VOLUME 35, NUMBER 10
©2019 Real Estate Publishing Corporation
November/December 2019
Minneapolis CRE market attracting outside investors, plenty of activity
365 Nicollet, photo courtesy of Opus Development Company By Dan Rafter, Editor
S
teady might be the best way to describe the commercial real estate industry in Minneapolis and St. Paul, with all the major commercial sectors showing at least some positive signs. But steady might not be the most appropriate description for two of the sectors here. The industrial and multifamily sectors? The word “booming” is more appropriate for them.
These sectors are performing well throughout the Midwest, of course. But they are performing especially well throughout the Minneapolis/St. Paul region. Just ask Phil Cattanach. He’s vice president and general manager for Minneapolis-based Opus Development Company. Cattanach said that demand is still outpacing supply here in both the multifamily and industrial sectors. And when he looks ahead to 2020, Cattanach says, there are few signs that either sector will slow
down much in the coming months. And in even better news, those sectors that aren’t quite as hot as multifamily and industrial remain firmly in that “steady” arena, with new projects still popping up across the Minneapolis/St. Paul area. Cattanach pointed, for instance, to seniors housing, which he said is still in great demand in the Twin Cities area. He said that demand for build-to-suit office products and even specialized retail remain MPLS to page 12
Across the nation – and the Midwest – multifamily market still on the rise By Dan Rafter, Editor
W
hat’s the strongest commercial sector right now? In most, if not all, major Midwest markets, it’s industrial. But a close second? It’s multifamily. And the strength of this sector – buoyed by the growing number of people who want to live in the center of urban areas – is showing no signs of slowing. Consider the latest research from Berkadia. According to the company's 2019 third quarter multifamily
report, the occupancy rate for apartments across the country stood at 95.8 percent in the third quarter of the year. That figure is strong and is unchanged since the third quarter of 2018. And apartment rents? Those are on the rise. Berkadia reported that the effective average apartment rent stood at $1,411 in the third quarter. That's up 3.2 percent the third quarter of 2018. With numbers like this, it's not surprising that developers are eager to build new multifamily properties. Berkadia reported that developers added 219,117
apartment units during the first three quarters of this year. Net absorption has been strong, too. Berkadia reported that 236,669 apartment units were absorbed during the first three quarters of 2019. But how strong is the multifamily market in the Midwest today? Very, as a look at some of the busiest Midwest markets will prove. Kansas City is a good example of a market that is seeing plenty of multifamily activity. Kenneth Block, managing principal with Block Real Estate Services in Multifamily to page 8
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NOVEMBER/DECEMBER 2019 • VOLUME 35, NUMBER 10
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Departments PEOPLE ON THE MOVE 4
CLOSINGS
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MINNEAPOLIS CRE MARKET ATTRACTING OUTSIDE INVESTORS, PLENTY OF ACTIVITY ACROSS THE NATION – AND THE MIDWEST – MULTIFAMILY MARKET STILL ON THE RISE
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FINANCING THE NEW KIDS ON THE BLOCK: CO-LIVING, WORKFORCE HOUSING AND CANNABIS
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WHAT BRINGS IN THE RENTERS? INTERNET ACCESS, PET PERKS AND SMART HOME FEATURES
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Financing the New Kids on the Block: Co-living, Workforce Housing and Cannabis As 2019 draws to a close, investor interest is growing in several emerging assets, including co-living, workforce housing and cannabis tenants. Matt Wurtzebach, senior vice president in the Commercial Finance Group at national real estate services firm Draper and Kramer, Incorporated, shared his thoughts with Minnesta Real Estate Jounrnal about what he’s seeing from the front lines, including lender appetite across these emerging segments of the multifamily market as well as special challenges associated with financing cannabis real estate. by Matthew Wurtzebach
How do prospective lenders view co-living deals?
