Multifamily W Minnesota

Twin Cities apartment development on a tear

Twin Cities apartment development on a tear,ph01
Flux Apartments in Minneapolis

It’s probably safe to say the Twin Cities apartment market has blown past expectations.

Strong market fundamentals, a healthy economy and a tight single-family housing market have extended the Twin Cities multifamily boom. The metro continues to boast one of the lowest vacancy rates in the U.S., which is driving both development and investor demand.

“It seems again that we’re at a point where the runway still feels very long and very wide in this industry,” says Josh Talberg, senior vice president in the Minneapolis office of JLL Capital Markets, specializing in multifamily assets.

For the third year in a row, Twin Cities apartment deliveries “shattered the previous year’s peak,” according to Golden Valley-based Maxfield Research and Consulting.

Maxfield projected 7,256 new units (both market rate and affordable) would come on line in 2019, up from the 6,164 new units delivered in 2018. Suburban development will account for 53 percent of the new product in 2019. Minneapolis proper will account for 31.4 percent of all deliveries in the metro area.

Looking ahead, 11,238 units are in the construction pipeline for 2020, according to Maxfield. (Many of those are phased developments). In 2020, Minneapolis proper will account for 42.6 percent of all deliveries in the metro.

Rent growth is on the rise

Historically, rent growth in the Twin Cities has been lower than the national average, notes Matt Mullins, vice president at Maxfield. However, the metro’s rent growth in 2019 is roughly 3.7 percent, which is one of the higher percentage growth rates in the U.S. (The national average is 3.1 percent).

Mullins says rent growth is higher in the suburbs than Minneapolis. The abundance of new product in Minneapolis has kept rents in check as developers have offered concessions. Some new projects are offering leasing specials to ensure absorption projections are met.

The metro’s vacancy rate is hovering around the high 2s to 3 percent – among the lowest in the U.S.

Coming out of the cycle, the Twin Cities has remained “one of the lowest vacancy rate markets in the entire country and that has been for several years running,” Talberg says. “We often get the question are we building too many apartments? My answer to that is always we haven’t built nearly enough apartment units to keep on pace with some other secondary markets and some other major MSAs across the country.”

Talberg says when considering the low vacancy rate as a supporting indicator, the Twin Cities has been and remains a very supply-constrained market.

“In fact, it’s economically a difficult market to build in, just with some of the regulations and now we have some inclusionary zoning polices that are taking effect,” Talberg notes. “In a market where labor costs and construction costs are increasing, economically, it’s making it more difficult to deliver new supply.”

Under new inclusionary zoning policies being adopted, developers must assure that some units in their developments are affordable for lower-income renters.

What’s driving demand for apartments?

Mullins says several factors are behind the multifamily boom including pent-up demand from the Great Recession when households lost homes to foreclosure and moved into rental units.

“That kicked it off,” Mullins points out. “We’ve also had no production basically for the last decade. No one was building apartments.”

At the same time, multifamily was one of the preferred asset classes that lenders were willing to provide financing for, so that helped stimulate the market.

“And then demographically, you’ve had the barbell effect, which is the boomers and the millennials,” Mullins says. “Demand is driven by these two large demographic groups that are peaking at the same time.”

Downsizing empty-nesters are selling single-family homes and moving into rental housing. The 55-plus housing market is thriving as more baby boomers look to invest in a new home to live out their retirement.

Meanwhile, millennials are flocking to Minneapolis, according to a report by SmartAsset. Minneapolis came in fourth on the list of cities that millennials are moving to.

Other drivers include a strong economy, new job creation, a low unemployment rate and wage growth.

People’s confidence is up, Mullins says. “People feel good and are spending money and more apt to form new households,” he notes.

Also, there’s a lack of supply in the for-sale housing sector.

Is a slowdown inevitable?

“There’s no question that we’re at the peak,” Mullins says. “I think things may cool off a little bit next year, but we’re not going to see a bust by any means.

“The question I get asked all of the time is where are we in the cycle?” Mullins continues. “What inning are we in? We’re in extra innings. We’ve been in extra innings now for a long time. In theory, we should have already peaked and there should have been a slowdown.”

However, the Twin Cities’ rent growth and vacancy rates remain strong. “If you have a sub-5 percent vacancy rate, that still suggests there’s room in the marketplace,” Mullins says. “As long as units are being absorbed, you’re going to keep seeing more and more new product. We still feel pretty good about the market. Sooner or later, we’re going to see some correction to some extent... We’re due in theory.”

