Apartment Finance Today

Regional Markets

Midwest

Holding Their Own

APARTMENT FINANCE TODAY • May/June 2010

The Minneapolis/St. Paul apartment market is stabilizing as improving fundamentals breed optimism for the future of the Twin Cities.

BY Tom Cooper and Harold Teasdale

About Face: Despite the Twin Cities’ decline in transaction volume, Kilkenny Court Apartments, a 92-unit seniors housing complex in Forest Lake, Minn., a suburb of St. Paul, was acquired for $5.2 million and underwent a major rehab that was completed in December 2009.

Photo: Minnesota Brokerage Group

AS IN MUCH OF THE NATION, the Minneapolis/St. Paul apartment market shifted dramatically during the past few years. Gone are the golden days of skyhigh appraised values and inflated asset appreciations.

But the Twin Cities area is holding its own, even in a weak economy, posting healthier fundamentals than many comparable markets. Minneapolis is one of four cities showing “relatively strong” fundamental market drivers—mortgage default rates are below the national average and the local job market is likely to outperform the country, according to New York-based research and risk analysis firm Moody’s.

The health of the apartment market compared to the country overall—and the Midwest in particular—can be attributed to a number of factors. A diverse economy with a strong concentration of large employers— including 20 Fortune 500 companies—as well as fewer new apartment units hitting the market, factor heavily into the equation.

Slow and Steady

Job loss and wage freezes conspired to make 2009 a tough year, but the numbers are improving. The Twin Cities finished 2009 better than it started, with unemployment at 7.4 percent, well below the national average of 9.7 percent. And job growth is expected to pick up significantly next year, with a 2.6 percent increase in employment, followed by a 3.4 percent increase in 2012, according to New York-based market research firm Reis.

The Twin Cities’ diverse economy continues to attract strong, steady population growth, even during the recession. In fact, the area’s household count is expected to rise 1.2 percent this year, and another 1.6 percent next year, according to Reis. And with the Echo Boomer demographic (those between 25 and 44) poised to drive demand, occupancies are expected to accelerate as the economy improves.

Still, the apartment market remains challenging. The Twin Cities’ vacancy rate ended 2009 at 5.4 percent and is expected to tick up slightly this year before declining again in 2011, according to Reis. Rents are flat, especially in urban and older, close-in suburbs, or declining slightly in outlying areas, dropping about 1.5 percent overall in 2009.

Average rental rates in the Twin Cities metro area showed a slight decrease of 0.7 percent from $875 per month to $868 in 2009. Annualized rent gains were highest in or near the cities. Rent reductions are expected to continue this year, but concessions are expected to be relatively modest. And the good news is rent growth is expected to climb 1.5 percent in 2011, plus an additional 2.2 percent in 2012, according to Reis.

Shrinking Investor Pool

Despite these positive indicators, there’s been a significant drop-off in transaction velocity. The Twin Cities saw only $180 million in apartment transactions in 2009 compared to a 10-year annual average of more than $400 million, according to Los Angeles-based real estate services firm CB Richard Ellis. In fact, there were only 69 qualified transactions in 2009, a 59 percent decrease from 2008, reported The Hawthorne Group, an Edina, Minn.- based multifamily brokerage and market research firm.

Tom Cooper (left) and Harold Teasdale are the founders of Minneapolis-based Minnesota Brokerage Group, which specializes in apartment sales primarily in Minnesota.

The number of active investors has shrunk, and those still in the game are generally long-term experienced ownerswho now have the market to themselves. But transactions are taking more time to close these days as buyers and sellers engage in a kind of stand-off—the first waiting for a drop in sale prices, and the latter waiting for the market to finally bottom out.

The lender pool is shrinking, too. Traditional sources for financing apartment properties have mostly retreated in the Twin Cities metro market. The banks that are still active are applying more stringent lending standards and requiring more security. Tighter lender scrutiny on both the sponsor and the asset is expected to continue for the foreseeable future.

Community banks, for short-term loans, and agency lenders such as Fannie Mae, Freddie Mac, and the Federal Housing Administration are the most active in the apartment market. And there is still considerable funding to be tapped from state and local agencies targeting energyeffi cient building improvements.

Metro Market Picks Up

Local observers appear cautiously optimistic about the economic outlook and the apartment market overall. Things are expected to get better soon—a small breakthrough during the second half of 2010 seems to be the consensus. What’s more, the state has started adding jobs again—a total of 15,600 in January.

Additionally, new apartment construction is resurfacing in the cities—four new projects received permits in Minneapolis already this year. In fact, permits for 432 units were issued for multifamily developments in the Twin Cities in the fourth quarter of 2009, nearly double the amount in the fourth quarter of 2008.

While an influx of newly constructed apartments may not be ideal for owners of existing buildings, it speaks to the growing confidence among the multifamily industry here. And that bodes well for their twin futures.