Wurtzebach: Co-living is a practical solution for price-conscious middle-income earners in their 20s and early 30s who want to live in top-tier locations with modern amenities, but lack the budget for a conventional apartment. In a co-living community, where rents are by the bed rather than the unit and often include furniture, utilities, cable, internet and other services, total monthly expenses can be 30-50 percent less than the cost of renting a traditional studio in a similar building. We are seeing increased appetite for this asset type among bank and
debt-fund lenders, and expect more permanent lenders to enter the space as additional transaction and operating data becomes readily available. We spend a lot of time upfront with borrowers compiling comparable data, showing the underwriting from multiple angles and creating a narrative for the business plan to demonstrate the merits of the project. This includes benchmarking rents against comparable studio and one-bedroom apartments in the submarket, stresstesting the underwriting against traditional apartment execution and making sure operating expenses are supportable. Most permanent lenders will want to see around 12 months of stabilized operating history on a pure co-living
the best terms, borrowers need to invest the time to educate the market and find the right fit for the loan.
What kind of financing is available for workforce housing?
Matthew Wurtzebach project. For co-living concepts that utilizes a master lease structure, we have seen resistance from some lenders once the lease exceeds 20 percent of the space. And, since the agency lenders are still evaluating the co-living concept, engaging and building relationships with balance sheet lenders is critical. Co-living is still new to many loan officers and their committee members. To find
Wurtzebach: Workforce housing is another area where we are seeing increased interest from lenders and owners. Some Midwestern cities estimate the local gap between supply and demand to be in excess of 100,000 units. According to the National Low Income Housing Coalition, most Midwestern states are meeting 40 percent or less of the demand As workforce housing can sell at a 300+ bps premium to luxury apartments, we are seeing more entrants in this market. This is particularly true in areas with an outdated housing stock near transportation, retail and other public amenities, and with low to moderate crime levels. The permanent loan market provides a variety of attractive finance options for loans beginning at $1 million with loan-tovalue ratios of 80-85 percent. It is important to receive quotes from all Financing to page 16
Page 8
Minnesota Real Estate Journal
November/December 2019
Multifamily From page 1
Kansas City, said that developers are still adding new apartment buildings to Kansas City's skyline. This new construction hasn't resulted in increased vacancies or lower rents, either, he said. "Our multifamily market has been strong for many years," Block said. "We are benefitting from the changing desires of the marketplace just like everywhere else. We are benefitting from the influx of renters by choice, the young people who want a different type of living experience." How strong is multifamily here? Block said that there was a time when he'd consider the addition of 3,000 apartment units in the Kansas City market to be an example of a boom year. In the 12 months leading up to June of 2019, though, Block said, the Kansas City market absorbed 5,000 apartment units. At that same time, about 8,500 apartment units were under construction. Even with all this new product, vacancy rates for this sector remained low in Kansas City. "We do have a lot of units under construction, but the deliveries on those units are spread out over 27 to 28
The multifamily market remains a busy one across the Midwest months," Block said. "You might have 8,000 or 9,000 units under construction, but you might only deliver 3,000 in any one year." Block attributes some of the strength of the multifamily market here to the solid economy in Kansas City.
