The Midwest apartment market never seems to grab the headlines, but it displays strong operating fundamentals and attracts investors with cap rates that pave the way for nice returns.
By Jay Madary (NREI Article) — With 2017 winding down, many multifamily owner-operators are gazing into their crystal balls to predict what the New Year may have in store for the markets in which they operate.
The Midwest apartment market never seems to grab the headlines from its coastal counterparts, but year after year, it hums quietly along, displaying strong operating fundamentals and attracting investors with cap rates that pave the way for nice returns. Next year and the years beyond should be no different. The multifamily industry in the region is poised for a bright future.
Reasons for optimism
Nationally, the past 12 months have represented something of a slight cooling off from the apartment industry’s recent white-hot run, with many metros across the country absorbing a fair amount of new construction. As a result, the national occupancy rate stood at 95.5 percent in the third quarter, down 50 basis points from a year earlier, but still within the definition of a tight market, according to RealPage.
Some markets across the Midwest have also dealt with the effects of rising inventory. In Kansas City, for example, nearly 9,000 apartment units were completed during the 12 month-period that ended on Sept. 30, according to Cushman & Wakefield. Still, the city’s vacancy rate actually dropped over the same period to end the quarter at 95.8 percent. Across the region, similar stories of market resiliency abound.
Looking ahead, there are several reasons to believe that the national and Midwest apartment markets will continue to overcome any short-term hurdles presented by the recent wave of new construction. For starters, according to a study jointly commissioned by the National Apartment Association and the National Multifamily Housing Council, demand for apartment living is set to soar across the country over the next decade-plus for a variety of reasons, including increased immigration and delayed home ownership. To meet that growing demand, 4.6 million new apartment units will need to be built by 2030, the report says.
Along those same lines, the percentage of U.S. households that were renting in 2016 stood at 37 percent, according to The State of the Nation’s Housing 2017 report from Harvard University’s Joint Center for Housing Studies. That marks a 50-year high, and the report goes on to predict “solid growth in renter households over the next 20 years.”
Given all this data and analysis, it’s certainly reasonable to predict that both the national and Midwest apartment markets will be in good shape in 2018 and the years ahead.
In addition to benefitting from the same long-term trends that will buoy markets across the U.S., the Midwest apartment sector should continue to perform strongly and appeal to investors for its own reasons. To start with, the region features higher cap rates than coastal primary markets.
Cap rates for class-A apartment communities in New York ranged from 3.30 percent to 4.30 percent in the first half of 2017, according to JLL. For San Francisco, the range was fairly similar, from 3.95 percent to 4.55 percent. Cap rates for class-A communities in secondary Midwestern markets are at least 100 basis points higher than their coastal counterparts, and they set the stage for higher yields, immediate cash flow and also make the region more accessible to private investors.
Additionally, the Midwest offers ample runway for rent growth, perhaps more so than coastal markets. In October, the average rent in San Francisco, across all asset types, was $3,671 a month, while in Kansas City the rate was just $957 a month, according to Rent Jungle, an apartment internet listing service.
Now, consider the impact of a 5.0 percent increase in rent. In Kansas City, that would translate to just $48 a month. In San Francisco, the same increase would amount to nearly $185 a month.
Those hypothetical increases provide a good sense of how boosting rents may be a little easier in the Midwest in the future than in some other regions of the country.
With solid operating fundamentals in place—and the underpinning of some nationwide trends and other regional dynamics—the steady, reliable Midwest apartment market is set to once again be a strong performer and attractive investment destination in 2018.
Jay Madary serves as president and CEO of JVM Realty Corp., an Oak Brook, Ill.-based apartment owner and operator.