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Strong occupancy throughout the Minneapolis metro area is driving construction activity, and developers are hurrying to get projects off the ground ahead of competitors.
Leasing activity is underway for a number of luxury high-rise projects coming on line in the city, heightening competition for renters who desire and can afford top-end amenities.
Projects in vibrant locations, such as the Mill & Main Apartments across the river from downtown Minneapolis, have been well received. The Mill & Main building, which is nearly 70 percent leased, has views of the Mississippi River and downtown.
New luxury apartments are attracting many nontraditional first-time renters, such as empty nesters. This trend is likely to expand the renter pool across the area as recovering housing prices give the large baby boom cohort more options when selling and downsizing. The higher rents that luxury properties command have reset the bar for Class A rents. Existing Class A properties near top-tier apartments will likely benefit because they can raise rents and remain more affordable than the newer units.
Development Pipeline
Nearly 3,000 apartments have been delivered in the metro area during the past 12 months, including 2,100 market-rate units.
So far in 2013, approximately 1,000 rentals have come on line. The planning pipeline includes more than 12,000 apartments with nearly 1,400 units scheduled to begin construction by year’s end.
Developers are slated to complete 4,000 market-rate seniors, student and affordable rentals metro-wide in 2013, resulting in a 1.6 percent increase in total inventory. The largest portion of the units will be delivered in Minneapolis.
Despite the wave of new inventory, the vacancy rate market-wide has dipped 80 basis points to 2.4 percent year to date as of the second quarter.
The lowest vacancy in the metro area is in the Minnetonka submarket at 1.8 percent, down 40 basis points year over year. Increased demand for rentals near major employment hubs along Interstate 394 and Interstate 494, coupled with a relatively stationary supply, has pushed vacancy down.
A flood of new deliveries and properties entering initial leasing in the Downtown Minneapolis/University submarket has boosted vacancy in the area 50 basis points during the past four quarters to 2.6 percent.
Vacancy metro-wide will likely continue to move upward, and year-over-year vacancy is expected to rise 80 basis points to 4 percent by the end of 2013 as new units come on line and rising home sales increase competition for renters.
Last year, 2,368 rentals came on line. The vacancy rate at the end of 2012 registered a tight 3.2 percent.
Rejoicing Over Rents
The strong demand for apartments and the addition of new luxury apartments with high-end amenities drove rents up 4.3 in the second quarter on a year-over-year basis to $1,010 per month. The downtown Minneapolis/University submarket, where many of the new luxury units are located, recorded the highest effective rents in the metro area. Here, the available effective rents averaged $1,315 per month, rising 5.1 percent during the past four quarters.
The North Minneapolis submarket boasts the most affordable rents across the metro area, averaging $860 per month. With vacancy at a miniscule 2.1 percent, operators have room for additional rent growth.
Continued demand for rentals throughout the metro area is expected to result in a 5.2 percent hike in available effective rents to an average of $1,032 per month by year’s end. In 2012, effective rents rose 2.5 percent.
Investor Challenges
The expanding economy in Minneapolis-St. Paul has attracted apartment investors, but with few quality listings available many buyers are left waiting on the sidelines. Apartment vacancy in the metro area is at one of the lowest levels in the nation, which provides owners with little incentive to divest.
High construction output and rising home sales, however, will require extra effort on the part of operators to attract and retain tenants in many areas of Minneapolis-St. Paul.
As more operators are forced to offer concessions, additional owners will consider listing their properties while buyer demand remains strong. This scenario will most likely occur among Class A properties in areas with a large volume of units underway, or in affordable suburban locations where more renters are likely to become homeowners.
Cap rates for top-tier properties are stable in the low- to mid-5 percent range and extend into the mid-6 percent area for Class B assets.
— Craig Patterson, regional manager, Minneapolis office, Marcus & Millichap Real Estate Investment Services