Apartment Market Continues to Rebound

• Vacancy rates are declining
• Landlords in stronger submarkets are pushing rents
• Apartment market benefits from languishing for-sale housing/condo markets; condo-to-rental conversions is a trend to watch 

A lack of new construction, foreclosures forcing homeowners back into renting, increasing interest rates and projected job growth are adding up to a Twin Cities apartment market that is on the mend.

Physical vacancy dropped to 4.4% in the first quarter from 5.5% one year earlier and a high of 7.4% in 2004. Even more impressive is economic vacancy—reflecting free rent and other concessions—, which dropped to 7.7% from 11%.

The Southwest and Northwest submarkets lead the recovery. Cities reporting vacancies in the 3-5% range include Bloomington, Burnsville and Brooklyn Park. Downtown Minneapolis reported a respectable 5.2% vacancy. The East submarket also saw improvements. Meanwhile, some pockets struggled. For example, downtown St. Paul’s vacancy was 10.5%.

Tighter overall vacancies means landlords are pushing rents. Average rent was $876—up 2.4% from one year ago. Rents rose in Plymouth, Eagan, Roseville and downtown St. Paul. Units most in demand were those priced $1,101-$1,200 per month, reporting 3.1% vacancy, down from 6.3%. Luxury units—priced higher than $1,500—however, saw vacancies increase to 12.5% from 8.8%.

Shifting Back to Rentals

Fewer renters are leaving apartments for homeownership. Sales of existing single-family homes/condos nationwide dropped in May to the lowest level in four years, reported the National Association of Realtors. Housing is impacted by large inventories and lenders tightening lending standards.

Development Pipeline Slows

Only 500-600 new units will open in 2007. Generally, rents are not high enough yet to justify land and construction costs for new units. There’s also a lack of multi-family-zoned sites. Few markets are at the point to support development; however, niche projects are planned for high-demand submarkets like Woodbury. The impact of unsold condos being converted to rentals and competing with apartments is a concern.

Renovations Occurring

With constraints on new development, more landlords are renovating existing properties. Previously, they renovated to maintain occupancy. Now they’re discovering renovations can mean higher rents and more revenue. Laramar Group, for instance, purchased International Village in Bloomington with plans for a major, $8 million renovation.

Strong Investor Demand

Improving vacancies, increasing rents, diminishing concessions, anticipated job creation and limited new construction are attracting investors. Real Capital Analytics reported local sales of 2,788 units totaling $226,402,000 in value since Jan. 1.

Waterton Associates LLC, for example, purchased Symphony Place in Minneapolis for $36.5 million, and Stuart Companies acquired a four-building portfolio from Equity Residential Properties.

The Outlook

As the economy continues growing and available units are absorbed, vacancy rates will continue dropping. Rents are poised to increase further. National investment interest will likely continue, as investors are confident there will be an uptick in rents. Landlords will not lose renters to homeownership at the pace they once did.  Increasing demand and rent potential will continue to create opportunities for renovations. Calendar year 2007 will be another flat year for construction. However, the impact of unsold condos being converted to rentals is a concern.