By Todd Phillips, Minnesota Real Estate Journal
With eight high-rise properties in the pipeline for downtown Minneapolis, developers have clearly not lost enthusiasm for multi-housing. Condominiums appear to be a bigger part of the mix, but rental units are still going strong. 2018, however, did see some planned projects get scrapped in Minneapolis as it appears some bears might be coming out to play with the bulls in 2019.
For the past six years, a strong market with low unemployment and vacancy rates have helped the metro area defy odds and continue to grow well beyond anyone’s early expectations. Minneapolis is continuing to see high demand with an average vacancy rate of 2.3 percent at the end of September 2018 according to Marquette Advisors, which is (amazingly) lower than a year ago.
“I would say we are at the peak of deliveries in a mature development cycle. Just over 6,000 new market-rate units and 1,500 affordable units opened in 2018, a record total amount for the two combined, and well over 6,000 units of all types are under construction and expected to be delivered in 2019” Tim Larkin, Senior Vice President at Dougherty Mortgage stated.
Investor Appetite Waning? Not yet.
2019 should continue to be a sellers’ market for multifamily owners, according to Steve Michel of Michael Commercial “All apartment product types are in high demand and selling prices are consistently hitting new high-water marks.”
Larkin adds, “we expect investors to continue to be interested in multifamily housing in the Twin Cities because of the strong fundamentals of overall low rental vacancy and low unemployment. However, with record apartment production volume and economic uncertainty seeming to grow, we expect investors to be much more discerning about which properties and which locations they will pursue. Now that the Green/Southwest LRT line has started construction, we expect the entire length of the corridor to continue to attract new housing investment.”
Grant Campbell of IRET, also sees appetite remaining strong. “Investor interest will remain high and 2019 investment activity will mirror 2018. Capital is plentiful right now and seeking well located assets. We expect return thresholds to remain the same, however, also believe more conservative underwriting assumptions are being made market wide, which will cause absolute dollar investment pricing to fall.” Campbell goes on to say, “we believe the urban core, and immediately surrounding high-demand neighborhoods, will display the highest resiliency and pricing power long-term.”
Lenders may also be tightening the belts a bit. “Debt Service Coverage Ratio covenants are tightening as the cycle has extended. On new construction projects, the mortgages are being debt coverage constrained and this is resulting in borrowers having larger cash equity positions” according to Nick Place, Chief lending officer at Bridgewater Bank.
Single Family Woes a Driver
“The lack of entry level supply for single family homes, whether existing or new construction, has been a real tailwind for the multifamily sector.” Michael Roessle, Market Economist at CoStar Group.
Larkin addresses the issue: “The increase in interest rates has made it more difficult for young people, many of which have substantial student loan debt and little savings, to buy houses.
New renters seem to be coming from two main sources – millennials moving out of their parents’ houses and empty nesters downsizing. Millennials are attracted to small apartment units and are focused on an affordable monthly rent amount, not as much on the rent per square foot. We can expect to see more ‘micro units’ come into the market to meet this demand. Empty nesters are attracted to the larger, and more expensive, apartments coming online Downtown Minneapolis and in various suburban locations.”
Light Rail and Loosening Parking Requirements also a Driver
Transit-oriented development is poised for another phase as the Southwest Light Rail breaks ground. Plus, loosened restrictions on parking requirements are bolstering development of small-scale units along existing transit lines. Parking requirements along transit lines were reduced to one parking spot for every two units, as compared to the typical one to one zoning around the metro. With Minneapolis’ 2040 plan recently approved, parking requirements may go away completely.
This is an area where small developers can still create successful projects; “primarily in urban locations that have strong access to transit, recreational and cultural amenities, and/or employment. Most infill projects in the central cities fall in the 50-80 unit size range” according to Larkin.
B and C markets ripe for Redevelopment
The market to redevelop class B and C properties is flourishing, but only for those able to acquire these projects. High demand continues into 2019 from developers that understand redevelopment. “There is rental upside as new construction rents are still much higher and vacancies remain low” says Roessle.
Larkin adds “nearly 170,000 Twin Cities renter households are considered ‘cost-burdened,’ where the household spends more than 30% of gross income for housing costs. This high number of financially-stressed renters’ places enormous pressure on the existing supply of older rental units and most owners are enjoying high occupancy rates. This also allows some owners to upgrade their buildings and raise rents.”
Nick Place also adds, “the low hanging fruit has been picked in many locations, so investors are either paying up in proven markets or pushing into new, less proven areas. The amount of renovations on these types of units over the last 8 years has taken a large amount of naturally occurring affordable housing off the market. These renters are really struggling to find places to rent. The effects can be witnessed in the very speedy lease-ups in newly built affordable housing properties across the metro.”
“The redevelopment of Class B and C properties, however, continues to place significant pressure on the availability of affordable rental product, for which supply is at an all-time low and demand is at an all-time high” according to Mary Bujold, President of Maxfield Research.
More Concessions in Minneapolis
“Rental concessions have been normal in the urban metro markets since the building boom began and have been appearing in suburban markets as well. Should we see an economic slowdown, I would expect renters in the luxury segment to see the best deals as that has been virtually all that has been built during this cycle. Renters in the Class B and below markets won’t be as fortunate as demand will continue to remain strong or even accelerate for more affordable options” according to Bujold.
Projects Scrapped
There appears to be some pullback or restraint in certain submarkets markets, such as Sherman’s cancelled plans to build apartments on the Thrivent site. Plans for Pentagon Park and an urban village project at the Mall of America were scrapped as well. Is this a sign of things to come in 2019?
The Twin Cities boasts a lower than national average unemployment rate, along with low vacancy rates, and that’s a key reason the developers are still getting after it going into 2019.
Vacancy Rates Headed North, Eventually
“I believe we are going to see a rise in vacancy rates among recently built properties as a portion of young renters hops around between new developments trying to maximize their opportunities to obtain move-in deals. These young residents have few belongings and are more easily able to change residences” according to Bujold. Logic dictates that this subset of renters are filling up new properties encouraging developers to build more, but as they jump, they may be leaving large vacancies in their wake.
Roessle adds “the metro wide vacancy rate is performing well and remains well below the U.S. average. Despite a slight uptick from 2017, demand remains positive in the face of the continuing supply. I do expect the vacancy rate to increase over the next couple of years, as additional supply and potential economic slowdown will weigh on the multifamily sector.
