If you’ve been following our Twitter for the last few months, you know we’ve been a little obsessed with market research. From New York to Michigan, Ohio to Kentucky, we’ve been diving deep on real estate investment analysis to serve up that sweet, sweet data that you, dear reader, love so much.
This week, we’re heading back where it’s a little warmer, to the city that plays host to both the world’s largest thoroughbred auction house and its largest peanut butter factory . . . the home of the Wildcats, the Horse Capital of the World, the Athens of the West.
You guessed it, it’s Lexington, KY.
The Athens of the West
In 1775, William McConnell and some frontiersman buddies were camping by a natural spring when the shot heard ‘round the world arrived in what would, 17 years later, be named Kentucky. McConnell and company promptly named the site Lexington — the first of several American places to be renamed after the famous battles of Lexington and Concord.
By the early 19th century, Lexington had progressed from campground to village, and from village to perhaps the thriving-est American metropolis west of the Alleghenies. Distant from any large natural bodies of water, Lexington never developed the dominant manufacturing sectors that put locales like Cincinnati and Pittsburgh on the map. Instead, Lexington — a formidable intellectual, cultural, and agricultural sector — enjoyed renown for horses, bourbon, tobacco, and universities.
Today, that heritage is alive and well in Lexington’s impressively diverse, resilient economy. Four Fortune 500 companies — Xerox, Lexmark International, Lockheed Martin, and IBM — employ a significant share of the city's workforce. UPS and Amazon also host operations in the metro area, and A&W's corporate headquarters, Fazoli's corporate headquarters, and Link-Belt Construction Equipment round out the city’s list of big names.
Lexington's economy is also protected by a strong Meds and Eds presence, in the form of the University of Kentucky (the city's largest employer, with nearly 17,000 employees), Central Baptist Hospital, Saint Joseph Hospital, and the VA Hospital.
The city’s legacy of economic diversity, cultural vibrance, and technological and infrastructural forward thinking protected it from the sector shocks and economic reinventions that reoriented many other cities. Lexington’s growth trajectory has usually pointed up and to the right.
In 2021, that could mean serious opportunities for real estate investors.
Opportunities and Risks
The market profiles we've written so far feature a few common themes, and they're all on display in Lexington. Profitable multifamily real estate investment depends on a multitude of considerations, but when it comes to evaluating new markets, two are at the forefront: economic stability (how likely residents are to seek out your apartments and pay rent), and the current state of the housing market (entry costs, appreciation odds, supply and demand, etc.)
The economy is stable and diverse, with upside potential
Because Lexington’s economy was never reliant on the continued prominence of a particular sector, like automotive or steel, its economy developed an organic diversification that continues to serve it well.
If you’ve read a few of these market profiles already, you know we’re going to talk about Meds and Eds. While Lexington’s economy isn’t as strongly reliant on education and healthcare as some other metros we’ve profiled, the metro’s largest employer is the University of Kentucky, and a host of other colleges and universities encourage scientific research, corporate and government collaboration, and the annual arrival of impressive numbers of 20-somethings looking for apartments.
Trade and logistics are also big business in Lexington, due to its favorable geography — within a day’s drive of two-thirds of the US population. Although COVID-19 took a toll on every industry, 2020 America ran on ecommerce, and Lexington’s economy took some shelter in trade expansion.
Professional services and manufacturing also play significant roles, and weathered the recessionary impact of COVID-19 better than most sectors.
With horse racing, bourbon tourism, and other attractions luring tourists from around the world, Lexington’s employment suffered most when the leisure and hospitality sector took a nosedive last year. Fortunately, an encouragingly swift employment rebound suggests that, as America braces for Vaccination and Vacation, Lexington’s tourism industry will be just fine.
Over the short-to-mid term, as the economic effects of COVID-19 subside, Lexington should be in a strong position to resume its growth rate; the metro could also, by virtue of its economic diversity, be exposed to upside if one or another industry takes off. Over a longer time horizon, the indicators have been just as strong.
Lexington never endured the dilution and population decline that affected some other cities’ populations during the 20th century. As the city’s population continues to grow, and the trifecta of universities, private firms, and government create opportunity, the economy should continue to foster favorable conditions for real estate investors.
Some quick hits:
- 2010-2018: the city created an average of 4,400 new jobs per year
- 2010-2019: Lexington’s population grew 9.2%
- 2019: 43.6% of Lexington’s residents held a bachelor's degree or higher
Lexington’s economic potential and growing population should insulate multifamily investors — particularly in the workforce segment — from economic turmoil and continue to create demand over the upcoming years.
