Earlier this month, we posted the first of a series of market profiles about emerging metros that we think could be promising for real estate investors interested in doubling down on the value proposition of workforce housing in the Heartland.
While the markets we’re analyzing differ in some important ways, some common themes are emerging: affordability, economic resilience, strong multifamily sectors, upside potential, and built-in downside protection that affords investors a lower risk profile than more traditional coastal markets.
This week, we’re focusing on the Flower City. The Flour City. The Young Lion of the West. The Image Center of the World. You may (or may not) have guessed it... Rochester, New York.
The Image Center of the World
The Rochester, New York region is home to more than 7% of the world’s freshwater reserves. The city began life as one of America’s first economic boomtowns, mainly because of the seed export industry and commercial agriculture of the Genesee river valley (this is how it earned the moniker “Flower City”). The town decided to double down with a homophone, adding “Flour City” to its resume on the strength of a growing flour mill industry, before picking up recognition for optics and engineering with the founding of Xerox and Eastman Kodak at the start of the 20th century.
The newly-dubbed “Image Center of the World” had become an important hub, and eventually added financial services (Western Union) and journalism (Gannett) to its industry resume. The city fell upon hard times as the industrial revolution slowed, and the process of deindustrialization that disruptedthe steel, iron, and heavy manufacturing industries in cities like Pittsburgh and Buffalo also showed up on Rochester’s doorstep.
But, Rochester’s story didn’t end there. Deindustrialization was more prolonged in the region, and heavy-hitting anchor companies like Eastman Kodak, Xerox, and Bausch and Lomb held on long enough to witness Rochester’s reinvention. This protection of the local economy and population helped Rochester see the rise of tech firms, universities, and medical centers that brought the region roaring back to life.
Today, Rochester is an emerging center for science and engineering, with strong research and development, advanced manufacturing, education, and health sectors. Some of the largest employers in town are Wegmans, Monro automotive, Rochester General Hospital, the University of Rochester and the Rochester Institute of Technology, and 17 other colleges and universities in the greater metro area.
Much like Cincinnati, Rochester’s diverse economy makes for a resilient backbone:
As is the case for most of the markets that Birgo Capital finds attractive, “Meds and Eds” employ a large share of workers and insulate the city’s economy against industry-specific bubbles. While old-school mainstays like Kodak and Xerox employ smaller shares of the city’s workers today than in the past, the diversification creates powerful downside protection — especially for multifamily real estate at the lower end of the cost spectrum — that supports investors’ cash flows even during recessions.
But, Rochester is more than just another 19th-century boomtown that reinvented itself into a diverse regional economy. Rochester is a comeback story, driven by the most promising growth sector in town: tech. Let’s talk about how that creates opportunity for real estate investors.
The Intersection of Opportunity and Affordability
It’s not exactly a secret that science and tech are some of the greatest economic growth engines in America. But increasingly, the traditional centers for innovation and invention have lost some of their shine as affordability issues and business-unfriendly regulatory environments encourage firms to relocate. Even before the COVID-19 pandemic , more than 2,600 people were migrating out of New York City every week — and other mid-Atlantic markets followed suit. As of February 2020, more than 21% of those seeking apartments in Rochester were leaving New York City, and Rochester’s proximity to other primary mid-Atlantic cities like Philadelphia, Boston, and D.C. lends it strong potential to attract more transplants.
Why are renters moving from traditional metros to tertiary cities? Affordability has always been a value driver — Forbes estimated cost-of-living in Rochester is 11% lower than the national average — and the pandemic has only emphasized its importance. Additionally, as living costs continue to rise in traditional markets and the ability to work from home becomes normalized, mobile professionals will continue to seek markets where their dollars go further.
While the city’s median age still skews upwards by families that have lived in the region for decades, more than 66% of incoming residents are millennials born between 1980 and 1998 — attracted by the one-two punch of affordability and opportunity. Many of those newcomers appear to be interested in living in Rochester for the long haul, as the city is one of the top 10 metros in the country for millennial home-buyers. As that happens, the population trends could begin to reverse. Also worth noting is that in 2019, more than 9% of Rochester’s population was foreign-born, suggesting the city may have potential for attracting international talent.
Burgeoning Technology Sector
According to the St. Louis Fed, Rochester’s GDP increased by more than 27% between 2010 and 2019. Especially over the past 5 years, much of that growth has been attributable to the tech industry.
Rochester’s vibrant tech sector attracts talent and adds value. Investors have attributed this advanced manufacturing boom to a high concentration of expertise in the city. A relatively high concentration of research universities in town has attracted partnerships with organizations like AIM Photonics, as well as start-ups backed by venture capital funding.
Those forces have converged to make Rochester the #1 market in the country by patents issued per thousand workers, the #1 market for cybersecurity hires, and — according to MIT economics — projected to become the #1 metro in the United States for future growth and strategic investment into tech innovation. Educational attainment is also high in the city: more than 37% of residents hold college degrees, and according to the Department of Education, Rochester boasts the highest number of STEM degrees per capita of any U.S. metro.
The combination of robust relocation, education, and tech investment has created value before, and we believe it will continue to be a decisive factor in selecting the hubs of tomorrow.
The Housing Market
The single-family market is relatively hot in Rochester, with home prices rising an estimated 25.9% during 2020, according to realtor.com. This makes Rochester one of the five most competitive seller’s markets in the country, right behind Austin. It should be no surprise, then, that over 33% of households opt to rent.
