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Do the Twin Cities really need this many luxury apartments?

Minneapolitans can be forgiven if they feel like they are living in a construction zone.

Promptly at 7 each morning, construction workers start noisily digging and hauling dirt at the large open pit outside my window. Their project, due to be completed in 2016, is The Encore, a 122-unit luxury apartment complex in downtown Minneapolis that will come complete with stylish amenities like a dog wash and a yoga studio.

Only a few blocks away crews are banging away at similar developments: Latitude 45, a 319-unit apartment building on Washington Avenue and the 195-unit Edition on South 4th Street.

Minneapolitans can be forgiven if they feel like they are living in a construction zone. The Encore and its pals, after all, are only the more recent manifestations of a boom in downtown apartment construction that’s been going on for the past few years. Since 2011, according to Finance & Commerce, 11,051 apartments have come on line in the metropolitan area. About 30 percent of those have risen in the two downtowns.

In Minneapolis, where forests of cranes loom over the streets, the numbers are particularly striking. Brent Wittenberg, vice president at Marquette Advisors, a real-estate consulting company, says developers added 1,100 apartments downtown in 2013 and 900 in 2014. He expects another 1,080 this year and 560 more in 2016. Some 2,000 are proposed for the following year, although it’s likely that some will never break ground, he says. 

As the saying goes, we are not alone. “The State of the Nation’s Housing 2015” from the Joint Center for Housing Studies of Harvard University reports that multifamily construction last year soared to 360,000 units, more than in any year in the 1990s or 2000s. Some 90 percent were apartments, rising to accommodate demand from older and wealthier households who would normally own, not rent. Developers and the lenders and investors who back them are betting that endless hordes of millennials and empty nesters who don’t want to buy (or can’t afford to) will fill the burgeoning units.

As thrilling as any boom can be — generating more jobs, more spending and presumably more prosperity — almost the minute it’s detected, there comes the worry about whether or when it will turn into a bubble and collapse. And so it is. Only about 20 minutes after the current surge in apartment building got under way in 2013, Burl Gilyard wrote in Twin Cities Business: “If residential real estate is the ultimate business roller coaster ride, full of exhilarating climbs and stomach-churning drops — how long until the screaming starts?” 

Whose vacancy rate?

Generally, little moans of fear start to be heard when a metric called the vacancy rate rises. It’s a pretty simple concept. You take the total number of unoccupied apartments in a circumscribed area, then divide by the total number of apartments in said area, period. If the rate is 5 percent, the market is considered in equilibrium (though more about that later). Five percent supposedly accounts for renters’ normal movements in and out. Below 5 percent, a market is considered “tight.” If the vacancy rate rises substantially beyond 5 percent, well, that’s not definitive proof of a glut in the market, but developers and lenders contemplating a new project may feel a scream rising in their throats.

Not all vacancy rates are alike, however. For starters, analysts don’t collect data in exactly the same way, nor do they necessarily collect the same data. For example, Wittenberg of Marquette Advisors says his company has a database of buildings over 20 units in size — about 160,000 units (including about 40,000 low-income units) for the Twin Cities seven-county metropolitan area. The numbers come in by telephone, email and fax, often from large building owners and management companies. Mary Bujold, president of Maxfield Research, a Twin Cities research analysis company, collects data mostly by telephone on 290,000 units in the metro. Buildings vary from 25 to 500 units. 

Reis, a national real estate data service based in New York, includes multifamily properties of 40 units or more in all states except California and Arizona, where the number is 20. Where they get the information they do not say. The company, according to a spokesman, also has “a dedicated team of New Construction analysts that monitor projects under construction, to ensure that we capture any changes in inventory growth accurately.” MFP in Houston culls data from apartment management software sold by its parent company and covers any buildings over 5 units. “We have 50 years of tracking the market,” says Greg Willett, vice-president of research and analysis.

National companies generally capture only metrowide vacancy rates. For most builders, investors or renters, what counts is what’s going on at the neighborhood level. More granular information comes from local research companies. But even among those there are variations. Again, Marquette Advisors focuses on buildings with more than 20 units. Gina Dingman, president of NAI Everest, a Minneapolis firm that advises commercial real-estate investors, won’t reveal the source of her data for fear of losing her competitive edge, but generally counts projects of over 50 units.

