When Nandan Piramal, scion of the Piramal family and vice chairman of Piramyd Retail [Get Quote], travels these days, it is mainly to small cities like Nagpur, Lucknow and Jaipur.

"I am amazed at what I see in these cities. They are what Mumbai was 15 years ago. I don't think they will take that long to get to where Mumbai is today," says Piramal.

This vote of confidence is endorsed by Susil Dungarwal, CEO of The Loot, a Mumbai-based discount retailer, "When I travel, two out of three destinations are tier 2 and 3 cities. That where the growth is for us and most other retailers."

His next three stores will open in tier 3 cities -- Surat, Vadodra and Nashik. And the Nashik store that opens in March this year will be biggest in that city in the apparel catagory at 6,000 sq ft. Aurangabad, another C-class town, is his next destination.

Piramal has finalised locations for Piramyd in Nagpur, Lucknow and Indore. Much of his expansion over the next two years is slated for these cities; he has even decided to introduce a new format specific to them. Dungarwal plans to invest 60-70 -per cent of his investment corpus in these cities.

And retailers are just the latest to join the small town bandwagon. A recent study puts the total amount of built-up property coming up in these towns at 7-8 million sq ft: most of it IT, commercial and retail.

The cities in the reckoning are state capitals like Lucknow, Jaipur, Chandigarh, Ranchi, Guwahati, Bhubaneshwar, Thiruvananthapuram, Bhopal and Jammu. Other smaller cities like Mysore, Kochi, Madurai, Vizag, Cuttack, Ludhiana, Nagpur and Aurangabad are catching up fast.

The clarion call was sounded by the IT industry, which was being wooed by state governments looking for investment and employment opportunities for the local youth. Chandigarh alone is estimated to have 5 million sq ft of IT space under construction.

While Infosys [Get Quote] is planning a campus there, GE is eyeing the Pink City, because of its closeness to Gurgaon. Jaipur has also begun to figure on the radar of realty venture funds who are looking for good entry points into a heated market.

Nagpur just attracted a Rs 300 crore (Rs 3 billion) investment from the Mumbai-based KSL & Industries group who bought the historic Empress Mills and plan to convert it into a mixed use complex with an IT park, luxury residences, a five-star hotel and a shopping mall. Indore's A B Road is fast emerging as a retail destination.

The last year has seen IT majors such as IBM, Dell, Cognizant and Satyam [Get Quote] unveiling plans for cities like Coimbatore, Mangalore and Vizag. Wipro [Get Quote] and TCS [Get Quote] have acquired land at Vizag, while Honeywell [Get Quote] is looking at expanding operations in Madurai.

Satyam has started work on its 50-acre campus in Vizag and is establishing a technology centre on the outskirts. Mphasis has invested Rs 70 crore (Rs 700 million) in a BPO unit at Mangalore.

Says Anshuman Magazine, managing director CB Richard Ellis, "There is a clear indication that other states are seriously working towards grabbing a share in the booming ITES sector."

Jaipur, for instance, is attracting investment from not only developers but also private realty funds. Says Sumit Anand, CEO of Anand Rathi Venture Funds, "We will look at smaller cities like Jaipur, as we believe investment there will yield more than in the metros."

Mumbai-based developer BSEL Infrastructure Realty [Get Quote] is planning to invest Rs 100 crore (Rs 1 billion) in a mixed use property. Says company president Shashank Joshi, "As new entrants, we can't afford land in south Mumbai or Delhi."

Karnataka is also attracting investors in smaller cities. Software Technology Parks of India (STPI) has already set up centres in Mysore, Manipal, Hubli and Mangalore. Dharwad, Belagum and Gulbarga are also attracting investors.

Both Dharwad and Hubli are being considered second-generation IT centres in the state as they boast of rail and air connectivity and low real estate costs, apart from a IT-skilled work force.

Kochi in Kerala is another growth story. With the state government recently approving the Smart City, the 100 acre IT city to be developed by Dubai Internet City, IT giants like IBM, Microsft and Intel have shown interest in the project.

This, along with the upcoming international container trans-shipment terminal, the international marine club and the Italian Fashion City, is expected to make the city a preferred destination.

One of the reasons IT companies move away from metros is the high rents. Internationally, IT companies prefer to keep their rentals lower than $1 per sq ft, but with rents in the metros beginning to close in, moving to smaller cities looks more feasible, says Anuj Puri of Chesterton Meghraj.

For instance, rentals in the Bandra Kurla complex in Mumbai are at Rs 115 per sq ft with total occupation cost going up to Rs 153. Compared to this, rentals in Hyderabad range at around Rs 34 per sq ft, with total occupation costs going up to Rs 64 per sq ft. Rentals in cities like Jaipur are around Rs 20-25 per sq ft.

Analysts point out that these developments are a pointer to the next stage of the IT boom. "For years, India's software and outsourcing services have been centred in a few hubs. The spread of IT and IT-enabled services to smaller towns will change that, as this revolution reaches out to the 300 million-strong middle class, one of the world's most attractive emerging markets. This will create thousands of new jobs, new education opportunities and make local governments more technology-savvy," says Magazine.

Typically, tier 3 cities currently provide definite cost advantages of 15-30 per cent over tier 1 and 2 cities through lower labour and real estate costs and reduced staff attrition rates, says a report by international consultants Jone Lang Lasalles. This gap is expected to widen further over the next few years.

However, they are not eveybody's cup of tea, feels JLL country head Victor Lottefier. "Despite their cost advantages, tier 3 cities will not appeal to all firms. The greatest risk factor with such cities is their smaller labour pools when compared to tier 1 and 2 cities.