Twin Cities remains a strong draw for apartment developers

Developers are on track to build a near-record number of rental apartments in the Twin Cities.

Through September, 3,920 new units have hit the market, 10 percent more than last year, according to a third-quarter report from Marquette Advisors. That doesn't include more than a dozen rental projects reviewed Tuesday by the Minneapolis Planning Commission, including a pair of high-rise towers and a half-dozen midsize buildings.

That flurry of new projects will help make 2018 what is expected to be the second-busiest year for apartment construction on record despite growing concerns about the depth of demand in some areas. To date, 2014 was the record with 4,451 new units.

"The mood is cautiously optimistic," said Matthew Rauenhorst, vice president and general manager with Opus Development Co., which recently completed a luxury high-rise in downtown Minneapolis and is about to break ground on a luxury apartment building overlooking the Mississippi River.

Rauenhorst said that leasing progress has exceeded expectations at 365 Nicollet, the downtown high-rise.

He cites a healthy local economy and strong job growth as the primary drivers of additional demand, but a fully loaded pipeline of new proposals is reason for caution.

"How many of these proposed projects will get built and when will they get built?" he said. "We will have to wait and see."

So far, the market has remained resilient. Throughout the seven-county metro area, the average vacancy rate was 2.3 percent at the end of September, up slightly from the previous quarter, but lower than a year ago, according to Marquette Advisors.

Factoring in properties still in lease-up, the adjusted-vacancy rate was up slightly month to month and year-over-year to 3.3 percent. The market is considered balanced between buyers and sellers when the vacancy rate is at 5 percent.

With vacancy rates still relatively low, rents are on the rise in some areas. Across the metro the average monthly rent rate was $1,188 during the third quarter, almost 3 percent higher than last year.

That annual gain is smaller than it has been in previous quarters, suggesting a gradual rebalancing of the market.

"The slowdown in rent growth relates to increasing competition and large numbers of units coming to market later in the year, when we typically experience a seasonal slowdown in leasing activity," Marquette's Brent Wittenberg said in a report. "Overall, the market remains quite healthy."

Apartments are no stranger to the city's monthly planning agendas, but the latest lineup includes a bumper-crop of midsize buildings, many of them pitched by Minneapolis-based North Bay Cos. and DJR Architecture.

Gina Dingman, president of Everest Real Estate Advisors, said a variety of factors are driving construction of smaller buildings. Those include more-permissive parking rules for smaller buildings, especially those in areas with mass transit, and a growing scarcity of parcels that are suitable for larger buildings.

"And the price of dirt is just going up," Dingman said.

One of the biggest residential projects that received approval this week is a 17-story apartment tower with 205 units that is being developed by the Wilf family at 240 Park Avenue.

Construction is expected to begin in March. That building will have first-floor retail and an innovative recessed "lanai" on the sixth and seventh floors that will serve as a covered space for residents but appear from the exterior as a notch in the corner of the building.

As far as construction patterns go, the Twin Cities is bucking a national trend. Federal data show that multifamily building permits across the country have fallen each month since March, suggesting a construction slowdown in the apartment sector over the next couple years.

"It's a pretty positive story in the Twin Cities," Dingman said.

She said investors shopped hard and spent big money on apartment buildings in the Twin Cities, signaling deepening confidence in the health of the market. According to a November market update by Everest, building sales in the Twin Cities spiked during the third quarter after a quiet second quarter: More than 20 properties changed hands, generating $687 million in sales volume.

Marquette Advisors said that during the first nine months of the year renters occupied an additional 3,462 vacant units, which is just shy of the full-year absorption rate in 2017.

Some submarkets are beginning to soften. In some areas, leasing activity is slowing, vacancy rates are on the rise and property managers are offering one-time inducements to encourage renters to sign a lease. Those concessions are often a discount on the first month's rent, a lease-signing bonus or gift cards for nearby retailers.

Many of those concessions are being offered to fill units before the full onset of winter when rental activity always slows. All eyes are now on downtown Minneapolis, where construction has been the most robust, developers are most concerned and rents are the highest. The average rent in that submarket is $1,728, which is now 6.7 percent higher than it was last year. The average vacancy rate is 3.5 percent — a stunningly low figure considering how many new units have been built. But when you factor in the more than 1,200 new units opening so far this year, the true vacancy rate is 8.4 percent.

With the exception of Bloomington, where the average vacancy rate was 15.5 percent, the vacancy rate of existing buildings ranges between 1 and 3 percent, which is why developers have largely shifted their focus to second- and third-ring communities.

Jim Buchta • 612-673-7376