Second-tier cities grab headlines and inward investment

“The world isn’t flat,” wrote Edward Glaeser, a Harvard professor of economics in his 2011 book The Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier and Happier, “it’s paved.” Today, 54 per cent of us live in cities compared with just 10 per cent in 1900. By 2030, the World Health Organisation estimates that more than 5bn people will be urban dwellers. Is this unprecedented rush to the city, though, confined to the world’s megacities – those with populations over 10m – or is the rise of the second-tier city a new feature of urbanisation?

What constitutes this second tier is subject to some debate. “Many of the second-tier cities in China are larger than capital cities across the world,” says Stanley Chang, managing partner for advisory services, China, at global accountancy group Grant Thornton. “Chengdu, for example, has a population of 14m; this is not a small city.”

China’s second-tier cities dwarf the rest of the world’s not just in size but also in youth. “If you look at the top 20 cities in terms of growth, they will be second-tier cities in China,” says Darren Rogers, a partner in the real estate team at law firm King & Wood Mallesons SJ Berwin. “The theme that underpins second-tier confidence is infrastructure; where there is national investment in high-speed rail and road systems, then companies tap into those cities, where wage costs are lower,” he says.

Developers and retailers seeking commercial property outside the overheated markets of the world’s capitals have flocked to these smaller cities – and not just the larger high street brands. Joe Magrath, director of development (China) at property investor TIAA Henderson Real Estate says, “What is most interesting is that the level of sophistication is rapidly moving upwards. While the likes of H&M and Zara have been all over second-tier cities for a decade or more, during the last five years we have seen exclusive luxury fashion brands come into high-end retail centres: Prada, Bulgari, Fendi, Jimmy Choo and Longchamp are all here.” Gucci’s largest outlet in Asia – at 800 sq m – is located not in Beijing or Shanghai but in Jing-Jin.

Interest in secondary cities is not just a Chinese phenomenon, however. According to US Census data released earlier this year, Austin, Texas, has seen the country’s biggest growth from domestic migration (up more than 5 per cent) while New York City has shrunk by nearly 2 per cent in the same three years to 2013.

Rosemary Feenan, director of global research at the advisory firm JLL, is unsurprised. “Up until recently, 50 per cent of all property investment across the world was in only 30 cities and those were dominated by supercities such as Tokyo, London, Hong Kong and Paris,” she says. “Since the financial crisis we have seen almost 60 cities move in and out of the top 30 places and there are several second-tier cities in that list.” Austin was highlighted by the firm’s 2013 Cities Indexes report as a “city to watch” together with Brisbane, Calgary, Nanjing, Shenzhen and Tel Aviv.

Property adviser DTZ has been working on a global occupancy cost that factors in not just rent per square foot, but costs per work station that include operating expenses, local taxes and wages, to help inform relocation decisions. “It’s important to compare apples to apples,” says Hans Vrensen, global head of research at DTZ. The costs can be matched to productivity per worker. “This relative productivity index,” says Vrensen, “identifies a sweet spot between low costs and high output. In the US, cities like Austin, Phoenix, Atlanta, Chicago and Boston do well.”

In Europe, the relative productivity index throws up some surprises. Copenhagen, Brussels, Lyon and Rome all score highly while London, Stockholm, Zurich and Geneva rank lower. “If you are a US or Asian multinational looking to have a first foothold in Europe, your instinctive landing place might be London or Paris. But we think that for some, Brussels might be a better choice,” says Vrensen.

The Economist Intelligence Unit’s Global Liveability Ranking points to a number of advantages, particularly to occupiers, of second-tier cities. The top cities “tend to be mid-sized, in wealthier countries with a relatively low population density”, it notes.

The popularity of big – but not mega – cities is being fuelled partly by millennials (those under 35) who “want to live close enough to the office to walk or cycle to work”, says Vrensen. “The city centre is not the cultural wasteland that is suburbia.” Second-tier cities can offer the buzz and cultural amenities that young, skilled employees want – without the traffic jams, unaffordable housing costs and pollution. The idea of working in a capital centre then enduring an hour or two’s long commute to a leafy residential suburb is anathema to this generation.

Success is also in part a function of the failure of some capital cities to manage their own growth rates. Beijing’s congestion and its inflexible rules for those without “hukou” (domiciliary registration) that make house and even car ownership a protracted process that can take up to five years to complete, is pushing the middle classes towards second-tier options, says Chang. “If I didn’t have to be in Beijing for work reasons, I wouldn’t want to stay here. It is simply too crowded. It affects everything: you don’t go to the restaurant across the city because the traffic is so terrible, so you eat closer by.”

The popularity of these cities is fuelled by under-35s, who want to live close enough to walk or cycle to work

The second-tier city is not a universal success story, however. “High investment risk and poor infrastructure combine to hold cities in Africa back,” says Feenan. “But improving education and the sheer dynamism of a young population makes Africa the continent to watch. It will take time, but it will come.”

Governance also has a big impact. “Germany’s federal organisation makes its regional capitals far more important than the second-tier cities in more centralised countries such as the UK, for example,” Feenan adds. A city’s ability to specialise, to offer world-class research and academic facilities and business-friendliness are also vital, she says. “Boston and San Francisco have mastered the art of permeability between research establishments and business. Eindhoven, in the Netherlands, has one of the world’s highest patent intensity scores by population, for example,” she says. “This has marked it out for innovation and popularity as a centre of the knowledge economy.”

Developers seeking property outside the heated markets of world capitals have flocked to these smaller cities

Another advantage of second-tier cities is that they tend to be pro-development. “There is an appetite to make things happen,” says Rogers. He cites the headline-grabbing investment of £800m by the Beijing Construction Engineering Group into the development of Manchester’s Airport City project. This was supported by its designation as a UK government enterprise zone, with business rate discounts, super-fast broadband connectivity and simplified planning procedures. And also, says Rogers, by the participation of other private investors.

The £850m development of St James Quarter in Edinburgh by TIAA Henderson Real Estate, the landlord of an existing shopping mall, is one of the largest regeneration schemes of its kind in the UK. Here, in an area that had become run-down and unloved, the 1.7m sq ft scheme will offer a mid-market hotel, up to 250 new homes and a million square feet of retail space. The project is supported by £61m of city council funding towards infrastructure improvement. “Being able to occupy exactly the building you want”, says Rogers, is far more likely in second-tier locations. “Sustainability, energy efficiency and corporate responsibility are increasingly important.”

Where once cities competed with each other, we can now see city clusters or networks growing up, adds Feenan, citing the Mumbai-Bangalore economic corridor that is helping put cities like Kolhapur, Haveri and Tumkur on the map. “However, just because there is good value in the second tier,” says Vrensen, “doesn’t mean we forecast that these cities will overtake capitals. Centralisation is a runaway train which seems hard to stop.”