HEARTLAND SNAPSHOT, JULY 2006

Minneapolis/St. Paul Multifamily Market

The pendulum that swung in favor of home ownership in the past few years is now beginning to swing back toward the multifamily rental market. As the federal government continued its measured rate increases, rental demand began to pick up as consumers found mortgage terms — not to mention higher home prices — beyond their means or not as economically feasible as renting.

The economic recovery and the corresponding stronger job market also support a stronger multifamily market. This holds especially true for affordable and mid-market apartments that attract recent college graduates beginning their careers and working-class families.

When interest rates reached record lows during the first quarter of 2004, multifamily vacancy rates climbed to 7.4 percent, the highest level in the past 4 years. Since then, the Minneapolis/St. Paul multifamily market has rebounded strongly, with vacancy dropping to 6.9 percent during the first quarter of 2005 and then declining to 5.5 percent by the end of this year’s first quarter. Moving forward, the multifamily market should hit a vacancy rate of 5 percent by late summer or early fall.

As the picture improves, owners are beginning to see real rent growth. While rent concessions still prevail in some of the softer suburban markets, this is becoming the exception rather than the rule. Improving demand fundamentals also point to modest rate increases in the affordable and mid-level markets.

At the same time, developer interest in the conversion market has peaked and new condo development has slowed. In the downtown Minneapolis market, many developers will soon face a key decision on their proposed condo developments — whether to build as condos or rentals.

Improving demand conditions will lead to steady absorption as more young professionals look to rent instead of buying.

Developers are looking at the southwest and northwest markets of the metro areas, as well as along the Hiawatha Light Rail Line and further out toward St. Cloud, Minnesota. Job growth in these sectors among young professionals presents opportunities, and easy access to mass transit provides another advantage.

Overall, average rent measures $855 across the market, which was slightly ahead of last year’s first-quarter average rent of $850. As expected, rents vary widely by product, with studio apartments renting for an average of $596, one-bedroom units going for $736, two-bedroom units averaging $931, and three-bedroom units at $1,231.

The lower and middle-tier properties in the market continue to fare well, with vacancy rates as low as 5 percent for studio apartments and 6.1 percent for two-bedroom units. And while product is much more limited on the upper end, luxury developments are still attracting renters. As an example, three-bedroom units that feature a den rent for an average of $1,464, but have the lowest vacancy rate of any product-type at 3.3 percent.

By area, Anoka County is the strongest market. The northern suburban area has only a 3.9 percent vacancy rate with average rents of approximately $800. Ramsey County, an area that includes downtown St. Paul, is close to the market’s average with a 5.4 percent vacancy and average rents of $795. Carver County in the southwestern suburbs has the highest vacancy rate at 8.7 percent, with the lowest average rent of $663. In the northwest suburban market, Washington County has the highest average rent at $926, with a vacancy rate of 7.6 percent.

Investors have been active in purchasing properties during the past year. We expect interest to remain keen as the multifamily market continues to tighten and development remains limited. Institutions in particular are trading properties sooner to capitalize on historically low cap rates, which are trending upwards with interest rates.

— James M. McCaffrey, senior vice president and principal, Gina Dingman, vice president, and Julie Lux, investment services specialist, specialize in multifamily investment sales and acquisitions in Colliers Turley Martin Tucker’s Minneapolis/St. Paul regional office.

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