"Kansas City is about as strong as it has been in a long time, economically and in how our citizens are doing," Block said. "Our gross regional product is running very close to 3 percent, which is stronger than it has been. Our unemployment rate was down to 3.3 percent,
which is lower than the national unemployment rate." And as long as that remains the case, the apartment market in Kansas City should remain strong, Block said. Multifamily to page 10
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Count David Funke, managing director with the Indianapolis office of CBRE, said that the multifamily sector in his market remains strong, too. "There is no sign of multifamily slowing down," Funke said. "The market for class-A trophy properties is so strong, particularly for properties located downtown. The capitalization rates are dipping into the 3s. I have never seen that in my career. That is the sign of a really strong market." Funke said that the multifamily market is so strong, it's bringing in investors from outside the state of Indiana. These investors are chasing return, Funke said. They know that prices have already been bid up on multifamily properties in the coastal markets. That hasn't happened in the Midwest. Investors also see that trophy multifamily properties in Indianapolis are selling well and attracting plenty of renters. That makes them particularly save investments. "Apartments are still being built here," Funke said. "There is no sign of these new buildings having trouble leasing-up. Prices have remained very strong. That is primarily because Indianapolis now has a downtown lifestyle that is very attractive to not only people in their 20s but to older people, too." As Funke says, a growing number of
Minnesota Real Estate Journal
people want to live in downtown Indianapolis thanks to the new restaurants, retailers and entertainment options in the center of the city. Developers, reacting to this demand, are happy to build new apartments in Indanapolis' CBD. "Now people can find anything they want to live, work and play in downtown Indianapolis," Funke said. Not all markets, though, are seeing a continued multifamily boom. John Manos, president of commercial real estate lending for Downers Grove, Illinois-based Bank Financial, said that he has seen demand for multifamily financing slow slightly. This slowdown, though, is happening mostly in those markets that have seen an especially large amount of new apartment construction, cities like Denver, Austin and the bigger metropolitan areas of the Carolinas. Demand for new apartments might have peaked in these markets, Manos said. And with that, have come concessions from building owners in an attempt to bring in more renters. “In some of these locations, too many units have come onto the market too fast,” Manos said. “Some of the markets have been overheated. As more units come online in those markets, the vacancies are rising. And secondly, we are seeing rents per square foot fall in some markets.”
November/December 2019
Chicago remains one of the busier multifamily markets in the country In the Midwest, Manos points to Minneapolis as an example. The Twin Cities is one of those markets in which multifamily demand started peaking three or four years ago, Manos said. As new units popped up throughout the Twin
Cities, rents started rising to new highs for the Minneapolis/St. Paul area. Today, though, rents are starting to dip while apartment vacancies are starting to rise in the Twin Cities, Manos said. “Minneapolis was one of the first Multifamily to page 17
Page 12
Minnesota Real Estate Journal
November/December 2019
MPLS From page 1
strong in certain pockets of the region, too.
But multifamily and industrial remain the stars “We are completing projects in the industrial and multifamily sectors and getting them leased up quickly,” Cattanach said. “We are still kicking off new projects in those sectors and continue to see strong fundamentals supporting them. To me, it’s a healthy sign of an economy that remains strong with continued growth and business expansion. We are still seeing new businesses coming to this market because the Twin Cities area is so strong right now.” This leads to the obvious question: Why has the Minneapolis/St. Paul commercial real estate market been so strong for so long? Cattanach cited the diversity of the local economy. Several Fortune 500 companies in an array of product types have a presence in the Twin Cities. This means that the region doesn’t rely on just one or two main industries. That provides a buffer in case of a slowdown in any one industry type. The Twin Cities is also more steady than boom, even with the strength of
3701 Wayzata, photo courtesy of Opus Development Company
the multifamily and industrial sectors today, Cattanach said. That steady nature of the industry prevents overbuilding when times are good. “We don’t have the lightning-hot activity that you see in some of the coastal markets,” Cattanach said.
“Conversely, we don’t get the same lulls that they get.” Cattanach said that the Twin Cities benefits from a large number of sophisticated and strong developers and contractors working the market. These professionals know what the Min-
neapolis/St. Paul market can handle and don’t build projects that then struggle to attract tenants. “We have a lot of developers with a national presence here. The best practices that they rely on are then brought MPLS to page 14
Page 14
Minnesota Real Estate Journal
MPLS from 12
to the Twin Cities market and applied here,” Cattanach said. “There is a strong awareness, too, of the supply-anddemand metrics. You see a lot of discipline exercised by developers here. You are not seeing the expansion or overbuilding that might have happened 10 or 12 years ago. A lot of those areas in the Twin Cities region that had been overbuilt years ago have been corrected over time. There is still a good amount of discipline being exercised by the developers in this market.”
