Job Growth Fuels Apartment Demand in Cleveland Market
For the year ending in March, multifamily vacancy in the Cleveland metro area tightened to the lowest level since 2016, keeping annual rent growth climbing. Measured supply gains amid increased renter demand over the past four quarters have resulted in steady vacancy and rent improvement. These trends should continue over the next several quarters, holding vacancy below the 5 percent threshold. Favorable apartment operations are capturing investor attention.
Demand for apartments is coming from an increase in employment that is allowing more people to move into rentals. Employers added roughly 14,200 positions year over year in May, nearly double the previous year’s growth.
Another encouraging sign for Cleveland is that most employment sectors added jobs during this period. The heightened hiring has kept the unemployment rate below 5 percent for the past five months and the rate is down 80 basis points since May 2018. Education and health services is the most dominant employment sector, and the construction segment led employment gains during the past 12 months, staffing more than 5,300 new positions, followed by professional and business services with nearly 4,200 people.
New apartment projects contribute to some of the construction jobs. Over the past four quarters, builders added 1,500 apartments to the market, lifting inventory 0.9 percent. A slowdown in the pace of construction is expected this year, however, as just 1,400 units are underway. More than half of the projects under construction have completion schedules into 2020 and beyond, and all are in Central Cleveland.
Some are conversions of older buildings into apartments, such as the Terminal Tower, as the city’s core undergoes a major renaissance. That is attracting young professionals to live and work downtown. The largest project due for delivery during 2019 is The Beacon, the first residential high-rise to be built in the city’s core since the 1970s. It will offer 187 apartments in the building’s 29 floors.
Over the past year, demand for apartments remained healthy as net absorption doubled supply growth, pushing vacancy down 100 basis points to end the first quarter at 4.5 percent. Among submarkets, the strongest performance during this time was recorded in the Beachwood-Mayfield area, even though nearly 400 new apartments were added. Only the Strongsville-North Royalton-Medina submarket had lower vacancy at 3.4 percent.
Meanwhile, Central Cleveland (Downtown/Ohio City/Tremont), which has received more than 2,000 rentals since the beginning of 2015, registered a 40-basis-point increase in the vacancy rate to 5.7 percent. New inventory due over the next two years will likely keep vacancy at a healthy rate slightly above 5 percent until these buildings have stabilized. By class, vacancy posted the largest annual drop in Class B units, where the rate declined 160 basis points to end the first quarter at 4.5 percent. New inventory contributed to the rate in Class A rentals jumping 50 basis points to 5.1 percent while vacancy in Class C held steady at 4.4 percent.
Among submarkets, new inventory contributed to rent pushing up an annual 4.5 percent to $1,376 per month in Central Cleveland. The submarket has the highest average effective rent metrowide. Renters seeking to lessen the burden of housing costs will find the lowest average rents in the metropolitan statistical area at $685 per month, up 1 percent during the past 12 months.
Cap rate discussions
Improving fundamentals and the potential for higher returns than are available in many other markets are shining a spotlight on Cleveland apartment assets. After stepping to the sidelines for a short time, buyers returned to Cleveland during the past four quarters, lifting their presence across all classes. During this time, the average price rose 7 percent to $61,100 and the average cap rate declined 30 basis points to settle at 6.5 percent.
Class B assets are drawing attention due to strong cap rates. First-year returns for these properties are higher than Class C deals in many other major metros. Listings east of downtown, particularly Class C properties that can trade at cap rates well above the metro average, are receiving additional interest. Yield-seeking buyers may want to consider Class B and C value-add offerings to capture elevated returns.
— By Michael Barron, Senior Managing Director, Investments, Institutional Property Advisors, a division of Marcus & Millichap. This article originally appeared in the August 2019 issue of Heartland Real Estate Business magazine.