The size of the development counted makes a difference. Studies have shown that landlords of smaller buildings want to keep their units occupied no matter what. They’ll sacrifice the amount of rent they collect simply to get a breathing body occupying the premises. (They can always hope to raise rents later, counting on tenants’ natural human desire to stay put.) In contrast, owners of large buildings have a tendency to let units go empty until they find a tenant who will pay the freight. 

That said, analysts who limit their data to larger projects likely wind up with a vacancy rate slightly higher than those who include smaller buildings. So, for example, Reis, which counts larger buildings, winds up with a Twin Cities-wide vacancy rate of 3.2 percent, while MFP says 3 percent. That rule isn’t iron-bound, however. NAI Everest, which counts even bigger buildings, estimates the cities-wide vacancy rate at 2.7 percent. 

I know, I know, 0.2 or 0.3 percent one way or another sounds like a smidgeon of a difference — but it’s one that amounts to about 2,400 to 3,600 market-rate apartments around the metro. And to a developer planning to add, say 150 units — and seeing his or her competitors each adding another 150 units — the difference can be meaningful. 

Another factor that can change the vacancy rate: new buildings. More specifically: When should they be counted? After all, on the day they open for business, they may be almost 100 percent empty; adding so many unoccupied units would, of course, change the vacancy rate. Analysts take a variety of approaches. Dingman of NAI Everest unforgivingly counts them immediately. Wittenberg gives them six months to lease up. And Mary Bujold of Maxfield Research generally adds a building to the inventory of apartments “when it stabilizes,” by her definition, when it is 93 to 95 percent full. But if it rents up faster, she may include it more quickly.

‘We are playing catch-up’

Despite the differences in the various models, the rates seem to converge. They also suggest that the Twin Cities’ boom looks to be far from bust. Historically, “Minneapolis is up there with New York and San Francisco as having one of the tightest vacancy rates,” says Willett of MPF Research. “The vacancy rate has run about 3 percent. And that’s what it is now: 3 percent.” 

The reason for the low rate, he says: “Lack of rental product.” We simply have not built that much multifamily housing in the past. Wittenberg of Marquette Advisors agrees. “We are playing catch-up” he says. 

Downtown Minneapolis is another story, however. According to NAI Everest, the vacancy rate there is 8.3 percent. Marquette Advisors had not at press time calculated its second quarter vacancy rates, but for the first quarter, it registered 8.8 percent for downtown buildings. Both would be well over the so-called 5 percent equilibrium.

But about that 5 percent. Eric S. Belsky, now director of the Consumer and Community Affairs Division at the Federal Reserve System, wrote in a paper for the National Association of Homebuilders way back in 1992 that it is simply “an idealized rule of thumb,” used by developers, investors, banks and even the government. But, he added, “comparing observed vacancy rates with idealized rules of thumb can end up distorting conclusions about the adequacy of supply.”

Equilibrium, Belsky wrote, varies by area and the type of rental units available, how often units turn over, whether the landlords are small or large operators. Again, in an area like downtown which is dominated by big landlords, a 7 or 8 percent vacancy rate may not be all that alarming. And, Bujold says, “We’ve had a lot of construction, but so far, the absorption has been quite strong.” Absorption is the speed at which units rent, and Wittenberg estimates that the downtown Minneapolis has sucked up about 2,500 apartments in the past two years.

Buildings do seem to be filling up. I looked at a dozen downtown developments built in the last few years, and, except for a couple of outliers, most had vacancy rates under 10 percent. Typically, when landlords become desperate, they offer rent concessions or rewards like a weekend in the Bahamas or a flat-screen TV. I found only one building openly offering discounts to would-be renters — LPM Apartments, the lozenge-shaped 36-story development near Loring Park. It is granting tenants willing to sign a 14-month lease for a 738-square-foot one-bedroom apartment two months of free rent. The tab: up to $1,815 per month, plus, says its website, “an additional monthly Utility & Service Amenity fee which includes the cost of heating, air conditioning, water, natural gas for cooking, and natural gas for the operation of the clothes dryer.” (Silly me, I thought the rent included all that.)