According to the Census Bureau, annual rent as a fraction of annual household income in 2019 was 17.37% in Rochester, compared to a U.S. average of 20.03%. Even more striking is the comparison to a New York State average of 21.78%. While Rochester isn’t going to crack any top-10 lists as one of America’s most affordable places to live, what’s important is that it’s dramatically cheaper than nearby options like NYC. For residents with strong regional ties who don’t want to pick up and move to the Midwest, Rochester is a bargain rental market situated right in their backyard.
As the economy grows and the single-family market stays fairly tight, people who are relocating will increasingly opt to rent. So, how big of a proportion of economic growth is the multifamily space able to capture? The answer to that question is a lot — according to Housing and Urban Development, between 2010 and 2017, all net household growth in Rochester was in renter households.
What this means for real estate investors is that rental demand will only increase as tech expansion and population increases. At the same time, the market is so deeply affordable right now that there’s plenty of headroom for investors to capture economic value through rent increases and still offer tenants far more affordable housing than they would find in NYC, Philadelphia, or Boston.
If the economy continues to develop, costs keep going up in NYC and other tech markets, and an abundance of highly-qualified professionals keep driving innovation in Rochester, multifamily investors should have line-of-sight to appreciation at exit. In combination with 2021’s favorable financing rates and Rochester rents’ durability to date, those forces could create real opportunity for interested investors.
That’s not to say there aren’t some forces to keep an eye on.
Population hasn’t reversed courses yet
As of 2021, net migration is closer to positive than it was for most of the second half of the 20th century, but Rochester has yet to see truly positive net in-migration. And, not all who relocate to the area are interested in renting. Single-family housing has been the hot market so far. Millennial migration does indicate future population growth, and the intersection of education and tech in the region will probably generate more opportunities down the line. These factors, combined with relatively stable rents in the multifamily sector, could suggest that multifamily is undervalued in the city — but it’s too soon to make the call.
Rochester is still coming back
Between 2000 and 2017, traditional mainstay employers Xerox and Kodak laid off more than 30,000 workers combined. There's a clear line-of-sight for Rochester’s future, but it’s still on the tail end of a transitional period, and some analysts have been concerned by Rochester’s somewhat muddy economic past.
But, there are at least two reasons to believe this concern won’t be a significant impediment to the Rochester-area real estate market.
First, anchor employers can make a boomtown, but they can also break one. An economy too-reliant on a handful of all-encompassing industries is more susceptible to economic downturns and valuation bubbles that can disrupt the entire city’s economy when they become obsolete. Concentrating a large proportion of residents in a single industry exposes the local economy to greater risk.
Second, Kodak and Xerox declined more slowly than heavy industry did in cities like Buffalo and Pittsburgh, keeping Rochester afloat long enough to attract significant science and technology investments that diversified the city's economy and propelled it into the 21st century. Meanwhile, the steady growth of the healthcare and education sectors offset the net loss in manufacturing jobs, hedging against future tech bubble risks and reaffirming our view that Meds and Eds are reliable economic anchors.
Is there built-in downside protection?
Diversification is usually the best safeguard against recessionary risk — a tenant base that takes home paychecks from a variety of industries is less likely to go delinquent en masse when the economy takes a dive. In the 2008 recession, that thesis played out perfectly for Rochester. Between 2008 and 2010, the metro area's nonfarm payrolls declined by 0.7%, compared to a national average of 1.9%. Manufacturing, wholesale, and retail bore the brunt of the recession, but were largely offset by the expansion of the health, education, and government sectors.
2020 and the pandemic economy were tougher on Rochester, hitting the economy harder than the 2008 recession. Employment struggled during the latter half of 2020. A 7.4% local net job loss between January 2020 and January 2021 shows improvement over the lowest point of more than 15% in mid-2020 — but the dip was lower in Rochester than the national average.
Plainly stated, employment both fell faster and recovered faster than many other markets — suggesting some volatility that investors will want to keep an eye on.
That said, tech start-ups were bullish on the city prior to the pandemic, and so far in 2021, that trend hasn’t slowed down. A 2021 DoD contract with the University of Rochester and AIM Photonics involves multiple in-town firms and intends to develop instantaneous COVID-19 antibody detection. Deals of this variety suggest that Rochester’s rising technology muscle can continue to produce growth as the country faces new threats and opportunities.
On one hand, the market is certainly more resilient now than it was a few decades ago. On the other hand, Rochester’s pandemic response wasn’t the slam-dunk that its 2008 recovery was, which could give some investors pause.
Rochester is still on the tail end of an economic reinvention that could be explosive if the city plays its cards right. But, like we pointed out for Cincinnati, it’s not “there” yet, and there are no guarantees. Appreciation will likely be slower than markets like Austin that are attracting the lion’s share of California expatriates. While New Yorkers are starting to look for more affordable options, and Rochester is a default choice for residents who aren’t quite ready to leave the state, the migration rate just isn’t as high as on the West Coast. On the other hand, slower growth is also less risky, and a stable, affordable housing market doesn’t need exponential growth to generate superior returns.
A few compelling attributes stand out:
- Out-migration from mid-Atlantic hubs like NYC, Philly, and Boston is real, and Rochester’s deep value positions it to perform well as COVID accelerates the trend.
- Rochester punches well beyond its weight class for science, research, and engineering. Advanced manufacturing and collaborations between local universities, government agencies, and tech firms have yielded impressive results in innovation, as measured by patents issued, STEM degrees conferred, and cybersecurity employment.
- Finally, as the comeback continues, Rochester is a good place to rent. Prices are affordable and stable, and the demand run-up of the past couple of years in the single-family space makes rental a comparatively more-attractive option.
Will Rochester be, as MIT Economics predicted, one of tech’s top hubs by the middle of the century? Time will tell.