The Long Road

After decades of sub-optimal performance, multifamily in the Midwest becomes a prime attraction for investors and developers.

Even before the Great Recession, the Midwest was not what one might consider a prime market in the apartment industry. With the exception of the Chicago area, vacancies were high and employment was low relative to the rest of the nation, and many investors were wary of the continued lack of stability in many major fundamentals.

Yet a few years following the financial crisis, this same region is now a beacon of opportunity for developers and investors alike. Debbie Corson, principal at Apartment Realty Advisors–Midwest, underscores the marked change in momentum multifamily has seen in the area in the last couple of years.

“There’s a lot of attention being paid to some of the Midwestern cities that you haven’t seen in the past,” says Corson. “These are all areas that, in the past, investors haven’t been real interested in because there’s been such a big loss of jobs, and we’re starting to see real turnarounds in all of those areas now. We saw rents go up where we hadn’t seen them go up much at all.”

Furthermore, with strong job growth taking hold in places like Ohio and with a steady transition between industries in the workforce, Corson notes that positive trends in the region will likely continue as people and companies become attracted to its low prices and ease of doing business.

“I think that the reason people come to the Midwest right now is that rents are still low compared to markets in the Northeast, Southeast and Southwest,” says Corson. “The Midwest is still viewed as being stable and consistent and underpriced compared to other markets.
I think that you’re seeing a lot of these cities transition from manufacturing to more service-based economies and I think that that’s increasing stability.”

Randy Fifield, vice chair and principal of Fifield Realty Corp., notes that the Chicago market—which has traditionally been more multifamily-oriented than other parts of the Midwest—will continue to see strong demand for all asset classes but particularly for high-end, Class A units as more people continue to opt for renting over homebuying.

“I think you’ll see increases across the board,” says Fifield. “People do like the Class A apartments because of the amenities that they offer. Even what used to be a second-home buyer, you see these people wanting to try out high-rise living, and so they will rent beautiful apartments to see if they like it. It allows them the flexibility of trying something before they make an investment in their future.”

Corson agrees that the luxury assets are coveted in the Chicago market and points out that, even while the area hasn’t seen the most robust job growth, there are other factors that have been driving Class A growth.

“Certainly we see the highest end doing the best right now, and a lot of the reason for that is because, up until now, the construction pipeline has not been really big and these markets are full,” says Corson. “Downtown Chicago is really flourishing—there are 1,300 units in lease-up right now and another 2,700 under construction, with another 1,700 units in the pipeline.”

Matt Bukhshtaber, vice president of CBRE Capital Markets in St. Louis, indicates that there has been “extreme competition” in the first-tier markets in the Gateway to the West, and that investor interest will likely continue to rise there. Additionally, given the strong demand, Bukhshtaber believes new development is on the horizon for the next couple of years.

“Owners renovating units are capturing the premium rents in the market,” notes Bukhshtaber in his Q2 2012 MarketView for the St. Louis metro. “Land owners, developers and lenders are beginning to actively pursue new ground-up construction as new supply has been limited the past few years.”

Bukhshtaber adds that the pool of renters is likely to continue to increase due to more college graduates opting for renting over the risk of a first-time mortgage. As such, concessions will drop and rents will likely rise.

Fifield believes that this dynamic will likely be ubiquitous across the Midwest but points to recent policies by the Federal Reserve that might make mortgages more attractive over the next couple of years.

“With Bernanke keeping interest rates the way that they are for the next couple of years, mortgage refinancing will continue to be heavy, but people need places to live while they’re saving their money to buy,” says Fifield. “Apartments produce a lot of flexibility that condos and houses don’t.”

In downtown Chicago, the volume of new projects in the development pipeline is giving an indication that rents may begin to ease and renters may actually have leverage in the years to come. Projects like Randolph Tower by Village Green and The Lex by ST Residential are bringing hundreds of high-end luxury units to the increasingly in-demand submarket.

“I think you’ll certainly see in some of these areas some concessions to get through lease-up, and that will put a damper on the really high rent increases that we’ve seen in the last year,” says Corson. “But I think for the size of the city… these units will get absorbed, and I don’t see any big crash coming.”

Fifield notes that her company currently has a number of projects in development for the downtown Chicago submarket and that 2013 will be a big year for deliveries. One of the biggest projects, the 34-story K2 at K station, will bring 496 units to the area and help satisfy the demand currently taking place.

“In 2013, throughout the year, you’ll see about 2,000 units being delivered, and it’ll take about a year and-a-half to absorb those,” says Fifield. “They continue to just pummel other buildings with services and amenities, and all of these buildings are going to give a little bit of concessions to get people to come down and try this way of life or to pony up a little bit more.”

One of the key factors driving the continued renaissance for multifamily in the Midwest, according to Corson, is the fact that banks have loosened their lending standards due to a couple of straight years of good performance, and investors from across the country are taking this to heart.

“In 2008 and 2009, you couldn’t get a lender to come to the Midwest, [but] they’ve started to relax a bit because the markets have improved so much and because we’ve gotten good rent increases,” says Corson. “So we’ve seen some of those strict limits that were imposed in 2008 being lifted a little bit, and I think that’s made investors a little bit more excited about coming here.”

Corson reiterates just how much of a bargain this region is compared to other parts of the country and he believes that some of its best days may still lay ahead.

“From an investor’s standpoint, you can get deals in the Midwest that you just can’t get in other areas right now,” says Corson. “So I’m hopeful and feel pretty strongly that you’re going to continue to see some investment come back here from people who want to be in multifamily.”