Last year, we wrote that the Heartland’s affordability and economic diversity are creating compelling opportunities for real estate investors to produce superior returns in the multifamily space at a lower risk profile than that of more traditional coastal markets.
This article is the first in a series about Heartland cities that we think could be attractive to investors who want to capitalize on these forces. In this piece, we’ll be focusing on the Queen City, The City of Seven Hills, The ‘Nati… you guessed it, Cincinnati.
The Queen of the West
“The City is, indeed, justly styled the fair Queen of the West: distinguished for order, enterprise, public spirit, and liberality, she stands the wonder of an admiring world.” — journalist Ed Cooke, 1819
In the first half of the 19th century, Cincinnati was a Western boomtown known as a meatpacking hub for the growing United States (Cincinnati was later dubbed with the less flattering nickname: “Porkopolis”). During the 1860s, Cincinnati lost some of its meatpacking share when Chicago leveraged its superior rail system to edge out Cincinnati’s steamboats .
After an iron boom around the turn of the century and a few economic reinventions, Cincinnati is now well on its way to becoming a diversified regional power, with thriving education, health, retail, and professional services sectors. Income streams throughout the regional economy are spread across industries. Major employers include a handful of Fortune 500 companies, some of which — like Kroger and Procter & Gamble — are headquartered in the city. This rebirth has resulted in a great deal of industry diversification that makes up the backbone of the metro’s economy:
Cincinnati's economic diversification served it well through recent economic crises in 2008 and 2020: the city was ranked 157th out of 505 U.S. metros for recovery from the 2008 recession. According to HUD, average home sale price declined less than 1 percent annually in the three years following the recession, from $140,300 during 2008 to $138,500 during 2011. This stability in housing prices signals strength in key drivers to the regional economy.
More recently, despite the ongoing pandemic, employment in the metro area bounced back more quickly than the national average:
The construction, trade, healthcare, and education industries proved especially strong, and showed again that a regional economy with multiple thriving sectors helps keep the workforce working.
Cincinnati’s economic resilience can be attributed to at least two factors other than diversification. First, Ohio is ranked sixth out of 50 in federal and state investment into infrastructure, and seventh in infrastructure development. Second, affordability is always a value driver, and last year, US News and World Report ranked Cincinnati as the country’s 13th-most affordable town.
Cincinnati is well-developed and affordable, which nicely positions the metro to be a focal point of the Midwest and could create opportunities for real estate investors, especially in the multifamily space.
Regional Economic Growth
We’ve shared many reasons about why we’re bullish on the Midwest:
• The region encompasses a wealth of infrastructure and natural resources.
• Industry and agriculture aren’t as dominant as they used to be, but this is a good thing: the region’s stability only increases as its economic landscape becomes more diverse as the Heartland becomes an increasingly logical home for tech companies.
• Meanwhile, property values and cost of living have yet to catch up to the new wave of prosperity, and we forecast that affordability will be a stalwart characteristic of these geographies for many years to come. (Supported in part by large firms’ relocations from the coasts to more affordable Midwestern cities eager to offer favorable business environments.)
Cincinnati is well-positioned to become a hub as the trend continues: employment and educational attainment are high in the city. Its GDP has increased by over 50% in the past decade, largely due to rapidly expanding transportation, warehousing, professional services, healthcare, and education sectors. The city is also within a day’s drive of nearly 50% of the nation’s population.
What does that prosperity mean for real estate investors?
Rent increases are a proven strategy by which investors can capture value from regional economic growth. As the Midwest attracts professionals who can work from anywhere, and prioritize value to maximize their quality-of-life, real estate investors have some margin to increase rents and remain well under what is typical in coastal cities like New York and San Francisco.
This is especially true in Cincinnati, where median rent increases over the past decade have been relatively slow. Importantly, absolute rent costs don’t tell the full story: affordability is a function of cost relative to income, and it’s in that analysis that Cincinnati pulls well ahead of national averages. Nationwide, median rent as a percentage of median household income was 20.03% in 2019. In Ohio, the percentage was 16.64%, and 15.34% in Cincinnati. For comparison, living costs in the city total only 8% lower than the national average, and 2019 median household income actually exceeded the national median.
