Uncertainty looms in Detroit, but most renters staying put.

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While a rapidly deteriorating local economy is weighing on apartment operations in Detroit, weakness is expected to be mitigated by residents remaining hesitant to transition away from rental units. The Detroit metro area has one of the most affordable housing markets in the country, as overbuilding and a declining population have resulted in a significant supply/demand imbalance. Nonetheless, many local inhabitants are exhibiting caution when considering a move into a home due to still-falling prices and the high-risk employment market. The weak national economy is limiting options for job seekers outside of the metro area, which could stem the tide of out-migration in the short term, boosting demand for area apartments. On the supply side, development activity is minimal again this year, as construction costs continue to outweigh attainable rents. Competition is emerging from fractured condominium projects, however, some of which are offering units for lease until demand rebounds.

Early estimates indicate that employers decreased payrolls by 6.8 percent, or 130,700 jobs, in the year ending in the first quarter. As auto-related companies restructure, 102,000 area positions have been eliminated in the last 6 months. While vacancy does not fluctuate significantly in Detroit, mounting job losses will force some local residents to double-up. As a result, vacancy is expected to finish the year at 7.9 percent, an increase of 120 basis points.

Local apartment community owners will continue to increase leasing incentives this year to help keep renters in units. Asking rents in Detroit finished the first quarter at $834 per month, while effective rents slid to $766 per month, annual losses of 0.2 percent and 0.6 percent, respectively. Average concessions have widened to nearly 30 days of free rent during the past year, the highest rate since early 2005. During the last 12 months, Class A rents have retreated 0.2 percent to $1,038 per month, while Class B/C rents have dipped 0.4 percent to $721 per month. Average revenue has decreased by 0.9 percent year over year due to lower occupancy levels and rents. As fundamentals soften through year end, the average revenue is expected to recede another 1.4 percent.

Although modest, deal flow in Detroit reached a sustainable pace early this year and is expected to remain relatively flat in the coming months. Most of the transactions in 2009 will likely involve local buyers exchanging assets to meet individual investment goals. Value-add plays in the Midtown/West Detroit submarket could attract some owners with a penchant for improving vacancy, although the current climate may challenge this approach. Additionally, underperforming properties in some high-end Oakland County, Michigan, submarkets, including Troy and Farmington Hills, could provide significant revenue gains for owners willing to adjust concessions to firm occupancy levels. Lower home prices in the county, however, are expected to limit rent growth over the next few years. Long-term strategies can be achieved in the Ann Arbor, Michigan, submarket, where the student population supports Class B/C demand. Regardless of investors’ goals, cap rates in Detroit offer buyers some of the highest initial returns in the country.

— Steven Chaben is a managing director of Marcus & Millichap Real Estate Investment Services and regional manager of the Detroit office.

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