Multifamily Market Overview Cleveland 1q09

RED CAPITAL GROUP®

Market Overview

Cleveland, Ohio Multifamily Housing Update

June 2009

EXECUTIVE SUMMARY

I

s there no limit to the sorrow that one city must endure? If Cleveland is a fair example the answer must be no. The Forest City economy has been in near perpetual recession since 2000, having reported yearover-year employment gains only between July 2004 and August 2006 (and then sporadically) and steadily increasing attrition since. Recent payroll job cuts were of devastating proportions, reaching a record 48,100 (4.5%) jobs during the year ended in April, and the unemployment rate approached 10%. Making matters worse, the city’s beloved Cavaliers failed to earn a second chance at the NBA championship by falling in the semi-final round, leaving denizens bereft of even this small recompense. Manufacturing remained this modern Troy’s Achilles’ heel, resulting in 14,100 job losses year-over-year in 1Q09, growing to 17,400 (-12.4%) cuts in April. The beleaguered auto and primary metals industries were responsible for fewer than one-third of the factory lay-offs, so further cuts may be in the offing as Chrysler and GM rationalize operations under bankruptcy protection. Attrition was nearly as severe in the key business service sector, which hemorrhaged 12,700 (-8.8%) jobs over-the-year in April. Professional and technical service and temporary employment establishments accounted for 80% of the losses. Construction headcounts also declined at an accelerated pace, falling by 8,400 jobs (-22.6%) y-o-y in 1Q09 and 9,000 jobs in the year ended in April. RCR forecast monthly cuts to average 41,200 jobs in 2009, 2,700 fewer than our prior estimate published in March. Losses will proceed at a 10,000-job or faster pace through 3Q10, with total losses next year of approximately 10,100 jobs (-1.0%).

SNAP SHOT The apartment market felt the impact of the economic difficulties, recording significant net tenant move-outs for the second consecutive quarter. Owners lost 493 tenants, according to Reis, representing a small improvement from 4Q08’s negative net absorption tally of 728 units. Average occupancy dropped 50 basis points sequentially to 93.6%, 100 bps below the comparable period in 2008 and the lowest level reported in two years. Demand was firmer in Cleveland’s higher rent submarkets, as both Downtown and Beachwood exhibited above average demand conditions. Metro effective rents fell $6 (-0.9%) from December to $699, trimming the metro’s over-the-year advance to $8 (1.2%). Upscale suburban precincts suffered the largest setbacks as Bay Village and Beachwood each saw rents fall by $29, representing -3.6% and -2.6% declines, respectively. Only the metro’s lowest average rent submarket (Bedford) chalked down a gain of 1% more, rising $7 to $589. Reis foresee fundamental weakness continuing through the end of 2010. Average rents are expected to fall another $6 (-0.9%) by year end and $3 (-0.4%) next year. Occupancy should be moderately firmer, dropping only 30 bps by December and another 10 bps in 2010 to 93.2%. Four property sales for a total of $12 million were recorded year-to-date, motivated either by portfolio strategies seeking to reduce Midwest exposure or REO liquidation. The former was represented by the divestment of Lakeshore Village and Bay Club by a public Reit. Cap rates were reported in the high 6% area. A star-crossed 2002-era 80-unit loft conversion was an example of the latter, as the condo turned rental was acquired for $46,250 per unit by a local property management group.

Y-o-y change

Projected 2009

100 bps

30 bps

1.2%

1.7%

Vacancy (6.4% - 1Q09)

Effective Rents ($699 - 1Q09)

Cap Rate (% - 1Q09)

Employment (1,007.9m - 1Q09)

bps

41.6m

41.2m

KEY POINTS

•

Demand for apartments declined due to economic distress. Metro occupied stock declined by 493 net tenants in 1Q, producing a 50 basis point decrease in average occupancy from December to 93.6%.

•

Owners were compelled to discount face rents and augment lease concessions to retain tenants. Asking rents declined by an average of $4 (-0.5%) from December to March, while the typical rent concession increased $2 to $36. The resulting $6 (-0.9%) dip in effective rents was the 24th weakest performance recorded among the RED 50.

•

Payroll losses exploded in construction, manufacturing and business services. Total payrolls declined at a record 48,100-job, 4.5% pace in April: the foregoing industries were responsible for 39,100 eliminated jobs.

•

Investment interest in Cleveland properties didn’t disappear entirely as buyers continued to bet that rental would play a prominent role in the metro housing market. Institutional quality assets traded at initial yields in the high-6% to 8% range.

•

Yield buyers have justification to kick tires, but no compelling reason to sin in haste.

Cleveland-Elyria-Mentor, Ohio MSA - 1Q 2009

VACANCY TRENDS

• •

Job loss and resulting out-migration, double tenanting and parental reunification caused occupancy to decay at the margins. Reis count a net loss of 493 leased tenants in 1Q09. The third consecutive quarter of negative net absorption represented a moderate improvement from 4Q08’s landslide 728 net move-outs but nevertheless caused average metro occupancy to decline by 50 basis points to 93.6%. Tenant losses were felt acutely by North Olmstead and East Cleveland properties. Sequential occupancy fell 230 and 200 bps, respectively, while over-the-year metrics declined by 360 and 410 bps.

