Midwest Real Estate News — February 2011
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Multi-Family’s Strength
Dan Rafter

Stable. That’s the word that Patrick McNulty uses to describe the multi-family market across the Midwest.

And today, “stable” really is the best anyone can hope for when it comes to commercial real estate.

McNulty, a director in the Chicago office of Uniondale, N.Y.- based Arbor Commercial Mortgage, said that the multi-family sector remains strong in most Midwest markets, outperforming retail, industrial and office as 2011 begins.

“When a bad economy hits, the office and retail sectors take a direct hit,” McNulty said. “Vacancies rise quickly. There are layoffs. Stores close. With multi-family, the hit from a bad economy is indirect. People lose homes in a bad economy. But they have to live somewhere. They turn to apartments. That helps keep this sector strong.”

McNulty is far from alone in this assessment. Commer cial real estate professionals across the Midwest agree that multi-family remains the strongest of the industry’s market segments.

Higher rents coming?

Landlords and building owners want to know one thing: When can they start raising rents again? And when they can start cutting back on the concessions they’ve made to entice renters to their buildings?

Charles Meyer, managing director of Columbus, Ohio-based Red Mortgage Capital, said that these days may be coming sooner rather than later.

As the economy shows some signs of life, apartment-building owners will be able to demand more from their renters, Meyer said, within reason.

“The ability to pull rents up is coming,” Meyer said. “It’s not here Yet, but as jobs begin to get created again, as the employment picture improves, we will see this happen. And you’re already seeing many of the concessions disappearing.”

The troubles of the housing market are helping this along. Residential mortgage lenders, chastened by the criticism they received for their lax lending standards leading up to the Great Recession, have now moved in the opposite direction. Many conventional mortgage lenders are requiring borrowers to come up with down payments of 20 percent of a home’s purchase price before they’ll approve mortgage loans.

Lenders are placing an even greater emphasis on credit scores, too, sending many credit-challenged borrowers to FHA loans as their only hope to acquire mortgage financing.

The numbers

As borrowers struggle to qualify for home loans, a greater number of them are renting. After all, they do have to live somewhere.

At the same time, many former homeowners, who have either lost their residences to foreclosure or who walked away from upside-down mortgages, are viewing renting as the sounder economic decision in today’s challenging economy.

At the same time, most Midwest markets haven’t overbuilt when it comes to multi-family properties. This has led to solid vacancy rates in most metro areas.

According to the 2011 National Apartment Report from Marcus & Millichap Real Estate Investment Services, developers will complete 53,000 total rental units across the country this year. That falls short of the number delivered in 2010, by a rather large 46 percent.

This new supply of apartments will again fall short of demand. As a rest, Marcus & Millichap is predicting that U.S. apartment vacancy rates will decrease 110 basis points this year to 5.8 percent.

Marcus & Millichap is also predicting that building owners will regain some of their pricing power in 2011. Asking rents will jump 3.5 percent to $1.067 a month in 2011, the company says, while effective rental rates will rise 4.5 percent to $1,002 a month.

Marcus & Millichap ranks Minneapolis/St. Paul as the top Midwest market for multi-family, ranking eighth overall across the country. Other Midwest markets ranked high by Marcus & Millichap are Louisville, ranked 22nd; Chicago, 23rd; Milwaukee, 25th; Kansas City, 26th; and St. Louis, 29th.

Harry Giallourakis, managing director of Cleveland-based Bellwether Real Estate Capital, said he isn’t surprised at multifamily’s continued stability.

“There has been no new construction in the Midwest in multifamily of any significance,” he said. “The housing market woes have helped multi-family. In the past, the apartments market came under stress because of the ease of access to home buying and financing. That’s changed, so people are turning toward multi-family.”

Giallourakis said that higher-end apart ment complexes across the Midwest are holding up especially well even as the economy continues to struggle. Occupancies for these buildings generally hover north of 90 percent, he said. Concessions at these buildings Are minor or nonexistent. And while real rents may not have increased yet, they have stabilized in these higher-end properties.

Any problems that multi-family buildings are having are occurring at the lower-end of the scale, Giallourakis said.

“That has to do with the economic woes of the working class,” he said. “There is still some pressure in these lower-end buildings for owners to offer more concessions to gain tenants.”

CMBS pressures

Giallourakis has seen some stress on the CMBS side, though.

“Three to five years ago, a lot of these loans were made. Some were interest only, and they were at maximum loan-to-value ratios,” he said. “These loans are under some stress today.”

The best hope for borrowers is to return to their mortgage servicers in the hopes of renegotiating their loans, Giallourakis said.

Not all Midwest markets, of course, are created equal. McNulty says that multi-family is struggling in Detroit, in parts of Indiana and in sections of Ohio.

Other Midwest markets, though, remain strong for multi-family, McNulty said. He pointed to Chicago, Milwaukee and Kansas City as solid multi-family markets.

But McNulty reserved the most praise for the Minneapolis/St. Paul market.

“Minneapolis is a great market,” he said. “It is doing very well. It’s one of the stronger markets out there. It has a very diverse economy. The area has never overbuilt. It’s one of those economies that doesn’t go through booms or busts. They don’t overbuild in Minneapolis/ St. Paul. It’s just a more conservative market, and that has helped it during this economy.”

Meyer agreed that Minneapolis/St. Paul is one of the stronger multi-family markets in the Midwest. But he also wanted to pass some positive comments to areas of Michigan.

Detroit’s multi-family market may be struggling, but many of the communities surrounding the city are actually doing well, Meyer said. He pointed to the Grand Rapids, Mich., market as an example .