Detroit suffered mre than its fair share among U.S. cities during the Great Recession. In 2009, the city’s official unemployment rate exceeded 20 percent, and some economists pegged the actual unemployment figure to be closer to 50 percent. Abandoned properties were a common sight, and bureaucrats right up to the mayor’s office mulled over plans to bulldoze vacant buildings. But things are finally looking up for the metro in several key areas important to the multifamily industry, including employment, new construction, asking rents, and vacancy rates, as well as other metrics.
Employment Picture Brightens
Perhaps most welcome for residents and investors alike is the improving jobs picture in Motown. After adding 21,000 workers to payrolls last year, Detroit-area employers will create 11,000 jobs in 2012, expanding staffs by 0.6 percent. Broad-based job growth, especially in the professional and business services and manufacturing sectors, will support positive net absorption, pushing vacancies to their lowest level in 10 years. Stagnant building activity and employment-generated demand will reduce vacancy 60 basis points in 2012, to 5 percent. Last year, vacancy contracted 130 basis points on net absorption of nearly 3,000 units.
Much of the expansion will result from the four-year deal the United Auto Workers Union recently ratified with the Big Three automakers, Ford, GM, and Chrysler, which includes $16 billion to invest in new products and infrastructure. The move will create more than 12,000 manufacturing jobs through 2014, with the bulk of the positions slated for facilities in the Midtown/West Detroit, Novi/Lavonia, and Dearborn/Dearborn Heights submarkets. Household formation will accelerate in these areas over the next year, spurring demand for Class B/C units. As a result, vacancy in these submarkets will tighten to the mid–6 percent range by year’s end, allowing owners to lower concessions.
Elsewhere, relocation incentives offered by large corporations will draw professionals to the Midtown/West Detroit and Downtown submarkets. Many of these renters will capitalize on the elevated concessions and lease Class A units, reducing vacancy in the area to 8 percent. Low multifamily starts numbers will help fuel the demand, with area construction remaining slow this year as 290 apartment units come on line. (No market-rate units came on line in 2011.) Asking rents will rise 2.3 percent, to $846 per month, accompanied by a 3.2 percent increase in effective rents, to $783 per month. As the local economy continues to gain momentum and operations improve, lenders will be enticed to work out deals with property owners who are underwater. As a result, the distressed pipeline will thin this year, though a few more REOs will trickle to the market.
Of course, Detroit isn’t the only metro benefiting from declining vacancy rates and rising demand for rental units. Tight supply conditions exist in most markets, with a favorable bias driven by shifts in demographic, economic, and social patterns that underpin demand for rental housing. U.S. apartment performance remained undeterred by slow economic growth in 2011, powering through the summer’s economic doldrums and recording strong gains in net absorption and lower vacancy rates. Foreclosures, potential owners unable to meet financing requirements, and households choosing rental housing for lifestyle reasons or employment mobility all contributed to a net rise in rental households, totaling an annualized 900,000 units in 2011. In addition, the 20- to 34-year-old age cohort captured approximately 70 percent of job gains recorded in 2011, stimulating new household creation.
Midwest Pickup
The confluence of several trends pushed investor demand further along the risk/reward spectrum throughout the Midwest, including Detroit, in 2011. Proven sustainability in apartment performance, confidence in property values, and access to low-cost debt spurred investors to seek arbitrage through value-add strategies. Midwestern sales activity surged through the first three quarters of 2011, characterized by portfolio sales, a return to pre-bubble sales volumes, and a narrowing differential between core and value-add yields. A significant shift in transactions to secondary and tertiary markets compressed cap rates for Class B and value-add properties to the 7.5 percent range, while core properties settled below 6 percent.
The number of offerings in October spiked to the highest level since 2007, yet the fourth quarter marked a moderate slowdown in apartment property sales in the region. Economic uncertainty played a role, but deal fatigue, rich pricing, and macro concerns caused investors in the top-tier segment to pull back in late 2011. However, many risk-tolerant investors view this as an opportunity, so it shouldn’t result in a major market slowdown.
Aided by tax incentives, property operators in Detroit will list performing assets, attracting yield-seeking buyers looking for outsized returns. The recent elimination of the 6 percent Michigan Business Tax will entice some owners to list their assets. Investors from overseas with an appetite for risk will take advantage of the favorable exchange rates and pay cash for stabilized properties in sought-after areas such as Oakland County and Ann Arbor. In addition, out-of-state buyers will expand their portfolios in the metro and capitalize on the highest cap rates in the country.
As competition heats up for Class A properties, first-year yields will compress below 8 percent this year. Local investors, meanwhile, will target redevelopment opportunities near Wayne State and the University of Michigan, where more than 70,000 students support the renter pool.
Investment Sales Jump
Despite the slowdown overall in Midwest apartment sales last quarter, sales velocity in Detroit accelerated more than 50 percent on a year-over-year basis in the fourth quarter of 2011, aided by increased activity among yield-seeking out-of-state buyers. The median price for an apartment complex in the metro held relatively steady during that time, at $19,800 per unit, representing a 50 percent markdown from the median price recorded at the peak of the investment market.
From fourth quarter 2010 to fourth quarter 2011, cap rates for performing, mid-tier properties in suburban corridors averaged in the 9 percent range, while similar properties in the city traded at cap rates closer to 12 percent. Entering 2012, some cash-rich, private investors will circle the Ann Arbor submarket, where a large student population has historically maintained one of the metro’s lowest apartment vacancy rates. Cap rates for stabilized assets in the area will reflect this perceived safety net, however, and will average in the 6 percent range when brought to market.
Capital-markets conditions in Michigan as a whole improved throughout 2011. Statewide gross domestic product and employment growth rose, shoring up property performance and revenue streams. Loan delinquencies receded from their cyclical peaks, and values firmed across most commercial property types, aided by the low cost of debt and the positive spread between cap rates and interest rates.
Nationally, the multifamily sector was the only property type with strengthening loan performance. Restored lender confidence stimulated apartment debt issuance and equity investment into a broader range of strategies, particularly given the return to pre-recession pricing and compressed cap rates for top-tier properties in major metros. The shift toward more competitive lending manifested in slightly higher loan-to-value ratios and lower spreads.
As the economic recovery begins to take hold this year, investment sales volume is expected to outperform last year’s totals. In the four major property sectors, sales activity rose by an estimated 35 percent in 2011, to $240 billion, as incredibly low interest rates, the availability of more financing sources, and abated fears of a recession brought more capital to the Michigan and national markets. Private investors who were once on the sidelines have become more active, and greater amounts of capital are flowing to Class B assets in light of rapid tightening of yields in the upper tier of the market, particularly in Detroit’s outer-ring suburbs.
The prospect of investing in a hard asset that is set to improve along with an expanding economy—even at a moderate pace—with generation-low cost of debt locked in for five to seven years and extremely competitive cash-flow yields points to a unique investment window for multifamily assets. The combination of these factors is setting the stage for an increase of 15 percent to 20 percent in property sales volume this year as well as a broadening of equity capital sources.