Source: Reis, Inc.

8% Metro Vacancy Rate

•

Apartment Vacancy Trends 6.4% 5.4% 6% 4% 2%

CLEVELAND U.S.A.

0%

Tenant interest in Downtown properties improved. Submarket occupancy advanced 20 bps sequentially and 140 bps over the year.

1Q 4Q 3Q 2Q 1Q 4Q 3Q 2Q 1Q 4Q 3Q 2Q 1Q

RANK: 23rd out of 50 COMMENT: Further decay is expected, especially in submarkets with substantial 1-4 family rental competition, but the rate of decline will slow.

00 00 01 02 03 03 04 05 06 06 07 08 09

Metro Rent Trends

RENT TRENDS

•

•

Average effective rent fell $6 (-0.9%) from December to March, reducing Cleveland’s year-over-year advance from the 1.6% metric posted in 4Q08 to 1.2%. This figure was still strong enough to place the metro in 15th position among the RED 50 markets. Anecdotal evidence suggested that rising joblessness put downward pressure on rents and increased collection problems, especially in properties targeting lower-income renters. Weakness in the East Cleveland and Strongsville submarkets supported these assertions. Asking rents in Lyndhurst submarket increased from $720 in December to $737 in March, according to Reis. Although concessions offers also rose, effective rents advanced 1.5% quarter-to-quarter.

Asking Effective

4% YoY Rent Trend

•

Source: Reis, Inc. 5%

3%

1.2%

2% 1%

1.1%

0% -1% -2%

1Q 4Q 3Q 2Q 1Q 4Q 3Q 2Q 1Q 4Q 3Q 2Q 1Q

th

00 00 01 02 03 03 04 05 06 06 07 08 09

RANK: 15 out of 50

Metro Multifamily Cap Rate Trend

PROPERTY MARKET & CAP RATE TRENDS

•

•

Investors continued to ply these waters, viewing Cleveland apartments as relatively high-yielding defensive plays. As one buyer put it, people always need a place to live. Four sales were recorded in the first four months of 2009 for a total of $12 million. Two sales were made by a public Reit seeking to divest non-core Midwest holdings. A third was a bank REO sale. The fourth, involving a class-B+ property in North Olmstead appears to have been a typical arms length transaction among local property managers.

7.4%

Although Reis are of the mind that the worst of Cleveland’s rent deterioration is already past, intermediate-term forecast rent growth is not particularly constructive for cash flow returns or value creation. Specifically, the service expects rents to begin rising gain in 2011 but only at a 1.3% rate, gaining momentum gradually to 2.7% in 2013.

7.8% 7.6% Cap Rate

•

Source: Reis, Inc. 8.0%

7.2% 7.0% 6.8% 6.6% 6.4% 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 07 07 07 07 08 08 08 08 09

NOTABLE TRANSACTIONS Property Name Bay Club (Euclid/W. Lake Co.) 1900 Euclid Lofts (Downtown) Carlton Park (North Olmsted) Lakeshore Village (Euclid)

RED CAPITAL Research

Property Class

Date of Transaction

Total Price (in millions)

Price per unit

Estimated Cap Rate

A A A Sect. 8

Jan-2009 Jan-2009 Feb-2009 Jan-2009

$3.8 $4.6 $2.5 $1.8

$39,142 $57,188 $51,250 $16,204

6.8% 7.0% 7.7% 10.5%

Cleveland-Elyria-Mentor, Ohio MSA - 1Q 2009

Metro Median Single Family Home Prices

DEMOGRAPHICS & HOUSING MARKET

Source: National Association of Realtors $225

CLEVE

•

US

Prices (000)

$200 $175 $150

•

$125 $100 $75 $50 06

07

Y

Y

•

4Q 1Q 2Q 3Q 4Q 1Q 07

08

08

08

08

09

Payroll Employment Growth

•

Annual Chg (000)

10

•

0 -10 -10.1

-20 -30

•

-40 -41.2 99 00 01 02 03 04 05 06 07 08 09f 10f

Year-over-year Payroll Growth Rate

CLEVE

USA

1% Rate

0%

•

-2% -3% -4% -5%

99 00 01 02 03 04 05 06 07 08 09

Cleveland establishments cut 48,100 (-4.5%) jobs over the twelve months ended in April, representing the largest year-over-year retreat ever recorded here. The severity of recent job cuts was due to deep reductions in industrial output that left 17,400 fewer factory workers on the job than in April 2008, and 12,700-job and 9,000-job cyts in business service and construction industry headcounts, respectively.

