The Archive apartments opened in mid-2021 in the North Loop neighborhood of downtown Minneapolis, where vacancy rates are still above the metro-area average. Though the occupancy improved slightly in the area, rental concessions aimed at wooing renters are still more prevalent than normal. (Brian Peterson | Star Tribune/The Minnesota Star Tribune)

The rental market in the Twin Cities rallied last year, boosting rents slightly and the prospect of another year of robust construction for apartment developers.

The number of occupied rentals in the Twin Cities metro increased by a record 8,900 apartments during 2021, including those in new and existing buildings, according to Marquette Advisors.

The company, which tracks market-rate rentals throughout the seven-county metro, said that was the best year on record for apartment absorption in the Twin Cities market, eclipsing the previous high of 6,400 units in 2010.

"I'm not surprised by the positive trend, but the actual number of units absorbed certainly exceeded our expectations," said Brent Wittenberg, vice president at Marquette Advisors.

For the metro as a whole, rents rose only modestly. The average rent at the end of year was $1,354, a 2.5% increase from the end of 2020.

Vacancy rates declined to 3.6% during the fourth quarter of 2021 from 4.4% a year earlier. Including new buildings still in the initial leasing phase, the vacancy rate was slightly higher at 4.8%.

The report doesn't include senior or income-restricted housing, which has been in critically short supply. There are now years-long waiting lists for many low-income rentals.

Wittenberg said demand for rentals was concentrated mostly in the suburbs, but even beleaguered landlords in the central cities where apartment openings were elevated last year saw modest gains.

In the suburbs, the vacancy rate during the fourth quarter fell to 3.0%, from 3.8% a year earlier.

In Minneapolis, the vacancy rate fell from 6.2% to 4.9%. And in St. Paul, the vacancy rate fell from 5.5% to 4.8%.

Wittenberg attributed those gains to an increase in household formation that's in part a result of household "debundling," meaning people who moved in with family during the pandemic are moving out and looking for housing.

Job growth has also improved, he said, bolstering in-migration to the Twin Cities.

Rental owners are also seeing demand from would-be home buyers who aren't willing to compete in an extremely tight single-family housing market.

The decline in the vacancy rate is good news for some property owners, many of whom offered rent concessions last year. In the suburbs, those concessions have largely evaporated, but they're still being offered in some downtown buildings.

Yardi Matrix, which tracks rental markets across the country, said that during January annual rent growth in the Twin Cities was the lowest in the nation at 5% compared with a national increase of 13.9%.

In the Twin Cities metro, rent gains varied dramatically by submarket. In Minneapolis, rents were up 4% during the fourth quarter, but in St. Paul they were flat.

In downtown Minneapolis, where the vacancy rate declined slightly to 6.4%, average rents were up 2.4%. In downtown St. Paul, the vacancy rate was 8.3%, and rents declined 1.3%.

"We're still seeing two months free throughout downtown, with historically high vacancy rates," said Curt Gunsbury, CEO at Solhem Companies, noting that rent growth in the Twin Cities remains way below the rate of inflation.

The company recently opened the Archive apartments in the North Loop neighborhood in downtown Minneapolis, and just down the street the company is converting a historic riverfront warehouse into the 724 Lofts.

"I'm hopeful that downtown will soon get back above 50% of office workers returning," said Gunsbury. "That will be a game-changer."

This year, Wittenberg expects 10,000 to 11,000 new market-rate units to be delivered. With downtown markets still soft, he expects 70% of those planned units to be built in the suburbs where Gunsbury is developing The Fred, a 408-unit rental project on the site of the Pentagon Park office complex in Edina.

There are, however, unpredictable headwinds for developers this year. Wittenberg said rising construction costs, supply chain issues and public policy decisions, including inclusionary zoning and rent control, are major concerns among most developers.

"I think developers remain confident in demand-side fundamentals in the Twin Cities market," he said. "But they, along with investors and lenders, are much more concerned about issues that make development much more challenging."

Mary Bujold, president at Maxfield Research, prepares market reports and feasibility studies for developers. Generally, she said, the mood among developers has been very positive except for the significant increases that they are seeing in construction costs and concerns about interest rates rising in the short term.

That could mean a slight decline in the development pipeline for 2022, she said.

"Most developers that I talk with are trying to determine how they are going to get projects done given the hard and soft costs as posted against what they can charge in rents," she said.