The past 10 years in U.S. multifamily investment have been marked by an intense focus among institutional investors on the Sunbelt region. Strong demographics, less regulation, relative affordability and favorable performance, until recently, have all made it an attractive bet. According to NCREIF data, exposure to the Southern United States has increased by 750 basis points (bps) since 2017. This focus has come at the expense of the Midwest, where only 6% of NCREIF multifamily assets by value are currently held, down from 11% a decade ago.1 This allocation represents a significant underweight compared to the U.S. rental housing stock, as approximately 20% of rental housing units in the United States are located in the region.2
This raises the question: Why are investors underweight the Midwest? The region garners a negative perception from investors because of lagging headline data, but investors might be missing the mark. Here's why:
First, the Midwest offers investors the highest initial yields of any region. Over the last 23 years, apartment properties in the Midwest have traded at cap rates, on average, 45 bps above the national benchmark.3 This higher initial yield might be partly attributed to the lower share of institutional capital investing in the Midwest. According to data from Real Capital Analytics, the share of acquisitions volume done by institutional capital over the last 10 years is the lowest of any region in the United States.4 While higher initial yields coupled with lower rent growth would be logical, historical rent growth in the Midwest has not been as poor as you’d think. In fact, long-run rent growth data shows that over the past 20 years the Midwest has matched the nationwide benchmark. Furthermore, if you exclude Chicago, where many institutional investors have historically focused their efforts, the data improves. The Midwest, excluding Chicago, has outperformed nationwide rent growth by 20 bps on a CAGR basis over the last 20 years.5
Second, while population growth in the Midwest has lagged, there’s variance within, and pockets of growth do exist. Indianapolis, Columbus and Kansas City are markets that have all seen positive domestic net migration over the last 10 years.6 Employment growth also reveals exceptions to the narrative, with both Indianapolis and Columbus outpacing the United States over the long term.7 More near-term indicators of economic dynamism also show positively for parts of the Midwest. According to the U.S. Census’ business formation survey, Indiana and Ohio have both seen a similar growth rate in new business applications in recent years to high-growth states like Florida and Arizona.8
Finally, and looking ahead, there are reasons to be optimistic about the Midwest's future. Whether it’s rent-to-income ratios or home price-to-income ratios, the Midwest consistently ranks as the most affordable region.9 Given the current unaffordability of the nationwide housing market, and the perception that this trend will persist long term, it stands to reason that migration to the Midwest, beyond the areas already experiencing growth, could increase. In fact, consumer migration data indicates that fewer residents have been opting to leave the region in recent years.10
Additionally, the effort to reshore American manufacturing in select industries could act as a catalyst for the Midwest, where manufacturing employment is 1.5 times more concentrated than the national average.11 As these initiatives to reestablish domestic manufacturing take hold, the Midwest stands to benefit from the resulting job growth. Notably, some areas of the Midwest are already experiencing this shift. Both Intel and Eli Lilly are currently under construction on major manufacturing projects in Ohio and Indiana, respectively.12
In conclusion, while investors have shied away from the Midwest, now is the time to start reconsidering. The higher initial yields, better than expected historical rent growth and existing pockets of growth all appear attractive today. Furthermore, the potential for a region-wide rebound could offer significant upside in the future.