The location was perfect for an upscale apartment community: An area beside picturesque Lake Calhoun in a historic, quaint section of Minneapolis characterized by a lively business district of bars, restaurants, and high-end shops, within walking distance of mass transit.

The developer imagined scores of residents ice skating on the large lake in the winter and swimming and picnicking in the summer.

“How often do you have a lake so close to a central business district?” said Jonathan Holtzman, chairman and CEO of the Village Green Cos., which own and operate about 35,000 units across the Midwest.

But there was one problem. A sprawling open-space parking lot for a neighboring office building dominated the site where Village Green wanted to develop luxury apartments. So, the developer approached the owner of the parking lot and office building, the Ackerberg Group, with a proposal.

“We proposed to do two levels of underground parking with an apartment project above,” said Holtzman. “We thought it would be a very innovative way to develop an apartment project on Lake Calhoun and to fully utilize what was just a surface parking lot.”

The Ackerberg Group liked what it heard and became a joint-venture partner in the development of Lake Calhoun City Apartments, which is slated to open its doors this summer. When it opens, the two levels of parking will be shared evenly. “Essentially it’s a mixed-use parking garage: during the day it’s for the office building, and during the night it’s for the apartment building,” Holtzman said.

Lake Calhoun City Apartments features 158 loft apartments mixed among studios and one-, two- and three-bedroom units, as well as 40 two-story penthouses and six townhomes. The units feature high-end finishes, nine- to 18-foot ceilings, hardwood floors, and kitchens with granite-topped islands, among other features. A community room leads to an indoor/outdoor swimming pool and hot tub, with a professional exercise facility nearby. Bank of America is the construction lender, and the company, which declined to provide loan amounts, is shopping for permanent financing.

The development may serve as prologue to a building boom in Minneapolis that industry watchers expect to begin next year.

Strong fundamentals

The Minneapolis/St. Paul economy is an anomaly among the manufacturing-heavy, economically challenged Midwest cities. The Twin Cities are expected to expand payrolls by 1.6 percent this year, adding 28,700 positions, up significantly over 2006 levels, when the economy grew 0.9 percent, adding 16,200 jobs, according to market research firm Reis, Inc.

“Where the Twin Cities really do distinguish themselves is that it’s a relatively well-diversified economy,” said Sam Chandan, chief economist for Reis, Inc. “Income is strong, there’s significant white-collar employment, population growth is relatively strong, and those position the market well, as compared to other Midwestern peers.”

That job growth is already showing up: 6,000 new positions were added during the first quarter of 2007, according to Marcus & Millichap. The local economic momentum should send vacancy rates down, which translates to a boom in construction after a few down years.

In the late 1990s and into 2000, the Minneapolis/St. Paul area averaged more than 1,700 new units a year. In 2003, a whopping 2,554 units were completed, and the following year, another 1,711 units were brought online. “What really motivated a lot of that construction was that the vacancy rates fell to very low levels over the course of the previous cycle,” said Chandan.

That construction glut pushed vacancies up as high as 7.3 percent in the first quarter of 2004. As the market softened and the for-sale market grew stronger, construction fell to 705 units in 2005, and only 575 units last year. “There was a gap of no apartments being built as everybody was building homes and condos,” said Village Green’s Holtzman. “We felt very strongly that the Minneapolis market was ready for some newer apartments.”

As the local economy continues to grow, and as the available stock is absorbed, vacancy rates are expected to again fall below 5 percent, signaling that it’s time to build again. “The market can sustain numbers around 1,400 to 1,500 units [annually], and it really is a response to the vacancy rate falling below 5 percent in 2007,” said Chandan. Reis forecasts 748 units to be completed this year, 979 units next year, and more than 1,400 units each in 2010 and 2011.

The vacancy rate is expected to end 2007 at 4.7 percent, down slightly from the 4.9 percent posted in year-end 2006, according to Marcus & Millichap. Landlords are expected to take advantage of the strong occupancy levels, pushing rents up 3.9 percent by the end of 2007, and implementing rent increases of between 3 percent and 4 percent for the rest of the decade.

The Twin Cities are anything but identical twins. While the vacancy rate in Minneapolis is around 3 percent, St. Paul’s vacancy rate is 6.4 percent, among the highest in the area. And St. Paul’s average rent of $878 significantly trails Minneapolis’ $1,011, according to Marcus & Millichap.

“The downtown area of Minneapolis has a vacancy rate of 2.7 percent, which, if it were its own metro area, would be among the highest occupancy metros in the country,” said Chandan.

More to come

Village Green is bullish on the Minneapolis market. The company broke ground in October on the Eitel Building City Apartments, a mix of new construction and the historic rehabilitation of a hospital that operated between 1912 and 1985. The new development will feature 213 luxury units (mixed between studios, one- and two-bedroom, and penthouse units) dispersed among three six-story buildings.

The project, located in the high-end Loring Park neighborhood, is within walking distance of downtown, and also includes high-end finishes and features such as 10- to 20-foot ceilings, oversized bathrooms, and a rooftop with gourmet kitchens, an outdoor movie theater, a hot tub, and an outdoor fireplace.

The restoration was aided by about $1 million in historic tax credits, purchased by Bank of America. JP Morgan Chase is the construction lender, and the company is shopping for permanent financing. Village Green plans to start pre-leasing this summer and anticipates first occupancy in early 2008.

More multifamily development is just around the corner: In south Minneapolis, local developer the Klodt Cos. is building 229 apartments in a $30 million, five-story complex of buildings, and local developer Chip Johnson is proposing a 109-unit luxury apartment building in the Uptown section of Minneapolis, which is just east of Lake Calhoun.