Built for the ‘high end of the market’

In fact, those downtown rents keep rising ever higher. And, in a couple of years, there may be a dearth of renters — even those anxious to be downtown — able or willing to pay, say, $1,531 a month, what Wittenberg estimates is the average for a one-bedroom apartment. A tiny one, at that. If the Twin Cities’ job growth tails off, screaming may lie ahead.

Already Ryan Severino, director of research for Reis, the national real estate data service, says he is surprised that the screaming hasn’t already started, at least in some cities. He headed his comments on 2015’s second quarter “Armageddon Postponed” and writes that while a huge number of units are coming on the market, an estimated 230,000 this year, renters continue to gobble them up. But, he warns, “the pipeline remains incredibly robust and the market is only delaying the inevitable” — a moment when there will more apartments than people who will want or be able to rent them.

Affordability is certainly an issue. Most of the apartments now rising here and across the nation are catering to the upscale among us. According to the Harvard report, “new units are primarily built for the high end of the market. In 2013, the median asking price for newly constructed multifamily units was $1,290, equivalent to about half of the median renter’s monthly household income. At that rent level, over two-thirds of today’s renter households could not afford this new unit at the traditional 30 percent income standard.” 

Comments (11)

  1. Submitted by Steven Bailey on 08/04/2015 - 11:11 am.

    Developers only develop 🙁

    Back in the 1980’s one of my professors brought in a guest lecturer that was a friend of his. The lecturer was the CEO of one of the largest Real Estate development companies in a large southwest city. Real Estate was starting to struggle locally but there was a lot of new apartments and strip malls being built. When one of the grad students in the class asked how can you still be developing when the vacancy rates are so high. The CEO explained that his company developed and that is what they do. As long as they can get financing to keep going it keeps all the payments going. He then went on to explain how at a certain level of market position high level bank loan officers can’t really say no anymore because they don’t want the train stalling on their watch. The result was that when the development company failed it single handedly brought down a large amount of the Savings and Loans in the state. It was the start of the S&L crisis. Everything in housing and Real Estate now is a manipulation of the system to try and undo the 2007 wrecking of the planet’s financial system and it can’t be done. Trillions of dollars were lost at the end of the fantasy economy of 2000 to 2007. Large financial interests are still holding back housing stock from the market at the same time they build and manage rental properties. The trillions in losses are and have been slowly externalized to the majority of society that had nothing to do with the 2007 crisis.

  2. Submitted by Anton Schieffer on 08/04/2015 - 11:16 am.

    Better more than less

    I’m really not too worried about the prospect of having “too many” luxury apartments on the market, as the worst case scenario is that the owners of these buildings will have to lower the rents if they aren’t filled. In addition, if these units aren’t built, the tenants who live there would just be driving up my own rent (in a non-luxury building), which has steadily risen over the past few years.

  3. Submitted by Rachel Kahler on 08/04/2015 - 11:20 am.

    Dragging prices up

    I question all of the luxury apartment building, as well. Theoretically, these new buildings should lure wealthier individuals out of older luxury apartments and drive the cost down in the older buildings to make room for less wealthy individuals/families to occupy. However, it doesn’t seem that that’s happening. Rents, on average, are staggeringly high. And, if you split the rental rates and then do your vacancy rate calculation, I bet you’ll find lower rent apartments impossibly squeezed, while higher rent apartments are less so. The problem is, if 7 or 8% isn’t a big deal for big landlords, that means that they can hold out for higher rents rather than fill those apartments for less. Not that many of the new apartments are suitable for families–urbanites want to have kids, too. I’m not sure we need to wait very long for screaming–I suspect it’s already happening if you listen for the right voices.

    • Submitted by Nicholas Hannula on 08/04/2015 - 11:50 am.

      I think you’re misattributing causation– rents aren’t rising because of the construction boom for new higher-end units; the boom and the rise in rents are both effects following from the same causes (low vacancy and changing consumer preferences).

      • Submitted by Rachel Kahler on 08/05/2015 - 10:25 am.

        Yes and no

        While they might not be directly cause and effect, it’s more than plausible that they’re linked. If landlords of higher cost housing can better tolerate higher vacancy rates, then there is no need to discount rental prices because it’s not imperative that they fill them. Those 7-8% empty units are not filled by people with lower means who must then remain in older housing, which means fewer vacancies of that housing, which means that there’s no need to discount that the rental rates of THAT housing, and so on down the line.