The multifamily demand Like in many Midwest markets, the urban center of the Twin Cities is attracting plenty of multifamily construction. As Cattanach says, people want to live in the heart of Minneapolis. And developers are reacting by bringing more apartment units to the CBD. It’s an example of the live/work/play mentality: People want to live close to where they work. They want to be able to walk to public transportation, restaurants, entertainment and shopping. By living in the urban core of the Twin Cities, they can reach these goals. At the same time, unemployment remains low in the Twin Cities. To help attract and retain the best workers, then, companies in Minneapolis and St. Paul
must offer office space in downtown, where workers more often want to live. This has provided another boost to the multifamily construction activity in the urban centers of the Twin Cities. “With that comes the population growth and those added services,” Cattanach said. “We are seeing more restaurants, retail and even grocery options in the CBD.” But it’s not just downtown. Cattanach said that developers are adding more apartment units to the inner-ring suburbs, too. “The demand for quality housing options in a variety of markets in the surrounding suburbs is very high right now,” Cattanach said. “The developers and the market are calling for this product.” Jeff Budish, senior vice president with the Minneapolis office of Colliers International, is seeing strong activity in the Minneapolis/St. Paul market, too. He focuses on retail and multifamily, and has seen positive signs in both sectors. The Twin Cities' multifamily market is especially strong, Budish said. This is partly because there wasn't much new construction in this sector before the current multifamily boom started. There's also the fact that a growing number of people are seeking interested in urban living. These two factors have helped push
Riverside, Minneapolis
November/December 2019
new construction in the apartment market here, and have led to higher rents and lower vacancy rates, Budish said. "Density and urbanization has become a goal in this sector," Budish said. "People want to live in the CBD and downtown. That is where we are seeing the greatest number of new apartment developments right now. Most of the multifamily projects getting built today have a high walkability factor. They are close to public transportation, entertainment and employment." Minneapolis' light-rail public transportation system is playing an important role in the multifamily market here, too. The newest spur of the light-rail system is now under construction. This will only further the desire of developers to build apartments in the city's urban core, Budish said. The biggest draw for potential tenants of these new buildings? Budish said that renters do expect modern amenities in newer, downtown-area apartment buildings. But these amenities aren't as important as a building's location or its walkability factor, he said. "If you can deliver something where everything works well and there are amenities either within the building or within the block, that is the key," Budish said. "Public transportation being nearby is a big deal. Easy access to their jobs matters. These are the keys to bringing
in tenants." The Minneapolis/St. Paul retail market does face its challenges, just like the retail markets in cities across the country. But Budish said that there positives in this market, too. For one, the high cost of new construction means that there has been little new retail product built in the Twin Cities area in recent years. This means that there is less competition for existing retailers. "You do not see a lot of places to build retail in urban locations," Budish said. "Parking is always a challenge. But when retailers do find the right location - anything with existing parking and some type of draw such as a high-traffic road or a good anchor -- they will have success." And those retailers that are doing well in the Twin Cities? They are often offering entertainment and food, Budish said. "Food, fitness and fun," Budish said. "That's what some say you need today in retail." Service business, though, are performing well, too, Budish said. This includes everything from beauty salons and nail studios to massage therapists, dentists and medical studios.
Industrial boom times As strong as the multifamily market MPLS to page 17
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Page 16
Financing from page 6
the GSE lenders, as well as traditional balance sheet lenders, to find the best execution. Current rates are inside of 3.50 percent for loan terms to 35 years. Small loans will price with a premium. The workforce housing bridge and construction finance space is lagging the permanent loan market, especially for loans less than $5 million and/or tied to projects with a heavy value-add component. During the last recession, many banks sustained losses in affordable housing and have been slow to re-enter the space. Local banks, and banks with a need for Community Reinvestment Act (CRA) credits, have shown the greatest interest. Finding those lenders requires a lot of local knowledge and longstanding relationships. Bridge lenders looking to create a pipeline for Small Balance Loan (SBL) agency platforms are active but often require a starting debt service coverage ratio (DSCR) of 1.00 – which eliminates heavy value-add – or higher loan balances. Similar to other asset classes, debt funds are filling the funding void, but
Minnesota Real Estate Journal
the pricing delta can be substantial. Where loans greater than $5 million or with a DSCR approaching 1.00 can price below L+250 (below 4.50 percent today), smaller heavy lift loans that do not fit a bank program can price in the high single digits. We expect rates in this market will compress as more sponsors and lenders chase yield; however, it is important to methodically cast a wide net in order to obtain the best-in-class terms.