The housing market is affordable and growing
We’ve argued many times that workforce housing is an attractive investment because it benefits from resilient demand over time — affordable solutions that are viable for a majority of working families will always attract demand — and Lexington is no exception. Multifamily is an affordable option in Lexington that attracts a sizable proportion of the metro’s population.
- Just over 40% of households opt to rent
- Lexington’s median rent as a fraction of median income in 2019 was 17.56%, compared to 17.74% statewide and 20.03% nationwide
- Rental unit vacancy is just over 6%
- Price-to-rent ratio in the metro area is 18.84
- Home prices in the metro area increased more than 12% over the last year
- As of 2017, more than 8% of occupied rental units in the metro area were occupied by students at the U of K
With a median age of 34.6, high educational attainment, stable population growth, and hot demand for single-family homes, Lexington’s fairly affordable apartments are compelling opportunities.
While the city is more expensive than the statewide median, and slightly more expensive than Louisville and Cincinnati, it’s still a powerhouse of affordability in comparison to coastal hotspots. Transportation, utilities, and groceries are also less expensive in Lexington than the national average. Combined with affordable housing and a robust economy that’s been creating jobs like clockwork for the past decade, Lexington could be a promising migration destination.
Stable, increasing demand for apartments in an affordable metro give rise to forces we’ve talked about many times before:
- As jobs are created, migration and apartment demand increase
- As demand increases and wages rise, rents rise commensurately and property owners capture economic growth
- If rents don’t rise too far as a fraction of income, metro-area multifamily continues to offer a comparatively affordable value proposition that preserves the strong demand that kicked off the cycle
Rising demand and constant supply could pose a risk
From prospective tenants’ perspectives, multifamily’s value proposition depends in part on the desirability of single-family alternatives. As has been the case everywhere else, Lexington’s single-family market heated up considerably during 2020 as families decided to trade compressed urban apartments for expansive backyards and spare bedrooms that could be converted into home offices. But, supply-side shortages are throwing water on the market in mid-2021, which could conceivably create a spillover effect into multifamily.
The bottom line: over the last year, housing demand has taken a trip to the moon. For investors looking to buy into the market, that could mean cap rate compression, bidding wars, and frothy valuations that discourage acquisition. On the other hand, for investors who already hold property, elevated demand and the current lending climate provide attractive opportunities to pursue a liquidity events.
It’s possible that this trend ends up being fairly idiosyncratic. After all, global pandemics aren’t supposed to happen very often. If the home-buying wave subsides, multifamily may no longer need to function as a heat sink, and valuations could normalize. On the other hand, if elevated single-family demand becomes a long-term trend, multifamily investors will have to take a more active approach. In any case, Lexington’s housing market isn’t unique in this regard — it’s just part of a broader trend.
Students are a transient tenant base and economic force
Like we mentioned earlier, in 2017, students at the University of Kentucky alone rented over 8% of occupied apartments in Lexington — and numerous colleges and universities are situated in the region. If the student population increases, investors interested in offering student apartments could see upside; as the situation currently stands, they should face resilient demand as large, public research universities continue to absorb market share from smaller, private institutions. But, the student apartment value proposition isn’t the same as the workforce apartment value proposition — and investors entering the space could face higher turnover than in markets less saturated with students.
(Although it’s highly unlikely, it’s also worth pointing out that if the University of Kentucky did ever capsize, apartment demand in Lexington could decrease significantly.)
Either way, a city that maintains a relatively large student population could experience more economic and rental demand instability than a comparable counterpart playing host to fewer students.
Is downside protection built-in?
Yup. Lexington isn’t enduring an economic reinvention like Detroit, and its economy is more diverse than that of a city like Morgantown. Rental demand is consistently high, and prices remain low. While investors can never truly rule out the possibility of unpredictable events, Lexington’s economic diversity, abundance of universities and medical centers, anchor corporations and brands with high name recognition, and cultural heritage should work to ensure that investors remain insulated from all but the most systemic shocks.
Of the markets we’ve profiled in this series, Lexington offers comparatively less risk. Where some cities are working through reinventions, emerging from localized recessions, or keeping most of their economic eggs in a single basket, Lexington is a testament to the power of slow, steady growth.
That attribute could keep conservative investors happy, but Lexington is somewhat less likely than riskier markets to present investors with the opportunity to earn astronomical returns. Lexington multifamily is affordable, but it probably isn’t undervalued, and investors have less headroom to capitalize on strong economic performance by increasing rents than in cities with more strikingly affordable markets.
Still, the rising tide of steady population growth, job creation, and wage increases could carry Lexington-area real estate investors towards strong returns.