  4. Submitted by Brian Krause on 08/04/2015 - 11:54 am.

    ‘But, he warns, “the pipeline remains incredibly robust and the market is only delaying the inevitable” — a moment when there will more apartments than people who will want or be able to rent them.’

    This might only be a problem at the upper end of the market. Vacancy rates have been in the single digits in the core cities now for years. The apartment market is extremely tight for those looking for mid-level or low end places. The boom in luxury accommodations won’t ease this pressure, but it is possible that they could ostensibly outstrip demand at the upper end.

    Obviously I don’t have the data to back this up, but given a hypothetical glut of high end accommodations I have a hard time imagining that perpetually indebted millennials will move up market to fill vacancies. I would imagine the prices would eventually have to come down.

  5. Submitted by James Hamilton on 08/04/2015 - 11:56 am.

    I’d be interested in knowing

    whether public funds have been involved in any of these projects, which, and how much. Any chance of seeing that in a future piece?

  6. Submitted by Ray Schoch on 08/04/2015 - 12:00 pm.

    Different numbers

    Purely from a personal standpoint, Ms. Harris illustrates why I’m never going to live in downtown Minneapolis. Aside from other potential negative factors for downtown living, for me, it all boils down to the proverbial bottom line: I can’t afford it.

    “…It is granting tenants willing to sign a 14-month lease for a 738-square-foot one-bedroom apartment two months of free rent. The tab: up to $1,815 per month, plus, says its website, ‘an additional monthly Utility & Service Amenity fee which includes the cost of heating, air conditioning, water, natural gas for cooking, and natural gas for the operation of the clothes dryer.’” Like Ms. Harris, I’d have thought utilities would be included in that hefty monthly rental, but no.

    I’m accustomed to having an income that doesn’t meet the median level of the community in which I live, but just for grins, I’ll point out that – in an admittedly less fashionable part of Minneapolis – I’m currently getting very nearly twice the space quoted above, plus covered parking, for about $950 a month *less* than the quoted figure. True, since I’m the titular “owner” of the property, I have to pay taxes, but even in high-tax Minneapolis and Minnesota, my taxes don’t begin to approach that $950 a month figure.

    On several occasions, I’ve asked myself the same sort of rhetorical question that’s in the article’s headline.

  7. Submitted by Neal Rovick on 08/04/2015 - 12:25 pm.

    I recently read of some newly completed apartment buildings being sold to investment companies for about $ 250,000 per unit.

    Do the math and you see the gap between construction costs and selling price–that’s all the incentive needed to keep construction happening–it’s big money for the companies doing the construction.

    As for the investors buying the completed building–that’s where the rental price crunch will come. In order to beat other investments, the apartment would have to return at least $1600 in rent after maintenance, amenities, wear and tear, vacancies, taxes, fees, utilities, and management costs are deducted–which would push the required rent well above $ 2400 /month–and that is a building that is new without any major issues

    Hence, the need for LUXURY apartments.

    10 years from now, when the costs for the maintenance have risen because of shoddy construction and wear begins to accumulate (and, coincidently the warranty is gone, the buildings will be sold as condos.

    Beware.

    It’ll fall apart at the

  8. Submitted by Michael Hess on 08/04/2015 - 12:36 pm.

    Impact on housing availability and prices

    Another related question would be where are the occupants for these new apartments coming from? If they are coming from houses that they are downsizing out of, part of the reverse migration from suburbia to the downtown lifestyle, that accelerates the movement out of these bigger places, increasing the supply and it should hold down or depress prices for these homes.

  9. Submitted by Karen Sandness on 08/07/2015 - 09:41 am.

    I happened to be downtown earlier this week when

    one of the new buildings in the North Loop had a fire alarm go off, so I was able to see all the tenants at once, gathered on the sidewalk.

    If there were any people over the age of 30 in the crowd, I don’t know where they were hiding.

    Studios start at $1200 in that building, according to its website. Also according to the website, they have a lot of vacancies: 14 studios, 64 1-bedrooms, and 19 2-bedrooms. This is a building that has been open for nearly a year.

    I guess the owners of this luxury building really are holding out in the hope that more affluent tenants materialize.

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