Apartment Market Starting to Recover

• Apartment construction slows to a trickle
• Condo, for-sale housing markets soften
• Job growth continues

Apartment Market Poised for Recovery

With rising interest rates deterring some would-be homebuyers and strong job growth continuing, demand for apartments is increasing. Vacancy dropped to 5.5% in first-quarter 2006 from 6.1% in fourth-quarter 2005 and a high of 7.6% in fourth-quarter 2003.

Economic vacancy, reflecting free rent and other concessions, is still impacting the market. At 11%, it is double the physical vacancy. Although concessions are diminishing in sought-after markets and premier properties, it’s still not uncommon for landlords to offer one month free on a 12-month lease. Meanwhile, rents in strong pockets are edging upward. The average rental rate was $855, up from $851.

The Southwest leads the recovery as traditionally it’s a strong destination for young singles. Eden Prairie’s vacancy dropped to 4.7% in March 2006 from 11.4% one year earlier. Meanwhile, the South and Southeast remained flat, and the core cities’ vacancies rose, as they still may be feeling effects of the recent condominium boom. Downtown Minneapolis’ vacancy increased to 5.5% from 4.4%, and downtown St. Paul jumped to 10% from 4.5%.

Construction Slows

New apartment construction slowed dramatically, allowing demand to catch up with supply. One of the few new properties is Riverview at Upper Landing in St. Paul. Owners struggled to rent units and have recently marketed it for sale as a condo conversion.

For-Sale Housing Market Cools

The condominium market is softening in both downtowns and in the suburbs as pent-up demand is met. New development/condo conversions are slowing. Interest rates crept up, which is deterring some buyers and speculators. However, premier condo locations still perform well, such as Edina’s 50th and France and Galleria sites. Meanwhile, local home sales for May were down 9.3% from one year ago; new listings increased by 16.6%.

Investors Scout Market

Improving market fundamentals are attracting investors. Buyers are forecasting rent growth and lower vacancies and like the market’s job growth and stability. One key story is Equity Residential exiting the market; the REIT sold a half-dozen properties so far in its large, local portfolio and expects to sell the rest by year end.

The Outlook

Small advances in rent growth and vacancy reduction will likely continue through 2006. The market should hit 95% occupancy market-wide and will be well-positioned for 2007-08. Concessions will continue to dwindle, and 2007 should see real rent growth. Don’t expect a rush to new development; rents need to increase 20-25% to justify new construction. Investor activity will be strong due to availability of capital and improving market fundamentals. Buyers believe this will be a growth market during the next five years.