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Influx of Supply Begins to Impact Minneapolis Multifamily Market

Development plans call for 158 apartment units and 22,716 square feet of retail space at Second & Second Apartments in Minneapolis.

Like several other markets across the country, the Twin Cities is experiencing the peak of the post-recession construction cycle. However, the traditionally tight multifamily market is in one of the best positions to absorb new units. In fact, Minneapolis-St. Paul has consistently reported one of the lowest vacancy rates in the nation due to a strong economic base and pent up demand for new units.

Metro Minneapolis is the second-largest economic center in the Midwest and the local economy has grown at an average of 3 percent over the past five years, a healthy rate in the Midwest. The 18 Fortune 500 companies headquartered in the area are a significant driver of job growth and rental demand, along with the hundreds of support firms.

Chris Collins, Marcus & Millichap

As a result, the unemployment rate is below 3 percent and among the lowest in the nation. Despite a lack of available talent, employers managed to create 30,600 jobs in the year-long period ending in the second quarter. Overall, payrolls expanded by 1.5 percent during that time.

Employment growth is encouraging development across several sectors in the market. In South Minneapolis, construction along the Blue Line is taking shape as $300 million in projects are coming out of the ground. Additionally, 1,000 housing units are planned near the route.

Lund Real Estate Partners is planning a 19-story, 186-unit apartment building in the southwest Minneapolis suburb of Edina. The project is estimated to cost $75 million.

Along the Green Line, Ryan Cos. and Luigi Bernardi are developing The Eleven, a 39-story condominium tower. Groundbreaking is anticipated to occur by year-end, and completion is slated for the second half of 2020.

Evan Miller, Marcus & Millichap

The influx of development increased apartment stock by 1.6 percent during the past year. Through the end of this year and into 2019, new units will test apartment demand. Thus far, the completion of additional apartments has done little to impact market-wide fundamentals.

Overall, the apartment market is on solid footing and only select areas and property classes are at risk of softening from heightened completions. By year-end 2018, vacancy is projected to inch up to 3.2 percent. As conditions remain tight, apartment operators will have sufficient leverage to raise effective rents 6.1 percent, one of the highest increases in the nation.

Which assets perform best?

Although overall apartment fundamentals are among the healthiest in the nation, some sectors will outperform. Pre-1970s vintage assets boast vacancy below 2 percent, which supported effective rent growth of 3.8 percent over the last 12 months. Many of these older properties are in core locations and residents have few other housing options. Apartments developed in the 1970s are also outperforming due to high demand. Vacancy at these properties was 2.1 percent in the second quarter, while effective rents jumped 4.3 percent.

Abe Roberts, Marcus & Millichap

At newer properties, the impact of new construction is beginning to become apparent. Apartments developed since 2000 have the highest vacancy rate at 4.4 percent. This category is also the only one that posted an increase in vacancy over the past 12 months. Going forward, the introduction of new units will continue to apply pressure to occupancy levels until the construction cycle winds down and new properties are stabilized. Developers appear poised to keep supply growth elevated well into 2020 and could add additional projects to the pipeline if vacancy remains manageable.

Nonetheless, apartment construction has been concentrated — and will continue to be focused — in select submarkets, limiting the threat of competition for most apartment operators. The Downtown Minneapolis/University and Uptown/St. Louis Park submarkets have received one-third of the new inventory completed in the past three years, and these areas have the largest share of planned and underway apartments. Both of these submarkets have sub-5 percent vacancy rates, highlighting apartment demand within the core, though limiting rent increases have encouraged absorption.

Investor concentrations

Although the wave of new amenity-oriented supply in the urban core has supported strong rent growth in the past, suburban submarkets have begun to carry the rent-growth mantle. Improving demand in less-developed suburban submarkets where availability is minimal is fueling market-leading gains. This is particularly true among older stock. The average effective rent for a Class C apartment is now only $200 less per month than a Class B unit.

In the investment arena, the distribution of transactions across property classes has remained consistent over the past five years. Over two-thirds of deals involve Class C properties, with an average going-in cap rate in the mid-6 percent range and price of $110,000 per unit.

Investor interest in the West Bank/Central Minneapolis submarket has notably improved over the past two years. Since June 2016, this area has led all other submarkets in sales velocity. When possible, buyers are acquiring older, value-add opportunities at an average sales price of $86,000 per unit, about $40,000 less than the market average. Out-of-state investors, meanwhile, are recently showing more interest in Class A and B assets.

— By Chris Collins, Evan Miller and Abe Roberts, Associates, Marcus & Millichap. This article originally appeared in the September 2018 issue of Heartland Real Estate Business magazine.

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