Mirroring Growth

“On the road to recovery” summarizes the current Twin Cities rental market. After several years of stagnant rents and above-market equilibrium vacancy rates, the market is again moving in the right direction. The first quarter vacancy rate this year was 4.4 percent, down from 5.6 percent a year ago. Two years ago, vacancies had climbed to roughly 7.5 percent, considered high for this smaller market. Annualized rent growth for the first quarter of 2007 was 2.4 percent.

Now, concessions have all but disappeared. What's more, according to developers, owners, and property management companies, 2006-07 has been the first year of solid rent growth in about five years. New projects are under construction, with a few more planned to break ground this year. Most of these new developments are located in historically strong locations that support upscale rents and have exhibited higher levels of rent growth.

Because of a traditionally strong local market and generally limited number of institutional-grade properties, multifamily properties in the Twin Cities are currently trading at historically aggressive cap rates—in the low to mid 5s for Class A properties and between 6 percent and 7 percent for Class B properties, according to Gina Dingman, vice president and chairman of Colliers Multifamily Group of North America. The highly aggressive cap rates reflect the lack of supply and plentiful capital, and Dingman expects the ongoing abundance of capital in the market to keep fueling the trend.

Most of the new development that has come online over the past few years has been concentrated in the two central cities of Minneapolis and St. Paul, usually on redevelopment sites. Mixed-income developments, several with street-level commercial space, have enjoyed good market acceptance. City Walk apartments in Woodbury, originally planned as a rental community, briefly converted to condominium before converting back to rental, and absorption has been strong.

New apartment properties include the 313-unit River Crossings, the 344-unit Riverview at Upper Landing, and the 267-unit 808 Berry Place—all in St. Paul—and the 162-unit Uptown City Apartments in Minneapolis. Four developments now under construction are Eitel City Apartments (200 units), Hiawatha Flats (260 units), Lake Calhoun City Apartments (163 units), and Founder's Circle Apartments (195 units). Still more will break ground in the next year or so.

Condo conversions occurred only sparsely in the Twin Cities. The largest and most notable conversions occurred primarily in the southwest quadrant (Eden Prairie and Minnetonka) and in the downtowns of Minneapolis and St. Paul. Smaller 1950s and 1960s buildings and older brownstones were also converted in high-amenity inner-city districts where the price of for-sale housing has long been out of reach for first-time buyers. Condos finally put these amenity-laden locations within reach of first-time buyers and allowed them to remain in the areas where they had been renting.

The 220-unit Camerata Apartments will break ground this year and is situated near a proposed commuter rail line in St. Louis Park. Combined with its proximity to shops, restaurants, and apartments, Camerata's location is bar none.

Some concern emerged that the rental market in down town Minneapolis would be affected negatively by investor condo units being rented alongside traditional rentals. While the number of investor condo rentals has increased, these units are generally at the top end of the market and have not significantly affected the overall traditional rental market.

New units along the Twin Cities' first light rail line have also proven to be successful. Oaks at Hiawatha Station (61 units) leased up rapidly. The same developer has undertaken a second, more ambitious development two blocks north of this property.

Hiawatha Flats is under construction and scheduled to begin leasing on the first phase of the development within a couple of months. An extensive amenities package is planned, with rents beginning at $1,200 for a 600-square-foot one-bedroom unit. According to the developer, renters have been willing to pay a premium for units on the light rail line, and a relatively high proportion of residents—up to 30 percent—do not own a vehicle. A shared car for errands and trips will be available for residents to sign out.

Camerata Apartments (220 units in St. Louis Park) is being developed by a team led by Mike Pagh of Great Lakes Management. Designed by Urban Works, a local architecture firm, the project is expected to break ground this year with occupancy scheduled for 2008. Camerata will be co-located with condominiums and commercial space. The apartments are adjacent to a proposed future commuter rail line that will provide access to downtown Minneapolis for workers from southwest suburban locations. St. Louis Park's location, with convenient access to the central city lakes district and to several nearby major employment districts, has made it a popular location for new multifamily housing.

Riverview at Upper Landing offers 330 units along the Mississippi River in St. Paul.

As rental rates strengthen and vacancies decline, the Twin Cities has generated more interest among property owners in rehabbing properties to achieve higher rents, especially in supply-constrained submarkets with higher barriers to entry.

A slowdown in the for-sale market has strengthened the rental market as some buyers have been pushed out of homeownership. Local developers generally agree that while the market is recovering, most submarkets in the Twin Cities have not yet hit rent levels that will justify new construction.

Despite the generally soft rental market in the Twin Cities over the past three years, new construction that came online during this period leased up well overall, better than originally projected. This occurred despite developments that were typically between 160 and 300 units in size.

The 208-unit City Walk Apartments in Woodbury brings an urban feel to suburban Minneapolis.

Demographically and economically, the Twin Cities remains strong with continued moderate population and household growth, an average age of 35.8 years, and a per capita income of $42,083. The Twin Cities ranks No. 1 of 25 major metropolitan areas in labor force participation and No. 4 in terms of people with bachelor's degrees. It also ranks No. 1 of 25 major metro areas in terms of the number of middle-income households, No. 6 in terms of new job growth (34,100 jobs in 2006), and No. 1 in terms of homeownership (74 percent).

The area needs to be able to sustain its current level of job growth and attract more rental development to increase the supply of units available for investors. For sellers, buyers are willing to pay top dollar for good-quality rental developments. There are just not enough properties for sale.

Recent multifamily sales in the Twin Cities have traded at between $125,000 and $150,000 per unit for Class A and from the mid-$80,000s to roughly $110,000 for Class B.

With 267 units, 808 Berry Place offers a mix of flats, lofts, and townhomes in St. Paul.

“The capital glut and profit-taking 1031 buyers still drive demand and sustain aggressive pricing despite the institutional malaise shown for the Upper Midwest,” according to James McCaffrey, principal and senior vice president with Colliers Turley Martin Tucker in Minneapolis.

Without a doubt, he says, there's room for improvement—and more development. “Why is it that interest rates, although still at historic lows, have spurred virtually no new construction in a major [metropolitan area] of 3.1 million people?” he asks. “Clearly, our rental economics are not keeping pace with other parts of the country.”

Mary Bujold is president and director of research at Maxfield Research, a real estate research and consulting firm in Minneapolis.

FAST FACTS

Considering Minneapolis? Here's what you need to know:

• Population: 3 million
• Occupancy: 95.6%
• Median Age: 36years
• Median Household Income: $42,083
• Average Rent: $876
• Unemployment: 3.7%

  NOTABLE: Twin Cities is home to 18 Fortune 500 companies in 2006. Cargill, headquartered in the Twin Cities, is the nation's second largest privately held company. The New York Times has said that outside of New York, the Twin Cities has the finest cultural scene in America.

  SOURCES: American Community Survey; Metropolitan Council; GVA; Maxfield Research