HEARTLAND SNAPSHOT, JANUARY 2009

Milwaukee Multifamily Market

Fundamentals in the Milwaukee apartment market are forecast to soften this year as elevated deliveries and ongoing job losses place upward pressure on vacancy. In 2008, developers completed the most new units in a decade, the majority of which will be located in the City East and City West submarkets.

As a result of this influx of new stock and the shadow rental market from new condominium projects that are converted to rental units, downtown apartment properties will likely record weaker performance than in recent years. Renter demand is anticipated to be strongest in the outlying areas of Waukesha County, Greenfield and Oak Creek, which have benefited from urban flight patterns and limited competition from new construction during the past 3 years. These trends are forecast to continue through the year, strengthening suburban fundamentals, particularly in the Class B and Class C segments.

The local market is undergoing a shift to a service-based economy, but the change has been slow to gain momentum. As such, Milwaukee-area employers are forecast to trim 12,000 positions this year, cutting payrolls by 1.5 percent. In 2008, 22,400 jobs were eliminated in the metro area. Approximately 700 apartment units are expected to come online this year, a 0.7 percent addition to local inventory. Last year, developers completed 363 units. Vacancy is forecast to raise 60 basis points to 5.2 percent this year due to increased construction activity. In 2008, when deliveries were modest, vacancy pushed 50 basis points higher.

Asking rents are anticipated to gain 1.9 percent to $865 per month this year, while effective rents rise 1.6 percent to $827 per month. Continued employment growth and limited construction activity along Interstate 94 in the Cudahy/South Milwaukee/

Oak Creek submarket may provide investors with the potential for long-term revenue growth.

The expectations gap continues to affect transaction velocity; however, unlike other Midwest markets, buyers will likely have to increase offers to obtain properties. Owners have recorded strong returns during the past 2 years and have been reluctant to offer discounts. As such, cap rates, which are currently in the low-to-mid-8 percent range, should remain relatively stable this year.

Buyers seeking distressed listings will likely be disappointed, as vacancy is expected to stay fairly tight and very few properties were financed using overly aggressive underwriting in recent years. Suburban Class B and Class C assets could garner the most interest, as fundamentals in this segment are forecast to outperform those in the metro area’s top tier in the near term.

Economic and demographic trends support a positive long-term outlook for apartments. In stark contrast to just a few years ago, mortgage underwriting standards are tight and first-time homebuyer programs are scarce, reducing attrition from the renter pool. Even higher-quality borrowers are facing tougher mortgage standards, with approximately 70 percent of banks tightening requirements for prime mortgages in recent quarters.

At the same time, echo boomers — totaling roughly 70 million U.S. residents — are entering their prime renting years, a trend that will continue during the next 5 to 10 years. On the supply side, construction starts are declining rapidly for all types of residential units, which should translate into a quick recovery for apartment vacancy and rents once economic expansion and job growth return.

— Matthew Fitzgerald is the regional manager of the Milwaukee office of Marcus & Millichap Real Estate Investment Services.

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