Welcome back to our Heartland real estate market profile series!
This week, we’re returning to the Buckeye State to visit the City of Champions, the City of Lights, the Rock and Roll Capital of the World, Forest City. The city is known as both “The Cleve” and “The Land,” so if you haven’t guessed it yet — well, allow us to recommend another shot of espresso.
The Rock and Roll Capital of the World
Cleveland, the city was founded by Cleaveland [sic], the guy. Situated at the mouth of the Cuyahoga River, Revolutionary General Moses Cleaveland founded the site in 1796. Although the city was named after Gen. Cleaveland, the local newspaper decided in 1831 to omit the first “a” so as to fit the name on their masthead — and the rest was history.
By the mid-1800s, Cleveland’s favorable location — just south of Lake Erie, at the mouth of a heavily-trafficked river — had fueled its rise to prominence as a transport and trade hub. In 1870, Rockefeller founded Standard Oil in town, and as the Industrial Revolution continued to take hold, early-1900s Cleveland attained renown as a manufacturing center — particularly in the automotive space.
During the second world war, Cleveland’s mayor volunteered its industrial might on behalf of the Allied cause, and Cleveland took its place in the Arsenal of Democracy. Unfortunately, as the 20th century rolled on, Cleveland was afflicted by the same story of suburbanization and deindustrialization that swept many of the cities we’ve written about in this series. The metro fell on hard times, including a default on federal debt. Fortunately, by the late 80s, Cleveland had begun to climb out of recession and revitalize its local economy.
Today, Cleveland’s economy is thriving and diversified, situated in the storied cultural center that brought the world Harlan Ellison, Henry Mancini, the term “rock ‘n’ roll,” and the original Superman comic. Some of the metro area’s most noteworthy employers include Sherwin-Williams, Parker Hannifin, Key Bank, Progressive Insurance, and Travel Centers of America. The largest employers, on the other hand, are virtually all concentrated in Meds and Eds: the Cleveland Clinic, University Hospitals Medical Center, MetroHealth Medical Center, Medical Mutual of Ohio, and Cleveland State University, and Case Western Reserve University.
Cleveland’s economic diversity and affordable rental market offer real estate investors opportunities and risks.
Opportunities and Risks
Balanced economy with upside potential
Cleveland’s economy has come a long way since the industrial bubble burst. Today, it’s economy is balanced, with an emphasis on the sectors most likely to preserve momentum through the 21st century.
Meds and Eds are the metro area’s largest economic sectors, but trade and transportation are a close second; Cleveland has been called “the best location in the nation,” and standing within 600 miles of 60% of the U.S. population, it’s not difficult to see why. Professional services and manufacturing are also large contributors; while industry isn’t the all-encompassing powerhouse it once was, both Ford and GM maintain plants in Cleveland that continue to receive significant investment, and the metro area’s manufacturing sector created around 900 jobs annually between 2011 and 2018. Finally, research and tech has been hailed as a rapidly up-and-coming sector in the city, with some pundits arguing that Cleveland may be positioned to become a formidable tech-sector hub in the coming years.
Cleveland’s balance of economic activity performs the usual hedging function, mitigating sector-specific risk and insulating the economy from non-systemic shocks. COVID-19 introduced a problem with that strategy: when everything tanks all at once, diversification won’t save you. Fortunately, Cleveland’s performance in the 18ish months since the pandemic’s outbreak have been encouraging.
The Bureau of Labor Statistics data invites some remarks:
- Nearly every sector’s employment is up from April 2020, because (a) employment in April 2020 was suppressed, and (b) a bull market encouraged investment and expansion as the threat of the pandemic has gradually decreased
- Cleveland employment is significantly higher now compared to before the pandemic, but could foreshadow an impending market correction.
- Similar to other trends, the onset of summer and continuing vaccination campaigns have begun to lure Americans from their homes after the Year of Netflix. Cleveland is no exception to the trend, with leisure and hospitality bouncing back twice as authoritatively as any other sector.
COVID-19 aside, Cleveland’s Meds and Eds economy — employing 19% of the metro’s workforce as of 2019 — offers investors economic advantages.
- Stabilized employment. Demand for Meds and Eds is resilient in the face of all but the direst crises; demand for health services can actually be countercyclical, as COVID-19 demonstrated.
- Academic and medical cross-collaborations opportunities attract value to the local economy, in part by incentivizing start-ups to locate in town.
- Cleveland’s potential for technological and medical innovation has been documented for a while, and its affordability in comparison to coastal tech hubs offers a compelling competitive advantage.
- As the population ages and demand for medical services rises, medical giants should continue to grow. A July 2020 HUD report projected that the Cleveland Clinic and University Hospitals alone should create 2,300 jobs in the metro area by 2024.