Stable, Competitive Returns
In the greater Cincinnati area, the vacancy rate for suburban Class B multifamily properties is only 3.3%, and the urban rate for similar properties is higher but still competitive at 5.8%. Meanwhile, at around 7%, Cincinnati’s Class B cap rates are in an attractive sweet spot for workforce housing investors, particularly in light of current interest rates. For Class B multifamily, a 7% cap rate is high enough to produce compelling cash-on-cash returns and provide opportunity for compression at exit, but low enough to imply a reasonable amount of market stability. As is the case with most multifamily markets today, high demand in the region has driven valuations up in recent years. However, given the reasonable current cap rates, purchase prices at a fraction of replacement cost, and upward trajectory for the local economy, real returns could potentially be higher than cap rates currently suggest. With an ability to lock in solid long-term cash flow through today’s favorable financing rates, the combination of attractive conversion to cash-on-cash along with clear line of sight to appreciation is compelling.
Between the 1950s and the 2000s, Cincinnati’s population steadily decreased. Since 2010, the trend has begun to reverse, growing by around 3% according to the World Population Review. But, that number alone isn't the full story. If you factor in the expansive suburbs covering the tri-state region, Cincinnati’s population exceeds 2 million. Especially outside the urban core, demand trends continued to demonstrate a squarely positive trajectory — even during the pandemic. Last year, exurban and suburban occupancy rates actually increased by 20-50 basis points.
Last, it’s worth noting that Cincinnati’s median age is only 32. That’s seven years younger than the Ohio median, and six years younger than the national median. An influx of younger professionals who migrate for the value and stick around to raise families is a precursor to future population growth, jumpstarting a value-laden demand cycle. Even as families populate a greater share of the region, multifamily housing’s value will be protected by Cincinnati’s unusually high home prices, which provides a moat of structural downside protection for affordable multifamily housing.
The bottom line: regional growth + high home valuations + low rents + low cost of living + young-skewed population = opportunity to capture value in the workforce multifamily space.
That’s not to say there aren’t some risks to keep an eye on.
It's a seller's market.
Cincinnati's multifamily market is relatively hot, due in part to an increasingly long list of investors who are generally bullish about emerging Midwestern cities. That means compressed cap rates and lofty valuations, which could potentially complicate entry for interested investors. Prices are still reasonable, but the depth of the buying market could generate costly bidding wars, especially if larger investors get involved.
“Tech Exodus” narratives can be misleading.
The Midwest is projected to capture significant economic growth over the next decade, but there’s no guarantee that those benefits will be disbursed equally across the vast Heartland. While Cincinnati’s population is increasing, and some start-ups have attracted non-local talent, the city’s net arriving talent flow is still relatively low compared to that of Sunbelt boomtowns. This presents opportunities to generate a better yield than those Sunbelt alternatives — but the growth story isn’t quite the same.
Cincinnati's economy is diversified and tough, but there's a risk that it will ultimately be surpassed by other emerging metros that remain cheaper than traditional markets, but attract a greater share of young, urban demand-driving professionals (commonly called “yuppies”). Over the long run, more growth will be captured in the Midwest and South by cities that successfully entice new talent, and it remains to be seen which metro areas will win the race.
Does the market have built-in downside protection?
As noted earlier, Cincinnati is fairly well-insulated against recessionary risks because of its economy and consistent demand for affordable housing. 2008 and 2020 put that resilience on full display.
Similarly, home prices in Cincinnati are high relative to rents, which protects demand for multifamily housing at the lower end of the cost spectrum.
Realistically, opportunity cost might be a more formidable risk than recession, which leads us to believe that downside protection is, in fact, built-in in Cincinnati. However, this is less pronounced in Cincinnati than our home market of Pittsburgh, so threats to the downside should be top of mind to investors considering this geography.
Cincinnati is an expanding market that could be competitive for talent from other areas over the next decade if conditions play out as indicated.
But, it’s not exactly a guarantee. On the one hand, appreciation in Cincinnati could be lower than a metro like Austin. But on the other, that cap on upside is also likely an indicator of downside protection: asset prices in Cincinnati are likely to allow for strong current cash flow. Valuations probably aren’t going to the moon, but it is a relatively stable market that we believe could be undervalued. Demographic and economic data from the past decade stands out:
• Cincinnati’s price-to-rent ratio in 2020 was 21, compared to a national 18.09. It’s no surprise that more households rent than buy.
• Reversing fortunes on the population front, bolstered in large part by young professionals seeking work in sectors like healthcare and professional services.
• With a median age six years younger than the national median, Cincinnati is well-positioned for growth, especially as compared to the rest of a generally aging country.
The data suggest that Cincinnati — like several other Midwest metros — is steadily adjusting to the realities of the new century while offering residents comparatively low cost of living. As the population scales up, and the price-to-rent ratio continues to increase due to unusually high home prices, rental demand will likely increase too. And, as Cincinnati’s economy continues to attract new sectors and grow, the combination of income increases and rental demand could position investors to earn strong returns on an undervalued workforce housing market.