Apartment Finance Today

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Cleveland’s Soft Landing

APARTMENT FINANCE TODAY • May/June 2009

The city didn’t boom, so it isn’t busting as limited new supply tempers population declines and high unemployment figures.

BY Debbie Corson and Brian Pace

ALL IS NOT DOOM AND GLOOM FOR Cleveland apartment owners.

Despite turmoil in the financial services sector and mounting job losses, demand for apartments in Cleveland remains relatively strong. Since multifamily development never grew too overheated here in the past few years—as opposed to some coastal markets— the market’s landing should be soft. Rent growth has been modest over the past year, at 1.2 percent. But when concessions are factored into the equation, effective rents have been flat during this period. And though the market is expected to see negative rent growth of 2.4 percent by the end of this year, rents are projected to grow by about 5 percent between now and 2013, according to market research firm Reis.

The overall occupancy rate of the city’s multifamily market (including its suburbs) was at 92.2 percent in February 2009, down only slightly from a year ago, when overall occupancies were at 93.1 percent.

Still, these are some solid numbers, especially when you consider that Cleveland has been hit hard by recession. The five-county metropolitan area has lost 2.8 percent of its population since 2000, though the rate of decline slowed each of the last three years. Unemployment currently stands at 7.6 percent, and non-farm payrolls decreased 4.2 percent from January 2008 to January 2009.

Most of those job losses have been in construction and manufacturing, but the Cleveland employment market is transforming into a center for educational and health services. The Cleveland Clinic is the biggest employer in Cleveland, along with University Hospitals Health System.

The unemployment and population figures are tempered by the market’s strong supply and demand balance. Very little supply is expected to come into the market in the near term. A total of 2,800 units were added to the market between 2006 and 2008, and a few projects are under construction this year. Sutton Crossing, located in Portage County, opened in 2008 and delivered its final buildings in March 2009. Another development, Stratford Crossing in the Akron submarket, will have completed 252 of a planned 348 units by the end of May.

Sales Slide, Credit Contracts

While sales in the Cleveland market have never been robust, the effects of the credit crunch have been sobering. Sales recorded from July 2008 to February 2009 totaled only $60.7 million in 11 transactions (one other property was sold, but the price is not available). Only two of these sales were more than $4 million. Excluding these two larger transactions, sales volume for the seven-month period averaged just $2.5 million. The largest transaction in this period was the sale of the Polo Club Apartments in Strongsville, which traded for $20 million, $500,000 less than its 2002 sales price.

Much of the decrease in sales has come as a result of the well-publicized credit crunch brought on by the implosion of the commercial mortgage-backed securities market in 2007. Lending options are now limited to Fannie Mae, Freddie Mac, and smaller local and regional banks.

Underwriting standards have become more conservative, as maximum loan-tovalue (LTV) ratios have been reduced to 65 percent to 75 percent, depending on the lender, says Jim Leonard, a principal of Cleveland-based mortgage banking firm Pinnacle Financial Group.

The good news is that interest rates are low, in the high 5 percent to low 6 percent range, for short- and long-term debt. There is, however, increased scrutiny of the borrower (even on loans which are non-recourse) and lenders are increasingly focused on the borrower’s overall portfolio of properties to make certain there are no cash flow problems.

Pinnacle is seeing increased activity for Federal Housing Administration (FHA) loan financing. As many banks and insurance companies scale back their lending activity, the rates and terms available through the FHA’s 223(f ) and 221(d)(4) loan programs are attracting a big volume of borrowers. However, the timing to close these loans can be lengthy—typically four to six months to complete the approval and closing process.

As a result of the credit crunch, the multifamily sector has turned into a buyer’s market. Capitalization rates have increased as much as 200 to 300 basis points, signifi- cantly compressing values.

On the Horizon

The apartment sector has traditionally been more stable than other commercial real estate here—even as major retailers are shutting down, the apartment market remains relatively solid. While there is no question that the multifamily market is feeling some pain in 2009, the local landscape does offer some bright spots.

About 31,000 jobs are expected to be added in Cleveland by 2013, and absorption is projected to outpace new supply. The supply of renters is anticipated to remain strong and will be bolstered by former homeowners returning to the rental market and by consumers who are hesitant to invest in an uncertain housing market.

These solid fundamentals mean that Cleveland-area apartment rents and occupancy rates should strengthen once the general economy improves, positioning the market for slow, steady long-term growth.