Why developers have stopped building apartments
The economics of building apartments in the Twin Cities doesn't work, and it could be a long time before it does.
Why it matters: The metro area is already undersupplied on housing. A staggering decline in multifamily building could drive up prices in the years to come.
By the numbers: After peaking at 15,500 in 2022, permits issued to begin apartment construction in the metro fell to 5,000 last year and are on an even slower pace this year, according to preliminary data from the U.S. Department of Housing and Urban Development.
Zoom in: Sherman Associates has been one of the most prolific local developers in recent years, building hundreds of units in Minneapolis and beyond.
The company doesn't have a single project under construction right now, and as CEO Chris Sherman told Axios, his Minneapolis firm can't make it work without public subsidies.
State of play: While there can be some outliers, the typical cost to build a midrise apartment building (think four to five stories) has reached $320,000-$340,000 a unit, Sherman said.
Meanwhile, the average price paid for Class A apartment buildings was $223,400 per unit last quarter, said Heidi Addo, a broker who sells multifamily communities for Michel Commercial Real Estate.
This massive gap is a nonstarter for most developers, especially merchant builders, who develop apartment communities, fill them up with renters and then sell.
The big picture: The three main reasons for the slowdown:
Construction costs have risen nearly 40% since 2020, according to general contractor Mortenson's Construction Cost Index for Minneapolis.
Interest rates have risen dramatically since 2022, and there's a correlation between them and what price sellers can get for apartments. When interest rates were historically low in 2022, the average sale price of apartments peaked at $285,000 per unit, according to a Michel Commercial Real Estate report.
Rents have not kept up with rising costs. Asking rents in the metro increased only 1.4% year over year in March, to an average of $1,543 per unit, according to the report.
Friction point: Sherman said apartment sales prices will have to eclipse $400,000 per unit before his firm begins building again, with the exception being projects that receive public subsidies, like the one they're working on in St. Louis Park.
"The numbers are just upside down — and not by a little, but a lot," Sherman said.
What we're watching: Both Addo and Sherman believe rent increases are coming. Addo is already tracking major hikes in areas of the metro where few units have been delivered in recent years, particularly the northern suburbs.
Sherman said the sweet deals renters have been getting — like free months of rent for new leases — will be drying up soon.
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