Rental Market Sees Signs of Improvement as Vacancy Drops, Concessions Taper Off

• Concessions are beginning to burn off
• New construction has virtually come to a halt
• For-sale housing/condo market has cooled

Chipping Away at Vacancies
The multi-family market has hit bottom and is on the road to recovery. The market is seeing slow, steady improvement in market fundamentals. Vacancy dropped to 6.1% in fourth-quarter 2005 from 7.3% one year ago and 7.6% in fourth-quarter 2003. Third-quarter economic vacancy, reflecting free rent and other concessions, dropped to 11.2% from 13.9% in first-quarter 2005. As concessions begin to taper off in many submarkets, asking rents remained flat at $851—virtually unchanged since 2002.

Job Growth Continues
Job creation, which impacts apartment demand, is increasing. The Minnesota Department of Employment and Economic Development reported a 3.7% unemployment rate in October, significantly lower than the national average of 5%. Manufacturing led the way that month with 3,000 new jobs. From October 2004 to October 2005, the Twin Cities metro area added 22,000 new jobs.

Supply Side Slows
New apartment construction has virtually stopped, which will help demand catch up with supply. Some suburbs are absorbing new construction that came on line in the past two years. In Eden Prairie vacancy dropped to 5.3% from 12% one year ago. Three conversions of Minneapolis rental properties to condominiums also removed 700 units from the inventory.

For-Sale Housing Market Cools
Although interest rates remained attractive, fall 2005 saw a slump in housing/condominium sales. New home sales nationwide dropped in November by the largest amount in nearly 12 years, reported the Commerce Department. The condo market, which was popular in the Twin Cities in recent years, is quieting as pent-up demand is met, and both development and condo conversions are expected to slow. Rising interest rates could also deter buyers.

Investors Eye Market
This cooling of the for-sale housing/condo market is prompting REITs and pension funds to take a hard look at the Twin Cities, as several large apartment portfolios traded or are for sale. For example, Archstone-Smith Trust, the nation’s largest apartment REIT, re-entered the market by purchasing two complexes in downtown Minneapolis. Buyers are accepting lower returns today because they believe the metro is poised for a recovery. They’re confident the bottom line will improve as concessions burn off and the market sees rent growth, even spikes, in some areas.

Outlook
More job growth is projected for 2006 and renter traffic will likely continue to increase. Meanwhile, the supply side will remain stable as the pipeline of new construction has dried up. Concessions will likely continue to taper off and landlords will begin to see rent increases. As these market fundamentals come together, the bottom line will improve for landlords. Submarkets likely to stabilize first are those strategically located inside the I-494/694 ring, spanning from the Northwest to the Southeast. These submarkets historically experience higher demand from both renters and investors. Investor activity will also likely be strong in 2006.