Schafer: How long can the apartment construction boom continue?

  • Article by: LEE SCHAFER , Star Tribune
  • Updated: August 10, 2013 - 4:02 PM
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Construction site of the Bridges Apartments at 950 University Ave SE, photographed on 6/14/13. Bruce Bisping/Star Tribune bbisping@startribune.com

Photo: Bruce Bisping, Star Tribune

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The real estate appraisal firm Nicollet Partners in Minneapolis tracks new and proposed apartment projects in the Twin Cities, and as of last week its pipeline report showed more than 7,000 units under construction and an additional 13,600 units proposed.

“And I’m sure we are maybe missing some,” said Doug Wageman, a principal with the firm.

Usually when you see that much activity in any segment of the real estate market, a famously cyclical industry, you know what’s coming next. Plummeting prices. Write-downs of loans. Projects abandoned after the foundation’s been poured.

So today must be when it’s time to call the top of the market in this cycle of new apartment development, right?

“Not today,” Wageman said. “In another year, let’s chat.”

As it turned out, Wageman was as close as I found to a pessimist on the apartment development market last week. In taking apart the arguments of the optimists, they actually make a good case.

This building boom, it seems, has a ways to go.

The first thing to understand is that while Wageman’s 20,600 total units may sound like a lot, it wouldn’t be news in similar markets like metropolitan Denver. It’s booming there, with about 12,500 units under construction, according to James Real Estate Services in Denver, and about 18,000 additional units in the pipeline.

In Minneapolis alone there are 2,084 units under construction, said Mary Bujold, a longtime market analyst and president of Maxfield Research in Minneapolis. That would be disappointing in Seattle, where just in the downtown area more than 1,200 apartment units opened in the first half of this year and as of June 4,650 more were under construction.

The Twin Cities apartment market is playing catch-up. Keith Collins, a broker with the global real estate firm CBRE, explained that “we have built like 20,000 units in the Twin Cities in the last 20 years. There’s a significant pent-up demand in our market.”

The Twin Cities didn’t even see the miniboom in apartment development that occurred in other metro areas in the middle of the past decade. With no-money-down liars’ loans available to finance a deal, likely Twin Cities renters just bought condos and houses.

The result of underdevelopment is easy to see in the reports on vacancies. Apartment developers expect that this week Marquette Advisors will announce, in its closely watched report, that the second quarter was the ninth in a row with an apartment vacancy rate of less than 3 percent.

As a practical matter, the vacancy rate really can’t get much lower. Even a 5 percent vacancy rate is considered a sign of a very healthy market.

Today there are about 330,000 apartment units in the Twin Cities market. If the vacancy rate increases to 5 percent, call that a 2.2 percent increase from what’s been seen this year, marketwide that means about 7,200 more unoccupied apartment units. So all 7,000 units now under construction could open and even if not a single one got rented, the vacancy rate still wouldn’t get any worse than what’s considered very healthy.

Based on how well some recently built properties have leased, such as the Flats at West End in St. Louis Park that opened recently with most of its units rented, there is no reason to think that any new project’s owner should expect to open without tenants.

One factor driving absorption, or the leasing of new units, is what is called “rent by choice.” That’s the consumer deciding to rent even when he or she has the means to swing a down payment and pay a mortgage on a house or condo.

When many of us boomers came of age, our middle-class parents preached “rent is throwing your money away.” The stomach-churning drop in single-family house values after 2006 taught younger people a different lesson.

Putting $50,000 down on a house and making 60 monthly payments of $2,000, and then losing the house through a foreclosure, well, that’s throwing your money away, too. Just in much bigger chunks than a rent check.

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