Market sees insatiable investor appetite

The Twin Cities continues to attract national interest and out-of-town investors pursuing apartment deals that have healthier returns than other major markets.

“There’s no question that there are a lot of dollars chasing apartments,” Mullins notes. “You have a lot of outside capital chasing deals today… and they’re paying top dollar for the assets.”

In addition to newer product, investors are also still seeking value-add deals.

“It’s a market that checks a lot of the boxes from an institutional capital’s perspective on where they want to place capital, and that has been the reason why we’ve seen a lot of new buyers coming into the market,” Talberg says. “There are a lot of new investors and new lenders, and we expect that trend only to continue.”

Talberg says many investors consider Minneapolis like a Denver or Austin, Texas, in that it’s a core secondary market.

Also, some believe that the Twin Cities is perhaps at a later stage of the economic cycle and a good market to place their money from a long-term hold perspective.

“We’ve been trending over the past few years around $2 billion in sales volume, which is up significantly from coming out of the recession where we were a $300 million to $500 million market,” Talberg notes. “We will be around that $2 billion mark as well in 2019. But I do expect that 2020 has the potential to be a record year and surpass the $2 billion.”

2019 was another active year

It has been another busy year in the multifamily sector, says Keith Collins, executive vice president in CBRE’s Minneapolis office, specializing in the sale of apartment properties.

CBRE tracked around $1.9 billion in Twin Cities apartment sales in 2018. Collins anticipates 2019 will be closer to $1.6 to $1.7 billion.

While the market is still very strong, investment sales have dipped slightly.

“I don’t think it’s a lack of capital,” Collins says. “We still have more and more capital looking to get into Minneapolis.”

It’s more due to a lack of willing sellers and also much of the older, value-add product has sold and much has been rehabbed, he notes.

“There’s less and less of those opportunities, and as far as the merchant builds, how many true merchant builders do we have out there?” Collins asks.

He says the market has some, but it’s not like there’s an abundance of the Opuses and Ryans of the world that are selling.

Collins also says the market hasn’t likely seen enough rent growth in the urban areas to justify owners wanting to sell right away. “They haven’t seen enough appreciation, so I think that’s halting a little of the sales volume,” he notes. “All in all, it’s good. Cap rates are still strong. I think our market is very well-received.”

What investors are active?

Collins says the market will likely have 18 to 20 sales of 100 units-plus in 2019.

“Of that, pretty much all but two are out-of-town buyers,” he notes. “People want to get into Minneapolis. It used to be a little under the radar. It’s not anymore.”

He says people are well aware of the Twin Cities including all of the Fortune 500 companies and the diverse base of employment.

“We’re certainly attracting the institutions – whether it’s pension fund advisors or life insurance companies,” Collins says.

There are also many private groups seeking assets in the Twin Cities. Whether it’s a regional sponsor with an institutional partner or core funds, core-plus funds, value-add funds, they’ve been very active acquiring more of the older product.

In addition, there’s high-net-worth private capital coming in from outside of the Twin Cities as well as 1031 activity and some public REIT activity.

Market is in a ‘new paradigm’

Two or three years ago, everyone was asking what inning is the multifamily market in? Collins says.

“Now everyone just realizes that there’s a new paradigm where the market has been in extra innings and will continue to be,” he says, noting new apartment units delivered and those in the construction pipeline. There’s also a shift to more suburban development in areas that have been underserved with newer product.

“Do I see the market shutting down anytime soon?”Collins asks. “No. Is it peaking? One would certainly think that we can’t keep going at this rate, especially in the urban locations where there has been much more meaningful supply, and then just how deep is that market? If there’s one challenge, it’s you haven’t seen the dynamic rent growth in the urban locations that you’ve seen in the suburban locations.”

Collins says strong investor demand for apartment assets will continue and pricing has remained very strong across the spectrum.

“There’s going to be continued abundance of capital. That’s not going away,” he says. “The debt markets continue to be very creative. There’s always this concern about the agencies – Fannie Mae and Freddie Mac—cutting back, etc. But they seem to continue to get enough of their allotment to stay very active and relevant in our industry, and that has happened again. I think with the interest rates, the debt markets remain very attractive.”

He also points to the upcoming 2020 presidential election. Collins says there’s the “mindset that, ‘Hey, it’s a good opportunity to capitalize that,’ because there’s probably more uncertainty with the post-election next year.

“Consensus from my colleagues throughout the country is it’s going to be a very strong and active on the capital side, for sure for the first half of the year,” Collins says.