The Milwaukee multifamily sector is plowing forward on a number of different fronts. Development activity is continuing its impressive run with a series of high-rise towers in various stages of construction or planning. Popular neighborhoods such as Walker’s Point, Bayview and the East Side are filling in with low- and mid-rise projects, many of which feature a mixed-use component.
From an investment standpoint, multifamily is still the sector du jour, with a widening investor pool of both local and out-of-state buyers.
Matson Holbrook, MBH Investment Real Estate
Leading the charge on the development front is Northwestern Mutual’s 7Seventy7, which is currently under construction in downtown Milwaukee with an anticipated opening in summer 2018. The 34-story complex will feature 322 apartments, ground-floor commercial and 1,400 parking spaces, many of which will service employees at the company’s recently completed 1.1 million-square-foot headquarters located only one block away.
Other major projects yet to break ground but slated to reshape the skyline in the coming years include:
• The Couture — Barrett Lo Visionary Development is planning to build a 44-story tower with 300-plus units, retail and parking across the street from the planned Lakefront Gateway Plaza, which will connect the area between the Milwaukee Art Museum and the Summerfest grounds. The site for the project, which will also feature a transit stop for the new Milwaukee Streetcar’s lakefront line, has been cleared with an anticipated construction start in January 2018. Rinka Chung is the project architect.
• The Goll House — Palisade Property Management is developing a 27-
story tower with 192 units on a blufftop site overlooking Lake Michigan just north of downtown Milwaukee. Architect Kahler Slater designed the project, which will incorporate the historic Goll Mansion into the new tower’s design. The Milwaukee Common Council approved the project in September after two previous attempts to win approval.
Construction starts peak
Over the past few years, new multifamily construction has been accelerating in the region. Completions in the Milwaukee metro market are expected to peak in 2017 at over 2,900 units for the year, almost 2.5 times the number of completions tracked by the firm in 2016, according to Reis, a New York-based commercial real estate data firm. Projections for 2018 and 2019 are expected to dip to 1,387 units and 1,268 units, respectively.
Data from the U.S. Census Bureau support this projected tapering in the issuance of multifamily permits. For the most recent 12-month period for which data is available (Sept. 1, 2016 to August 30, 2017) as of this writing, the number of units for which multifamily permits were issued for structures containing five or more units was 1,672 in metro Milwaukee.
That’s a decrease of 34.9 percent over the previous 12-month period, returning to a level below the long-term average (1980 to 2016) of 1,791 units per year.
With the influx of new units hitting the market, what does this mean for apartment market fundamentals? As of the second quarter of 2017, average occupancy in the metro area was 3.7 percent, unchanged from the same period a year earlier, according to Reis. However, the data firm projects vacancy will increase to 4.5 percent by the end of 2017 with the expected second-half deliveries, which is on par with the recently reported third-quarter national vacancy rate of 4.5 percent.
The average monthly asking rent for the metro area was $977 for the second quarter, reflecting a 2.6 percent increase over the same period a year ago. The average effective rent, at $936 per month, registered a smaller gain of 2 percent during the same period, suggesting landlords offered more concessions to fill up units.
While newly constructed units are not necessarily competing with the existing Class B and C apartment stock for renters, there is some ripple effect for larger units. Dan Wilkins, a local investor and appraiser with Lauenstein & Associates, reports that older three-bedroom units are hard to rent these days, especially the more expensive they are.
This cohort of tenants may be willing to pay a little more for less space in newer units that offer better amenities. Reis data supports this notion as three-bedroom units were the only unit type to report negative rent growth for the first two quarters of 2017. On the flip side, Wilkins stated that smaller studio and one-bedroom units are easy to fill.
Investor appetite is strong
How does all this translate to the multifamily investment sales market? Investor appetite remains elevated and properties are trading as high as ever, especially those that are well managed and in good shape. Milwaukee is on the radar for out-of-state buyers chasing yield, and the prolonged low interest rate environment helps support the pricing that is being achieved. Local lenders are still offering five-year money to the most qualified buyers at interest rates under 4 percent with an 80 percent loan-to-value and 30-year amortization.
One of the main challenges in today’s market is a lack of inventory of properties for sale. Not only does this impede buyers’ ability to source deals, but it also keeps those potential sellers who would be faced with a large capital gain on the sidelines as many prefer to identify a 1031 exchange property prior to committing to sell.
For those properties that are actively being marketed, sellers’ pricing expectations are aggressive. While it is customary to see pricing guidance for Class A assets south of a 6 percent cap rate in this market, there are now Class B assets in the most sought-after locations, such as the East Side neighborhood of Milwaukee, that have asking prices/guidance in that same range.
With such aggressive pricing, transaction timeframes are stretching out, according to Ryan Sikorski, director of valuation services at Colliers International. This trend is evident in both the marketing and due diligence periods, where buyers may take extra time in underwriting to confirm feasibility.
When a deal becomes too tight, some buyers are electing to acquire the entity that owns the real estate as opposed to acquiring the real estate itself, particularly when the market value of the asset is significantly higher than the assessed value. Since a real estate transfer return is not recorded with the state in this scenario, this acquisition strategy may extend the amount of time before assessed values are reset upwards by municipalities, resulting in a longer period of low real estate taxes, which in turn support a higher net operating income (NOI).
One area of concern for the Milwaukee apartment market is the region’s employment growth trend. According to the Bureau of Labor Statistics, the Milwaukee metropolitan statistical area (MSA) lost 3,100 jobs over the one-year period ending August 2017, and five of the last 12 months registered year-over-year declines.
However, the August 2017 preliminary reading of 866,600 non seasonally adjusted nonfarm payroll employees in the MSA is still higher than the most recent cyclical peak for the month of August that occurred in 2007. Additionally, the region’s unemployment rate has improved 80 basis points over the past year to a non seasonally adjusted 3.9 percent, outperforming the 4.5 percent national unemployment rate.
Building boom downtown
Despite the mixed employment numbers, there is a palpable excitement surrounding Milwaukee and the billions of private and public investment dollars flowing into the region, especially downtown where $3.6 billion has been invested since 2005. Another $3.6 billion in projects is either under construction or proposed (including a new Milwaukee Bucks arena slated for completion in 2018).
And with Taiwanese electronics maker Foxconn Technology Group recently announcing a $10 billion manufacturing facility that will ultimately employ up to 13,000 workers in Racine County, just south of the Milwaukee MSA, the I-94 corridor that connects Milwaukee with Chicago is filling in such that it will soon be difficult to pinpoint where Chicago ends and Milwaukee begins.
While interest rates remain low, expect more Chicago and out-of-state buyers to be active in the Milwaukee investment market in the short term, providing support for the pricing levels that have already been achieved here. Additionally, seasoned local investors who have been through multiple investment cycles may sit on the sidelines and let younger investors stretch to do deals as they look to build portfolios.
A decline in the issuance of multifamily permits may keep development in check down the road, but will that be enough for the new supply coming on line to fully stabilize in line with developers’ lease-up pro formas?
Stay tuned.
— By Matson Holbrook, Principal, MBH Investment Real Estate LLC. This article first appeared in the November 2017 issue of Heartland Real Estate Business magazine.