Market Insights

By: Brad Dulas

Despite a new construction pipeline indicating developers will deliver a wave of apartment properties to the region over the next several years, conditions in the Twin Cities apartment market remain tight, as healthy demand continues to support improving operating fundamentals. According to REIS, developers added 1,279 units to the local apartment inventory in 2012, up from 477 units delivered in the year prior and 437 units reaching lease-up in 2010. Further signaling an increase in new apartment construction in the area, multi-family construction permits were issued for 5,719 units in 2012, up significantly from the 1,368 units permitted in 2011. Although new construction activity continues to ramp-up, healthy apartment demand has fostered tight occupancy levels and a solid pace of rent growth throughout the region. According to REIS, average asking and effective rents in the Twin Cities apartment market increased year-over-year by 3.2 percent and 4.3 percent, respectively, at the close of 2012. In near lock step, the average apartment vacancy rate decreased by 20 basis points during this same time period, falling from 2.6 percent in December of 2011 to 2.4 percent in December of 2012.

Some market observers speculate the anticipated wave of new construction could result in softer market conditions, particularly within the core and inner-ring submarkets. Occupancy levels in the local apartment market, however, are among the highest in the nation, and vacancy rates in the Twin Cities apartment market have remained resilient in the face of macroeconomic headwinds over the last several years, barely exceeding the market equilibrium of 5.0 percent even at the peak of the recent economic downturn. While average vacancy rates may tick upwards within some submarkets in the near-term as a result of the surge in new construction activity, we believe the local apartment market has the wherewithal to weather the storm in a reasonably impressive fashion. Factors indicating the local market will remain strong include the steady stream of apartment demand supported by broad-based employment growth, encouraging demographic trends, and the region’s relatively youthful population. Moreover, recent gains in the local for-sale residential sector are likely to keep some potential buyers from entering into homeownership. According to the National Association of Realtors, the median single-family home sale price in the Minneapolis-St. Paul Metropolitan Area increased by 15.7 percent over the year ended in the fourth quarter of 2012, reaching $175,300 at the close of 2012. In comparison, as of the fourth quarter of 2012, the median single-family home sale price in the Chicago Metropolitan Area stood at $167,400, while the median home sale price in the Kansas City Metropolitan Area was recorded at $146,600. As sale prices in the for-sale residential sector increase, more entry-level buyers will be unable to afford or qualify for a home mortgage and remain in the renter pool as a result.

Tight market conditions and an overall positive market outlook have encouraged a high level of investment interest and activity in the Twin Cities apartment market. A relatively robust pace of sales transactions showed no indications of waning in the final six months of 2012 and through the first quarter of 2013. On an annual basis, according to transactions tracked by Shenehon Company, sales volume for 50+ unit market-rate apartment properties in the Twin Cities increased by 23.4 percent in 2012, while the average price per unit increased by 14.4 percent during this same time period, reaching nearly $90,000 per unit. Although cap rates may pull back slightly for lower-tier product, investor appetite for multi-family assets in the greater Twin Cities region is expected to remain essentially unchanged, through the near-term, due to attractive financing opportunities and strong market fundamentals. A bullish outlook from investors is likely to keep cap rates in the low- to mid-5 percent range for the most desirable assets with quality Class B and C assets trading at rates between approximately 50 to 150 basis points higher. Rising building costs are also forecasted to help maintain a comparatively low cap rate environment in the market, preventing sale prices on a per unit basis from bumping up against replacement cost.