What challenges do borrowers face for properties with cannabis tenants?
Wurtzebach: As more states legalize cannabis, the conflict between state and federal regulations is having an increased impact on commercial real estate transactions. While this is not a business line we actively seek at Draper and Kramer, it is an issue we are encountering more frequently, and borrowers should know how it will impact their capitalization. Even though Congress continues to advance legislation easing banking regulations for cannabis-related tenants, nationally chartered banks, life insurance companies, CMBS lenders and other financial institutions direct-
ly under the purview of federal regulators are not financing properties with cannabis-related tenants. For these lenders, properties with cannabis-related tenants, which often includes tenants that service the industry but do not touch the product, are off-limits. In some instances, lenders have received letters from federal regulators post-closing after unknowingly financing assets where a cannabis tenant was a small portion of the collateral. This is starting to prompt changes in loan documents and required standard lease forms specifically prohibiting cannabis tenants. Given the headline risk, even when federal law changes, many of these lenders will be slow to follow. Despite the challenges, there are lenders financing these properties. Debt funds, particularly those not relying on a CLO exit, are active in the space at rates as low as 5.50 percent. State-chartered banks will also provide competitive loans, but even here, borrowers need to do their research first. Banks with meaningful retail deposits, and therefore FDIC insurance, are less likely to compete. Additionally, both groups of lenders have varying standards on tenants.
November/December 2019
For example, some will not allow product on-site or will only quote the opportunity if the cannabis tenant is a small portion of the revenue. To improve certainty of execution, it is important to clearly define the use, describe the tenant’s business and demonstrate that the tenant is paying a market rent. Matthew Wurtzebach is senior vice president of the Commercial Finance Group at Draper and Kramer, Incorporated, a national real estate services firm based in Chicago. Draper and Kramer’s Commercial Finance Group is the largest single-office mortgage banking group in the country. Since joining Draper and Kramer in 2005, Wurtzebach has closed more than 360 CRE loans totaling in excess of $5.5 billion.
November/December 2019 MPLS from 14
is, the industrial market in the Twin Cities is even more robust. Cattanach said that investors have increased their appetite for commercial real estate. And they’re especially interested in industrial assets, something that has provided a boost to the Twin Cities industrial sector. Then, of course, there is ecommerce. As consumers do more shopping online, and demand that the products they order arrive ever faster, companies are investing more in industrial space located closer to population centers. This trend has boosted the industrial sector throughout the Midwest, and Minneapolis/St. Paul is no exception. And while developers are adding new industrial space to the Minneapolis/St. Paul market at a high rate, they’re not overbuilding, Cattanach said. New industrial space is filled quickly, and the demand exists for even more space, he said. “The demand for industrial space today can’t be ignored,” Cattanach said. “Capital is flowing and looking for this investment. The institutional investors, the REITs, they are all looking for industrial.” The strength of the Twin Cities industrial market has attracted an increasing number of developers from outside Minnesota, Cattanach said. They are
Minnesota Real Estate Journal
attracted to the strong fundamentals of this sector and the overall strength of the Minneapolis/St. Paul market, he said. This, of course, has resulted in more spec industrial popping up across the region. Cattanach estimated that about 50 percent of the new industrial product that Opus is building is speculative and 50 percent build-to-suit. That’s about the same percentage that most major developers in the Twin Cities market are following, Cattanach said. The good news is that this spec space is filling quickly. There aren’t large chunks of empty industrial space looking for tenants. Cattanach predicts that the industrial market will remain strong and active in 2020. Companies still need modern, functional industrial space, Cattanach said. That need isn’t about to lessen anytime soon, he said. The demand for quality space extends, too, to the office sector, Cattanach said. Unemployment remains low, so companies are working hard to attract and retain top employees. One way to do this is to offer modern office space with plenty of amenities. Companies, then, are offering bike storage areas, rooftop decks, training rooms and club rooms in thier office spaces. This has led to an increased demand for retrofitting old, outdated office spaces — spaces that do, though,
boast good locations — into modern office space. This trend isn’t about to slow, either, Cattanach said. “Businesses are still looking for qual-
Page 17
ity options for their employees,” Cattanach said. “As long as we see a lower unemployment rate, this isn’t going to change.”
