As in Aesop’s tale of the tortoise and the hare, the race doesn’t always go to the swift. While “rust belt” cities like Cleveland may never outpace the coasts in terms of growth rates or construction starts, their predictable steadiness is attractive to out-of-state investors weary of the furious but volatile coast markets.

“It’s a slow, steady Midwestern market,” said Debbie Corson, a principal in the Ohio office of investment advisory brokerage firm Apartment Realty Advisors, Inc. “In the bigger markets, like Atlanta, or Dallas, or San Diego, you see big growth but you also get big downturns. You don’t get that in Cleveland.”

Though plagued by population losses and a stagnant economy over the last several years, limited new construction pushed occupancies and rents slightly higher in 2006. What’s more, Cleveland has been hit hard by a single-family foreclosure crisis that is expected to send a new stream of renters into the apartment market.

Make no mistake, the forecast for the overall metropolitan area is bleak. But bucking the out-migration trend is Cleveland’s revitalized downtown, where a series of luxury, mixed-use developments are under construction.

City center

Last year, 744 new apartment units were brought online in Cleveland, which may serve as a high-water mark for years to come—analysts don’t expect that level to be revisited any time soon. Market research firm Reis, Inc., forecasts only limited construction for the rest of the decade as the local economy staggers along, with 256 units projected to be completed this year, 300 next year, 300 more in 2009, and 332 in 2010.

Much of that construction activity has been centered on Cleveland’s downtown area, where mixed-use developments featuring high-end rental and condominium units slowly are being added to the cityscape.

“Cleveland has done a nice job of revitalizing their downtown, and it’s drawn young urban [dwellers],” said Mark Rohr, a partner with market-research firm and brokerage Hendricks & Partners. “Those folks are generally looking for small apartments that are finished nicely: hardwood floors, stainless steel appliances, granite countertops.”

As a result, studio apartments are gaining traction in Cleveland. “The two-bedroom and three-bedroom units are the weak performers—rent growth has been strongest for studios,” said Sam Chandan, chief economist for Reis. Studios are averaging rents of $1.20 per square foot, compared to one-bedroom units at 89 cents, and two- and three-bedrooms at 79 cents.

Overall, Cleveland continues to lose population—Reiss expects the city to lose 0.4 percent of its population annually from 2007 through 2011, a net loss of about 50,000 people. And the economy is expected to remain stagnant through the rest of this year and into 2008 and 2009.

“Employment is flat to declining, and household counts are flat to declining—that’s a tough spot to be in,” said Chandan. “But the downtown area has been engaged and is becoming more attractive.”

While the overall metropolitan area lost 5 percent of its population during the ‘90s, its downtown population grew 32 percent, from 7,261 residents in 1990 to 9,599 residents in 2000, according to U.S. Census data.

The downtown area is the highest-rent district in the city, according to Marcus and Millichap. “We’re more or less landlocked, so we see very little new apartment construction,” said Dan Burkons, an associate director of Marcus & Millichap’s Cleveland office. “Construction costs are very high and only so much rent can be achieved here. The fundamentals make it so that it’s only possible to build Class A properties.”

Developers are doing just that downtown.

Mixed-use downtown

Last September, local developer The Zaremba Group broke ground on a $250 million residential development on downtown Cleveland’s eastern edge. The first phase of the Class A development, dubbed the Avenue District, is slated for completion in spring 2008, and includes 50 luxury lofts, eight penthouses, 15 townhouses, and 9,000 square feet of retail space.

The Avenue District master plan calls for 426 condominium units along three blocks. In a measure of downtown’s momentum, the mixed-use development had $11 million in pre-sales contracts before it even broke ground. That interest level may spur more condo development—Zaremba recently obtained an option on a 1.4-acre vacant property adjacent to the Phase 1 development, where first occupancy is expected in August.

More Class A development is planned on both sides of the once vibrant “flats,” which run along the banks of the Cuyahoga River. The area, an entertainment mecca up until the early ‘90s, has fallen on hard times over the last decade, after three drowning deaths in a one-month period in 2000 brought unwanted attention to the area, and a city crackdown on health and fire code violations combined with a weakening local economy led to many bars and nightspots shutting down.

But two significant developments—one planned and one ongoing—may help breathe life back into the area.

Developer Scott Wolstein, CEO of local REIT Developers Diversified Realty, is reportedly procuring tracts of land, some of it through eminent domain with the help of the city, for a massive lifestyle community along the east bank of the flats. The $230 million Flats East Bank Neighborhood would feature a mix of apartments and condos totaling 331 units. The project is planned to include 255,000 square feet of retail and entertainment space, and a 450,000-square-foot office building over 18 acres.

The K&D Group is continuing construction on the multi-phase Stonebridge Waterfront development, a mix of condominiums and apartments, on the west bank of the flats. Construction began in 1999, and the company has slowly but steadily added hundreds of rental units since then.

In September, the developer unveiled Phases 5 and 6 of the massive 12-phase development. The first four phases created 500 rental units, and 108 luxury units are now under construction for The Plaza at Stonebridge, where occupancy is expected to begin this summer. About 1,200 additional housing units are planned over the next five years.

Another area developer, Bob Stark, has proposed a $1 billion project for the nearby Warehouse District, which calls for 1 million square feet of retail, 750,000 square feet of office space, 6,000 parking garage spaces, 173 for-sale units and 427 rental units.

Out-of-state interest

The area’s stability has helped garner attention from out-of-state investors looking for predictable yields, a relatively recent trend in Cleveland. “Almost half of our deals over the last two years have gone to out-of-state buyers, and four or five years ago, that was unheard of,” said Michael Barron, an associate director at Marcus & Millichap’s Cleveland office.

Likewise, a little more than half of the Cleveland deals sold by Hendricks & Partners over the last year have been to out-of-towners. Cap rates, the ratio between the cash flow produced by a development and its purchase price, are high in Cleveland at the moment, in contrast to some softening coastal markets. Average cap rates in the Midwest are around 7.2 percent, compared to 5.2 percent for the larger cities in the Northeast, according to Real Capital Analytics.

“Cap rates are being pushed so low in the Southwest, Northwest, Southeast, that [investors] go into the Midwest and buy higher cap rates,” said Rohr of Hendricks & Partners. “They know they’re not going to get the kind of rental increases [that coastal markets get], but they’ll have stability.”

While Real Estate Investment Trusts (REITs) have been exiting the area since the market’s downturn began in 2002—between 2002 and 2006, the top five apartment sellers in the Midwest were REITs, according to Real Capital Analytics—other private investors, especially those using Tenancy-in-Common (TIC) structures, have picked up the slack.

“I’ve got four or five TICs telling me that they want to buy in the Midwest now,” said Rohr. “A year ago, TICs wouldn’t even look at the Midwest.”