Favorable hiring trends in metro Detroit have driven household formation to its highest point since the start of the new millennium. As a result, multifamily asset performance and operations have shown marked improvement with respect to demand, occupancy, rents and prices.
In the first quarter of the year, local employers created 14,500 jobs for a year-over-year gain of 2.3 percent, which brought Detroit’s unemployment level to its lowest level since 2001. Employment advances were led by the professional and business services sector as well as the leisure and hospitality sector, which added 16,100 and 6,000 workers, respectively. Total employment at the end of 2016 is projected to be 1.9 percent higher than it was at the end of 2015.
The generally higher paying professional and business services jobs will lead to broad-based employment growth through the rest of the year, and gains in this segment are expected to support growing demand for luxury rentals. In any event, rental demand in Detroit is on the rise for the foreseeable future.
Construction takes off
Steven Chaben, Marcus & Millichap
Encouraged by positive employment trends, economic indicators and a recovering automotive industry, new construction, renovation and conversion are thriving.
Developers have new multifamily projects underway in more than half of Detroit’s submarkets, which, in addition to creating construction-sector jobs, will bring annual deliveries in 2016 to the largest level in a decade.
By the end of the year, 2,200 units will have been added to the rental apartment inventory, with most activity focused in Ann Arbor and the Downtown/ Midtown/ Rivertown submarket.
The largest new development slated for completion this year is Packard Square, developed by Craig Schubiner of Harbor Cos., in Ann Arbor. The 249-unit project is being built on the former site of Georgetown Mall and is on schedule to start accepting occupants later this summer.
Additionally, there are more than 900 units under renovation or conversion. Value-add oriented renovation and conversion activity has centered on Downtown and Midtown. Despite the deluge of construction, absorption of new product will be swift, perpetuating tight vacancy levels.
Vacancy rate contracts
During the first quarter of 2016, new deliveries pushed up average vacancy in metro Detroit to 3.3 percent, but that’s still lower than it was a year ago. By product vintage, the vacancy rate for apartments built before 1970 registered 4.3 percent in the first quarter. Developers find this vintage in desirable neighborhoods attractive for renovation/conversion opportunities.
Despite high levels of construction this year and greater competition from the single-family home market, the vacancy rate across the metro area is expected to fall to 3.1 percent by year’s end on net absorption of 815 units. More importantly, the tight vacancy rate is expected to lead to an increase in average effective rents.
Rents rapidly advance
Strong renter demand and tight vacancy this year — especially in the most competitive submarkets such as Ann Arbor — will foster an estimated 4.9 percent increase in the average effective rent to $903 per month. This represents the largest annual rent growth since 2012.
These gains will be largely attributable to the abundance of new, amenity-laden, and in many cases luxury, units where many rents top $1,500 per month. That said, the relative affordability and competitiveness of single-family homes may work to slow the rate of apartment rent increases for some areas of metro Detroit.
Overall, improving multifamily real estate fundamentals will help boost property values, which will generate greater investor interest in the area.
Influx of investors
Drawn by relatively lower entry costs and higher yields, new multifamily investors will continue to flock to Detroit, which provides advantages for a myriad of investment strategies.
Many investors will seek to deploy capital into coveted stabilized assets in downtown Detroit or in Ann Arbor, where initial yields can be found in the 6 percent range. Well-located properties with cutting-edge amenities that have upside potential will start to trade at initial yields in the 5 percent tranche.
Suburban cities such as Novi, where Google is building a self-driving car R&D center, and Royal Oak, a suburb popular with young professionals, have also piqued investor demand. That is causing prices in the area outside the core metropolis — particularly in cities south of Detroit — to rise.
Value-add investors, meanwhile, are targeting well-located properties with strong upside potential and cap rates in the 7 percent range.
Rising property values, transaction activity and the low cost of capital have inspired some owners to consider rebalancing their portfolios.
Owners who perceive a lack of reinvestment opportunities will likely hold onto their assets and benefit from higher cash flow while operations continue to improve. Owners who perceive reinvestment opportunities will consider selling, which could translate to a more active listing environment for the remainder of the year.
Robust employment growth and household formation have brought a new groove to Motown. Although a competitive single-family home sector could pose an impediment to multifamily property growth, improving operations and performance with respect to demand, occupancy, rents and property value growth suggest otherwise.
— By Steven Chaben, senior vice president, Marcus & Millichap. This article originally appeared in the July 2016 issue of Heartland Real Estate Business.