Detroit – Apartment vacancies here dropped to 7 percent in the first quarter of 2006, down from a peak of 7.3 percent at the end of 2005, according to a survey of the 206,474 apartments in the metropolitan area by Reis, Inc.

Even better, after twitching upward to an anticipated 7.2 percent in the second quarter, Reis expects the vacancy rate to decline until reaching 6.2 percent by 2010.

Although 6.2 percent is far from healthy, it would be a nice improvement for the city’s battered apartment market. Vacancies in Detroit have grown steadily from 3.1 percent in 2000. From 2001 to today, more tenants have left their apartments than moved in every year, according to Reis surveys. The number of occupied apartments has dropped from 197,894 in 2000 to 192,042 in the first quarter 2006. That’s negative absorption – to the tune of 5,852 units.

Job losses account for most of the trouble in the market: Bad news bludgeoned the Motor City as Ford Motor Co. and General Motors Corp. announced job cuts last year totaling 60,000, while Delphi Automotive Systems filed for Chapter 11 bankruptcy, which may lead to further job losses.

For decades, Detroit has been a city with one main industry – automobiles. But American car makers aren’t selling as many cars as they used to, and their share of the market for light vehicles in the U.S. dropped to just 57 percent in 2005, down from 72 percent in 1990.

Still, the domestic car business isn’t dead yet. GM is planning to invest $545 million in Michigan, and Ford will spend another $340 million to upgrade a plant in the Detroit suburb of Sterling Heights. Other employers are coming to Detroit, including medical centers, manufacturers, and casinos. “Employment will begin to stabilize in 2006, with positive growth resuming in 2007,” said a 2005 report from Hendricks & Partners, an apartment brokerage firm.

Developers completed only 110 apartments in 2005, though Reis expects that number to surge to 1,292 in 2006, and remain at more than 1,000 a year through 2010. Fortunately, Reis also expects the market to absorb 1,389 units in 2006, bringing positive absorption to the area for the first time since 2000. Reis expects that positive absorption to continue, increasing every year through 2010.

These figures do not include projections for condominium conversions, which took 419 rental units off the Detroit market in 2005 and 898 units off the market in 2004, Reis said.

Such conversions, which are concentrated in downtown areas, might help explain why the percentage of occupied apartments inside Detroit’s city limits held at a healthy 96.2 percent at the end of 2005, according to a survey of 1,711 apartments in the submarket for the Detroit Metropolitan Apartment Association (DMAA).

Apartments in the city itself still rent for less than in neighboring Oakland County, with studios leasing for $544 and two-bedroom, two-bathroom apartments leasing for $1,119 in Detroit, according to DMAA. In contrast, two-bedroom, two-bathroom apartments in south Oakland County rent for $1,370 on average.

Effective rents also grew throughout the market, despite the area’s high vacancy rate, averaging $751 in the first quarter, up from $743 a year before, according to Reis.

As vacancies rise, sale prices are dropping for apartment properties in the Detroit area. Garden apartment communities sold for an average $75,445 per unit in the first quarter of 2006 – not bad for the Midwest, where garden apartment units sold for an average of $66,407, according to data from Real Capital Analytics, a market analysis company based in New York City.

But cap rates have remained surprisingly stable. A cap rate expresses the income of a property as a percentage of the sale price. Garden apartments in Detroit sold at an average cap rate of 8.1 percent in the first quarter, well above the Midwest average of 7.4 percent.

Like many national apartment experts, Ron Terwilliger, CEO of Trammell Crow Residential, based in Atlanta, seems surprised that apartment cap rates have not gone higher in Detroit. “That’s just insane to me,” he said in a presentation at a National Association of Home Builders conference in April.

At least some investors seem to have more faith that Detroit’s problems are temporary and are buying up apartment properties. Many recent sales were made to local investors such as the Hayman Cos., based in Troy, Mich., and McKinley Associates, based in Ann Arbor, Mich.

Investors from outside the Detroit area also spent substantial sums over the last year to purchase properties in Michigan.

Southfield Apartments in Southfield, Mich., was bought by Archstone-Smith, based in Englewood, Colo., for $51.8 million or $131,000 per unit. Archstone bought the property as part of a portfolio of 36 properties owned by Oakwood Worldwide, based in Los Angeles.

Also in the first quarter, AEW Capital Management, L.P., based in Boston, bought Diamond Forest in Farmington Hills for $22.5 million, or $85,000 per unit, according to Real Capital Analytics.

Despite heavy job losses, these investors are betting on Detroit’s future and an apartment market that seems to be creeping down the road to recovery.