plans, valuing portfolios and deciding where to lease space. The key discipline is to compare price and income together instead of chasing the highest headline yield.
A high yield in a thin market may simply reflect the extra risk of being unable to sell or re-let.
In practice
Real-world examples.
Example
A global investment fund buys a $90,000,000 office tower in a Tier 1 financial centre. It accepts a 4.5% yield because the building is easy to sell and tenants are plentiful. The fund treats the purchase as a safe anchor holding.
Example
A retail chain with 40 stores opens its next five in Tier 2 cities, where rents are 40% lower than in the largest cities. Sales per store are lower too, but the shops cover their costs sooner. The finance team tracks each location against a payback target of four years.
Example
A family office buys a small warehouse in a Tier 3 town for $1,800,000 and leases it to a regional distributor at a high yield. The tenant is its only customer, so a departure would leave the building empty. The family office sets aside a reserve to cover this risk.
Formula
Calculation
Capitalisation rate = Net operating income / Property price
Suppose two buildings each earn a net operating income of $600,000 a year after running costs. The Tier 1 building sells for $12,000,000, which gives 600,000 / 12,000,000 = 0.05, or 5%. The Tier 3 building sells for $7,500,000, which gives 600,000 / 7,500,000 = 0.08, or 8%. The 3 percentage point gap is the extra yield investors demand for accepting a smaller, less liquid market.Case study
Seen in the real world.
Summit Row Capital is an illustrative, fictional property investor with $60,000,000 to deploy. Its analyst compares three apartment blocks, one in a Tier 1 city at a 4.8% yield, one in a Tier 2 city at 6.2% and one in a Tier 3 town at 8.5%.
The Tier 3 block looks best on paper, but the analyst notices that only two employers support its tenants and the town has a falling population. She recommends splitting the money, with 50% in the Tier 1 block, 35% in the Tier 2 block and 15% in the Tier 3 block.
The blended yield works out at about 5.8%, and the portfolio is far less exposed to any single employer. In this illustrative case, the board accepts a lower headline return in exchange for a steadier income stream.
Watch out
Common mistakes.
- Treating the tier labels as an official, fixed standard when they differ between countries, firms and years.
- Chasing the highest yield in Tier 3 markets without allowing for the risk of vacancies and a slow resale.
- Confusing market tiers with building grades such as Class A or Class B.
Questions
People also ask.
Does Tier 1 always mean the best investment?
No, Tier 1 usually means lower risk and higher prices, but the lower yield may not suit an investor who needs more income.
Can a city move between tiers?
Yes, a fast-growing Tier 2 city may be reclassified as Tier 1, and a declining city can slip down a band.
Who decides which cities belong in which tier?
It depends on the country, as some use official population or output rankings, while others rely on broker and research firm conventions.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related