The bottom line for investors: Cleveland’s economy has weathered COVID-19 fairly well; diversification should continue to insulate against risk; and sectors like medicine and technology could, provided that demand continues to expand, create meaningful upside over the coming decade.
Very affordable rental market (sort of)
To kick things off:
- In 2019, less than 42% of housing units were owner-occupied
- As of July 1, 2020, the residential rental vacancy rate was 8.1%, versus 12.6% in 2010
- 2019 rent as a fraction of income in the metro area was 17.05%, as opposed to 16.64% statewide and 20.03% nationwide (ACS)
- The price-to-rent ratio for the metro area is 8.31
Rent has historically been very affordable in Cleveland; over time, median rent in Cleveland has come to closely follow statewide median rent — which is surprising for an urban area. Compared to Columbus, Cleveland rent is a bargain, and it’s slightly cheaper than Cincinnati.
Here’s our take on the multifamily market:
- The city’s fairly large renter faction owes its strength, in part, to an outsized senior population. The 2020 HUD report found that “[h]ouseholds with adults 60 years and older account for approximately 27 percent of all renter households, up from 22 percent in 2010.” Proximity to health services providers and affordable rents could continue to expand this section of the market.
- Cleveland’s rental vacancy rate remains somewhat higher than that of most other cities we’ve written about in this series; while population growth in the revitalized downtown continues to create demand there, 0.2% net out-migration from Cuyahoga County has depressed demand in less-central neighborhoods.
- Meanwhile, although single-family demand has increased significantly countrywide over the last year — in Cleveland, home prices inflated about 19% — Cleveland’s historically low home prices, combined with an unusually low-rate 30-year mortgage, could create favorable conditions for prospective home-buyers and somewhat attenuate rental demand.
- Cleveland’s absolute rent is some of the most affordable for urban Ohio. However, although Cleveland’s median rent is more affordable — as a fraction of median income — than in many U.S. cities, it’s somewhat less affordable by this measure than the statewide figure.
Where does this leave investors? For those looking to enter the market, comparatively high vacancy could increase cap rates and reduce acquisition costs. But, this force is more likely to apply in less-popular neighborhoods which have reaped fewer benefits from expanded employment and downtown revitalization, limiting the upside captured as a result of economic growth.
On the other hand, in the city center, demand is tighter, which could increase pricing. For investors already in the market, or who successfully acquire buildings, Cleveland’s growing technology sector — one of the fastest-growing in the country — could invite meaningful in-migration and increased demand, warranting rent increases and capturing economic growth.
While those strategies will certainly earn some investors strong returns, we’d be remiss not to return to the affordability question.
Poverty poses a risk
In 2019, Cleveland overtook Detroit to become America’s poorest city, with more than 30% of residents falling below the poverty line. Consequently, even absolutely affordable rents are comparatively more expensive than they appear.
Poverty, unfortunately, often coincides with elevated eviction rates. While eviction rates were decreasing in Cleveland prior to the onset of the pandemic, the city still witnessed an average of 12 evictions per day in 2018.
For some investors, this is flatly a risk. For other investors, an ongoing shortage of affordable housing could present significant opportunity; new buildings constructed to house the poorest contingent of Cleveland residents would certainly not suffer from a shortage of demand.
Concluding Thoughts
Cleveland is probably one of the riskier markets we’ve profiled. Its diverse economy has weathered the pandemic well, and the expansion of medicine and technology in the city may herald promising economic growth in the next decade.
On the other hand, the city’s high poverty rate and unevenly-distributed rental demand warrant investment risks. Pick the right building and the economy expands, income increases, and rent normalization could yield impressive returns for insightful investors. Pick the wrong building and returns may lag.
While that’s basically valid in any market, we’re wondering whether the importance of skillful acquisition might be amplified in a market that’s looking increasingly bimodal.
Our analysis of Columbus concluded that predictable growth and proportionally decreasing rents creates safe, but capped opportunity for investors. We wrote that “There’s just not a lot of opportunity for wild bets that could earn aggressive investors outsized returns contingent on economic recovery, or the continued growth of a few downtown blocks.”
Cleveland may well offer more opportunity to make those bets. An increasing senior and student population, expanding downtown, and housing shortages for the least-wealthy third of the population could all create niche opportunities for savvy investors to yield excellent returns.
However, the probability that investors could materialize acceptable returns by buying any random building and sitting on it for a decade while cap rates magically compress themselves is pretty low.
The bottom line?
In some neighborhoods, emphasizing affordable housing and new construction could be the surest avenue to strong returns, but more conservative investors — or those more interested in Class A and B — won’t be likely to pursue this option.
In other neighborhoods, steady job creation, an innovation-friendly atmosphere, and a balanced economy will reliably point the arrow up and to the right, and the rising tide of rent increases should earn strong returns for more conservative investors.