The unemployment rate reached 9.0% in April, up from 5.8% in the year earlier period. Seasonally-adjusted, the April rate was 9.2%, the highest rate recorded in the Cleveland metro area in 24 years. First Quarter 2009

•

-1%

Total metro payrolls fell to 1.013 million jobs in April, the lowest number for that month in 16 years.

•

•

Source: BLS 2%

The FHFA/OFHEO repeat sales index for Cleveland dipped only 1.53% in the year ended March 31, ranking 147th out of 292 metros.

Past 12 Months

20

3%

Increased sales of foreclosed homes produced a dramatic drop in median home prices in 1Q09. The median price of a home sold in the quarter was $69,900, according to the N.A.R., a –31.5% decrease from 2008. The Ohio Association of Realtors reported that home sales in Northeast Ohio fell -23.2% in April from 2008 and that the average price of a home declined –21.3% from $124,650 to $98,101.

EMPLOYMENT TRENDS

Source: BLS Data & RCG Research Forecast

-50

Metro Cleveland county population declined by 6,594 (-0.3%) persons in 2008, according to Census Bureau data, the smallest decline recorded since 2003. Population losses were attributable principally to Cuyahoga County, which suffered a net population loss of 11,262 due to domestic out-migration of 15,757 persons

Cleveland establishments shed 41,600 positions in 1Q09 relative to the year before, a –4.1% decline. Only the health care, education and leisure services sectors registered over-the-year advances. The health care and social services sector remains the metro’s most robust industry with a 2,300-job, 1.6% advance to 150,100 jobs. Goods producing industries accounted for 24,300 job losses. Durable good manufacturing was responsible for 10,400 of these cuts of which only 4,800 originated in the primary metals and transportation equipment segments. The bankruptcy filings of Chrysler and GM may contribute to wider losses in these industries as the year unfolds.

Forecast

• RCR expect year-over-year losses to continue through the end of 2010. For 2009, losses should average about 41,200 jobs. Next year, attrition should subside gradually, producing a net loss of 10,100.

10% 5%

RED Estimated Generic Unlevered Asset Total Return Probabilities CLEVE

MIDEAST AVG 1.6%

0.8%

3.2%

1.9%

4.3%

3.1%

5.3%

4.6%

6.8%

0% -5%

-1.0% 90%

70%

50%

30%

10%

RED CAPITAL Research

SUBMARKET TRENDS Effective Rent

Submarket Strongsville / Berea / Brook Pk North Royalton / Brecksville Parma / Independence Bay Village / Westlake No. Olmstead / Fairview Park Lakewood / Linndale / Brklyn Bedford / Garfield Heights Beachwood Lyndhurst / Mayfield East Cleveland / Cleve Heights Euclid / West Lake County Downtown / The Flats Metro

Physical Vacancy

1Q08

1Q09

Change

1Q08

1Q09

Change

$637 $673 $633 $818 $679 $603 $583 $1,088 $689 $638 $627 $1,042

$637 $666 $656 $793 $676 $619 $589 $1,092 $712 $651 $652 $1,024

0.0% -1.0% 3.7% -3.0% -0.4% 2.6% 0.9% 0.4% 3.4% 2.1% 4.0% -1.8%

4.9% 8.8% 4.4% 6.4% 4.8% 6.1% 6.2% 5.4% 5.3% 4.5% 4.2% 8.5%

4.9% 8.9% 6.2% 7.6% 8.4% 6.1% 5.7% 4.6% 4.6% 8.6% 5.4% 7.1%

Unchd 10 bps 180 bps 120 bps 360 bps Unchd -50 bps -80 bps -70 bps 410 bps 120 bps -140 bps

$691

$699

1.2%

5.4%

6.4%

100 bps

SUPPLY TRENDS

•

•

• •

In February, developers broke ground on a 240-unit substantial rehab project Downtown. This is the final phase of an historic preservation project known as 668 Euclid Avenue. The development transformed a vacant department store shell into office, retail and residential space. The apartments are expected to begin leasing in early 2010.

Completions and Absorption Source: Reis, Inc 2,000

A 56-unit luxury project in Westlake’s Crocker Park lifestyle center nearly was complete in late spring. Management offered model apartments for show and accepted applications. Reis expect the property to receive final C.O. in July. Proposed rents range from $920 to $2,225, equating to roughly $1.15 to $1.35 per square foot. Reis also report that the University Lofts project near Cleveland State broke ground and is scheduled to debut in October. Although the project includes rental units as well as for-sale condominiums it is not clear that the rental component has moved forward. After leasing for about 12 months, a new garden property in Berea was about 82% occupied in March. Asking rents range from about $0.85 to $0.95 per square foot. A 200-unit condo and townhome development on St. Clair Avenue near Downtown was in pre-sale in June. Summer delivery is expected.

Daniel J. Hogan Director of Research [email protected] 614-857-1416

William T. Hinga Business Development [email protected] 614-857-1499

Completions

Absorption

1,500 1,000 Units

•

500 0 -500 -1,000 -1,500 02

03

04

05

06

07

08 09f 10f

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