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Apartment Market Still Shines In Twin Cities Despite Surge In Development

Optimism abounds in the Twin Cities apartment market, and for good reason. It’s a top performer in the Midwest, and ranks high in the nation overall. The key indicators are compelling: low vacancies with rental rates rising; steady apartment sales; robust new development, especially in core urban and first-tier markets; and flowing pipelines.

Among 52 metropolitan areas showing the most economic momentum heading into 2014, Minneapolis/St. Paul ranked No. 14, according to the Praxis Strategy Group. Criteria included GDP growth, job growth, real median household income growth and current unemployment.

Property owners, buyers, developers and funding sources are all benefiting from a strengthening apartment market, a trend that began in 2009. Although statistics vary by source, there is consensus on future apartment trends in the seven-county metro area.

For apartment owners, a tight rental market means growing revenues, a far cry from the glut of vacant units that existed a few years ago.

Last year, vacancy rates averaged 2.8 percent, compared to 7.9 percent in 2009, according to real estate research firm Reis.

A boon for landlords, rising rents are forcing many lower-income renters out of the cities into the suburbs. Statistics show the average rent in the Twin Cities metro last year at approximately $980 — up 9 percent from a few years earlier.

Downtown rents are the highest at $1,343 on average, up almost 7 percent from the previous year.

Outside Investors Fuel Sales

Pent-up investor demand for apartments is driving sales in the Twin Cities. Even with a relatively low supply of properties on the market, the transaction volume by total dollar amount across all classes of space remained steady at about $475 million in 2013. (Low supply, in part, is linked to a strong local preference by owners for long-term hold periods.)

Out-of-state buyers are targeting strong secondary markets. According to Keith Collins, first vice president with CBRE, the firm’s apartment sales volume in the Twin Cities market reached $500 million in 2013, up from $400 million in 2012. Of that total amount, $225 million was product purchased by first-time buyers. Of the company’s 10 biggest deals last year, eight involved out-of-town investors.

The biggest transaction was Stoneleigh at the Reserve, a 361-unit property in Plymouth, a first-tier western suburb, which sold for $53 million last fall. Chicago-based Capri Capital Partners was the seller and Kirkland, Washington-based Weidner Apartment Homes was the buyer.

Other major purchases in 2013 for out-of-town investors included Lake Calhoun City Apartments in Minneapolis and Nicollet Ridge Apartments in Burnsville. Lake Calhoun City sold for $37.25 million. L&B Realty Advisors of Dallas bought the 158-unit property for $236,076 per unit.

A Philadelphia-based real estate investment trust acquired Nicollet Ridge Apartments, a 339-unit property in suburban Burnsville, for $33.1 million in December.

In a new twist, outside investors are targeting the value-added Class C market. City Limits, a 198-unit property on the southern edge of Minneapolis, was acquired last year by Colorado-based Monarch Investment & Management Group LLC for $12 million. The property generated multiple offers and was under contract within a month.

Capitalization rates remain low, ranging from approximately 5 percent for Class A properties to the mid-7 percent range for Class C product. Rising interest and cap rates are expected as the economy expands. The big question is how much and when.

Housing Supply Expands

Both Minneapolis and St. Paul are creating housing and light-rail transit to attract people and jobs. There’s an influx of new upscale, urban apartments and new transportation systems that link the cities and the suburbs. So far, absorption is keeping pace with new supply.

According to CBRE, about 4,300 units were delivered in the Twin Cities area in 2013, and 6,300 are currently under construction, with an additional 15,600 units proposed.

Minneapolis has two notable high-rise projects set for completion this year with more in the pipeline: LPM Apartments, a 36-story, $100 million Loring Park tower developed by Chicago-based Magellan; and the Opus Group’s 253-unit, 26-story Nic on Fifth.

St. Paul also is experiencing new apartment construction. The Penfield, a luxury apartment complex developed by the city, opened this February. The $62 million project includes 254 market-rate units and a full-service Lunds grocery store.

Two redevelopment projects will add 450 market-rate units downtown. The Pioneer Endicott is a conversion of three 19th-century office buildings into luxury apartments, while Custom House is the conversion of a 17-story post office into luxury apartments.

Stable Economic Vital Signs

The state’s economy is expected to continue growing, but the pace may slow slightly. Based on the recent economic outlook from the Federal Reserve Bank of Minneapolis, employment in Minnesota is expected to grow by 1.2 percent in 2014.

The unemployment rate is projected to drop from 4.6 percent in November 2013 to 4.3 percent by the end of this year. Personal income is expected to grow 5 percent.

In the apartment market, funding sources have money to spend, and the cost of funds is at historic lows. (The 10-year Treasury yield stood at 2.7 percent as of mid-February.) The lenders who retreated a few years ago have returned with renewed vigor.

There are still big challenges ahead. With low cap rates, it’s a good time for apartment owners to sell. With their buildings finally filling up and rents rising, it’s also a great time for owners to hold. It’s a dilemma that keeps product inventory in short supply, making it difficult for hungry buyers or owners wanting to exchange.

For developers, pent-up demand is still the driving force in new apartment construction. In the next few years, the balance between supply and demand may be harder to maintain. In the meantime, however, the Twin Cities metro apartment market is all systems go.

— By Tom Cooper, Broker and Founder, and Maddy Butler, Associate Broker, of Minnesota Brokerage Group. This article first appeared in the March 2014 issue of Heartland Real Estate Business magazine.

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