Multifamily from 10
Midwest markets in which we saw the multifamily market start to peak,” Manos said. “We had been seeing record-low cap rates and record-high rents. Now things are starting to flatten out a bit. Some of those vacancies are increasing and we are seeing prices dropping in some Class-A buildings. That is putting a bit of pressure on Class-B properties, too.” This doesn’t mean that the multifamily market is heading for a deeper slump. As Manos said, even as vacancies start to rise, the multifamily sector remains one of the safest real estate investments. Why? People always need a place to live. And as the demand for urban living increases, a greater number of people want to live in the middle of cities. Apartment units remain a strong option for these consumers. Bank Financial, then, still views multifamily financing requests as solid opportunities. The bank, though, does look for certain factors
before approving these requests, Manos said. For one thing, bank officials will look closely at individual markets. How strong will a particular market be in five years or seven years? Will demand for apartments still be strong? Are rents more likely to rise or fall? “We are very cautious in our lending decisions,” Manos said. “We take a good look at the markets, the property and the sponsor.” What Bank Financial doesn’t want are risky loans. The bank stays away from higher-leveraged properties, for instance. It also prefers to work with borrowers who have a history of success in the multifamily sector. “When we sit down and explain our methods to our borrowers, they do appreciate it,” Manos said. “They appreciate the approach we take regarding risk.”
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Minnesota Real Estate Journal
November/December 2019
What brings in the renters? Internet access, pet perks and smart home features By Dan Rafter, Editor
W
hat do renters want in an apartment home? According to the latest research from the National Multifamily Housing Council, building owners should provide fast Internet access, smart thermostats and perks for pets if they want to attract the greatest number of renters to their properties. The 2020 NMHC/Kingsley Associates Apartment Resident Preferences Report suggests that Internet access is especially important to renters. According to the report, 91.2 percent of apartment residents say that reliable cell phone connection is important, and 44 percent say they won't rent an apartment unit without it. The report also found that highspeed Internet is important to 91.7 percent of residents, while preinstalled WiFi is important to 74.8 percent. An additional 69.3 percent of
residents said that community WiFi is an important feature. This isn't surprising. The National Multifamily Housing Council report found that a growing number of residents own more than one Internetconnected device. In fact, 54 percent of survey respondents said that they had one to four connected devices, while 35.4 percent said they had five to nine. These residents, then, rely on fast Internet access. An increasing number of renters work remotely, with 41.5 percent of respondents saying that they telecommute. What's interesting, though, is that a majority of renters don't use their apartment building's onsite business center. The Multifamily Housing Council found that only 33.3 percent of renters used this space. Smart home technology increasingly matters, too. The survey found that 70.5 percent of renters are interested in smart thermostats, and would expect to pay $30 a month extra for this perk. A total of 66.9 percent said
they are interested in smart lighting and would expect to pay an extra $29 a a month, while 63 percent are interested in smart locks and would expect
An increasing number of renters work remotely, with 41.5 percent of respondents saying that they telecommute.
to pay an extra $33 each month for this premium. Renters are increasingly focused on their health, too, so it's little surprise that so many modern apartment buildings feature well-stocked fitness centers. But what do renters expect
from these centers? A total of 83.9 percent said that exercise machines were either important or very important, while 78.7 percent said the same about free weights. The council found that 70.9 percent said that weight machines were important or very important, while 50 percent wanted yoga classes and 38.8 percent fitness classes. More than one-third of the survey respondents were pet owners. The council found, then, that dog owners expected to pay from $28 to $34 more per feature per month for perks such as a community dog park, pet-washing station or onsite pet services.