Despite apartment building boom, it's still a landlord's market

Several years into an apartment construction boom, it's still a landlord's market across the Twin Cities metro.

Throughout the 13-county Twin Cities metro the average apartment vacancy rate during the second quarter was 2.7 percent — virtually unchanged from last year and the fifth year that vacancies have remained below 3 percent, according to the Twin Cities office of NAI Everest, a national commercial real estate firm.

At least as far as demand, the Twin Cities is outperforming much of the nation. Across the U.S., the vacancy rate was nearly twice as high and has increased for three consecutive quarters. Rents in the Twin Cities, however, have been rising at a much more moderate pace than many of those biggest metros. The NAI report said the average rent across the metro increased only 2.19 percent to $1,085, a figure that includes both income-restricted apartments as well as traditional market-rate buildings.

Rents are on the rise across the region despite the appearance of rental concessions in some parts of the metro that are showing signs of at least temporary saturation. Since 2010 more than 16,000 new units have come to market, and while construction activity this year has slowed, the lull isn't expected to last — another boomlet is on its way.

"This is a cyclical business and we tend to build until we overbuild, but it's difficult to know when we'll hit the end of the cycle," said Gina Dingman, president of NAI Everest.

There are now nearly 40 market-rate developments with about 6,500 units under construction and expected for delivery by the end of 2017, Dingman said, and an estimated 14,000 units have been proposed and are at various stages of the planning process, not including a couple thousand units that were announced just last month.

While apartment construction in downtown Minneapolis, which had the highest average rental rate ($1,593), hasn't evaporated, the development boom is shifting to first- and second-ring suburbs where there's deep demand, an abundance of building sites and a dearth of options for renters.

Several significant apartment projects have recently opened or broken ground in Bloomington, Edina and St. Louis Park. For now, the lowest vacancy rates in the metro continue to be in the eastern and southern suburbs. The weakest market was in downtown St. Paul, where 1,364 units have been built since 2011, with another 1,831 units planned or proposed. The overall vacancy rate there was 7.3 percent.

Because downtown Minneapolis has been ground zero for apartment construction since the recession, all eyes are on that market and surrounding neighborhoods, including Uptown, for signs of weakness. Though downtown Minneapolis continues to see the strongest demand and number of units delivered — 4,135 units were built since 2013, the average vacancy rate actually fell from 5.8 percent last year to 4.7 percent during the second quarter. During this same period, rental rates increased 2.29 percent from $1,238 to $1,320 per unit.

Most of that downward pressure on the downtown vacancy rate is the result of a deep shortage of inexpensive rentals. The vacancy rate for affordable rentals in downtown was just 2.2 percent compared with a market-rate vacancy rate of 8.3 percent.

The second phase of the Edition in the burgeoning East Town neighborhood near the new Vikings stadium opened in mid-July and 133 of the 195 units are now leased.

"The traffic continues to be positive, especially with the completion of the Commons and the stadium," said Jennifer Gordon, senior vice president for the Excelsior Group.

She said that market surveys are showing that an increasing number of properties are offering concessions, but she's still seeing healthy rent growth over one to two years ago.

Dingman said right now some of the most vulnerable areas are parts of Edina, St. Louis Park and Golden Valley where several projects are expected to open at around the same time. The Uptown neighborhood in Minneapolis, which saw 1,200 units come to market in one quarter, has already experienced some weakness.

Despite those concerns, Dingman said the apartment market in the Twin Cities is considered far more stable than many others, including Denver, where upward of 10,000 units are being built every year.

That's why the Twin Cities continues to be the darling of the investment community. Abe Appert, senior vice president for CBRE, said the region is on track to break another apartment sales record.

So far this year, there have been nearly $800 million in apartment sales, and he expects 2016 to top out at $1.2 billion in sales, besting last year's record by at least 20 percent.

He said that national investors are still leading demand, and that eight of the last 12 deals over $25 million have been consummated by first-time buyers in this market.

Jim Buchta • 612-673-7376