A long-underperforming region of the country is now a leader for apartment occupancy, and that’s helping operators there step up their pricing strategies.
The nine major apartment markets in America’s Rust Belt – post-industrial areas primarily located in Michigan, Wisconsin, Indiana, Illinois, Ohio and Pennsylvania – have historically tended to lag national performance indicators. However, both occupancy and rent growth in Rust Belt markets have shown solid performance improvement lately.
Three Rust Belt markets ranked in the top 10 nationally for occupancy in mid-2019, and two others bested the national norm. For annual rent growth, five topped the U.S. average of 3.1%.
These are significant developments in this long-struggling region. Rust Belt markets have had difficulty recovering from the nation’s industrial decline beginning in the 1970s and were late to build any momentum following the last recession. In recent years, however, economic revitalization efforts, including a focus on industry mix diversification, have helped to improve market fundamentals.
The nine Rust Belt markets added more than 1.4 million jobs in total since 2010, and 80% were in service sectors such as education, health care, business services and leisure and hospitality. Robust gains in these areas highlights the region’s shift from its traditionally manufacturing and government heavy employment base. Local governments in the Rust Belt have undergone dramatic transformation in recent years, and manufacturing has been an ailing industry nationwide for decades. However, U.S. manufacturing showed some renewed strength in 2018, which no doubt provided extra lift to apartment performance in Rust Belt, which still has meaningful presence of manufacturing jobs.
Market fundamentals are improving at a time when capital investment in most of these Rust Belt apartment markets is still limited. While money has steadily flowed into new apartments at a national level in these post-recession years, investors have tended to overlook Rust Belt markets for development, which has kept new apartment supply levels there low throughout the cycle. Chicago and Indianapolis are the primary exceptions, but development in both is effectively limited to high-priced downtown areas and an upscale Indianapolis suburb.
Detroit offers the best example of this limited development trend, as the Motor City market’s apartment stock has grown at the slowest rate (2.3%) of any major U.S. market this cycle. Major Ohio markets all grew less than 8%, which is in line with expansion in St. Louis. Pennsylvania markets logged growth below 10%, while Milwaukee managed 11% growth.
By comparison, apartment inventory across large markets outside of the Rust Belt swelled 13% since 2010 on average, with some markets growing 20% or more.
Limited apartment completions and better economic momentum have resulted in favorable conditions for apartment owners and operators recently. As more new jobs stimulate apartment demand, new renters primarily backfill existing vacancies instead of leasing newly completed apartments, which are scarce due to lack of building in recent years. This dynamic has caused demand to outpace new supply in every one of these markets over the course of the current cycle – by a large margin in some.
At the same time, Rust Belt apartment properties are losing fewer existing tenants to move-outs, as more renters with expiring leases are choosing to stay put. In seven of nine Rust Belt markets, the percentage of expiring leases that were renewed in the past year topped the U.S. average of 53.4%. Renewal conversion rates increased more than 100 bps year-over-year in all but one market.
With demand outpacing supply, occupancy has tightened across the region. Occupancy levels in mid-2019 reached cycle highs in Cincinnati (96.7%), Detroit (97.1%), Philadelphia (96.5%) and St. Louis (95.1%). Indianapolis (94.7%) and Chicago (95.4%) were both within 50 basis points (bps) of their cycle occupancy highs. In both of those markets, cycle highs corresponded with temporary slowdowns in new apartment deliveries.
At just 10 bps off its high, occupancy in Cleveland (96%) is also unusually tight. Milwaukee’s occupancy story is a little different from its regional peers. At 97% in mid-2019, occupancy in Milwaukee is about 40 bps down from the peak in 2016 that followed a stretch of strong job growth. Supply levels there have remained modest throughout recent years.
All but Indianapolis, Chicago and St. Louis exceed the national norm for occupancy in 2nd quarter. Detroit, Milwaukee and Cincinnati ranked in the top 10 for occupancy among major markets nationally.
Fewer vacancies have emboldened apartment operators to get more aggressive in their pricing strategies lately. But even with the recent momentum, these are not high rent growth markets, so none were national leaders for new-lease rent growth in the past year. However, five of these traditionally slow-growing metros matched or topped the national average of 3.1% – which has not occurred at any other time this cycle, underscoring recent momentum in the region.
All but two Rust Belt markets outperformed their cycle averages for annual rent growth in mid-2019. The exceptions were Chicago and Cleveland. In Chicago, continuing urban core construction has hampered rent growth in the downtown area, which has a large influence on the market’s overall rent growth performance. Meanwhile, Cleveland has struggled to muster annual rent growth above 2% in the past three years. Moderately better performances earlier in the cycle boost Cleveland’s average to 2.4%.
Of note, a high-performer among this group is Detroit. The Motor City market has achieved annual rent growth rates that are higher than the U.S. norm for the past 14 consecutive quarters. It also boasted the highest cycle average in the Rust Belt, at 3.6%. No other market has averaged growth of 3% or more.