Good Times Continue to Roll for Apartment Owners in Metro Cleveland

Dan Burkons, Marcus & Millichap

Dan Burkons, Marcus & Millichap

Cleveland will host the Republican National Convention in July 2016. In response, hospitality firms have steadily expanded payrolls with the addition of 9,200 workers, the biggest relative gain among all employment sectors. The overall labor force will expand 1.6 percent this year, or by 16,500 new workers.

Thousands of these newly employed workers are seeking rental housing, particularly in the urban core where housing prices are much higher than the metro average. In addition, the urban core’s transformation to a 24-hour city has created its own momentum.

Demand Exceeds Supply

High net absorption outpaced construction during the past four quarters, putting downward pressure on vacancy. Last year, average vacancy dropped 160 basis points as tenants absorbed more than 3,400 units. In the last 12-month period ending in June, nearly every Cleveland submarket posted a drop in vacancy.

Net absorption is expected to end the year more than 40 percent higher, with vacancy projected to slide 50 basis points to 3.4 percent, one of the lowest levels in the country.

Builders have responded by expanding the project pipeline. More than 1,700 rental units have already come on line during the past year. However, compared with almost any other major metro in the country, this is just a drop in the bucket.

This robust net absorption of rentals is expected to lift the average effective rent this year in Cleveland by 2.5 percent. Rent growth outpaced the national average, surging 5.4 percent year over year, the largest increase since 2011. Rates downtown have continued to climb, with the newest product reaching $2.10 per square foot at the Flats East Bank and The 9.

Should I Rent or Buy?

Median home prices in metro Cleveland appreciated 2.7 percent, reaching $122,000, well below the national median of $221,000. Due to low-cost housing and affordable financing, the average mortgage payment for a median-priced home is around $650 per month.

Monthly rent for marketed apartments is nearly $200 more expensive on average, but can get up to $350 higher for spaces built since 2000. Those properties realized the biggest gain, with rates rising 2.2 percent to $1,010 per month, and Central Cleveland boasting the highest per unit price at $1,180 per month.

Although homeownership is significantly more affordable than renting, stagnant home prices and the proximity to urban entertainment centers and workplaces offered by apartments will keep vacancy rates low.

Amenity-laden apartment complexes or well-located properties will have more pricing power, but the low cost of single-family housing could eventually persuade renters to become homeowners.

That being said, home-buying conditions have been favorable for several years, yet renters have yet to make the switch, possibly because they don’t have the capital to make the down payment.

This is a national issue as homeownership rates remain at multi-decade lows, despite record-low interest rates.

Low Cap Rates Persist

Deal flow was steady during the 12-month period that ended in June. Transaction velocity has been most pronounced in the urban core and inner-ring suburbs, where buyers seek to locate near downtown and the major higher education and medical institutions hub of University Circle.

Traditionally, Cleveland investors have focused heavily on Class C assets. However, in the past year, they have shifted to more established mid-tier properties.

The low cost of capital from the Federal Reserve’s ultra-low interest rate policy has allowed the compression in cap rates for years. The Fed’s expected token rate increase this fall will not undo that trend.

First-year yields inched down 20 basis points, but remained in the mid-6 percent range for Class A product and as high as the low 8-percent range for Class C properties.

Indications from the Fed that interest rates could increase may put pressure on sales activity as investors try to make deals before capital becomes more expensive. Many institutional investors must buy with specific return characteristics, eliminating many of the more expensive metros.

No Sticker Shock

Out-of-state buyers who haven’t previously looked at Cleveland may be surprised to find prices haven’t been bid up as high as neighboring markets such as Columbus, Indianapolis and Pittsburgh.

They will also be pleasantly surprised to find the rent levels superior to several of those more popular markets and the threat to new competition is much lower.

Commercial credit has eased considerably as loan-to-value ratios increase because of stiffening competition among lenders. Investors have been eager to scoop up assets yielding more than 300 basis points above comparative properties in larger markets.

Trading activity will likely pick up in 2015 as market participants position portfolios for the first rising interest rate cycle in more than a decade.

— By Dan Burkons, CCIM, First Vice President Investments, Senior Director, National Multi Housing Group, Marcus & Millichap. This article first appeared in the September 2015 issue of Heartland Real Estate Business magazine.

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