Talking about interest rates is boring unless you are a property developer. They could determine whether the 2040 Plan succeeds.
Because we don’t like fun, we recently spent a considerable amount of time reading comments on the 2040 Plan from five years ago. Today we are reviewing a few of the strengths and weaknesses of comments we read.
Status of the 2040 Plan
The Minnesota legislature has provided proponents of the 2040 Plan an opening by shutting down lawsuits designed to stop it. While appeals could still hamper its full implementation, for now, it is full steam ahead—sort of.
On June 25th, Mayor Frey took a victory lap for the 2040 Plan. He spoke to a crowd of supporters and press on the rooftop of the new Wakpada Apartment building at 46th and Minnehaha Avenue. Speakers included Aurin Chowdhury and the property developer, Sean Sweeney of Hall Sweeney Properties.
Much of the original opposition to the plan focused on the fact that it eliminates zoning for single-family homes. Minneapolis is the first city in the country to take this step. There was concern that duplexes and triplexes would be plopped down into single-family home neighborhoods and change their character. From day one, this scenario seemed unlikely. People live in their homes. The idea that homeowners would move out of their houses, rent an apartment, and tear down a perfectly fine house to build a rental property never quite made sense financially or motivationally. Existing neighborhoods are safe from an onslaught of homeowners turned general contractors and landlords.
One of the main reasons people choose to live in these neighborhoods is to raise a family. People want a yard and privacy. They want a kitchen with counter space. Studio apartments at Wakpada are available for $1,375 a month for 500 square feet. Your bedroom is also your living room. If you’re single and earn $66,000 or more a year, you may not mind living in one of these apartments. However, when you marry, or have a child—or children—you will want more space. If you can save enough for the down payment on a house while sending 25% or more of your earnings to your landlord every month, you will use that money to buy a single-family home because you need more space and want to start building equity for the future. When people who spend their 20s and early 30s washing dishes at the foot of their bed have children, they move into a single-family home. The fitness center down the hall and the lobby artwork become a lot less important when you share that spacious 500 square feet with another person or two or three.
People do not want to move out of their single-family homes. Despite high interest rates, there are more people looking to start families in these homes than there are homes available. Why? Because the interest rate current owners have on their mortgages are lower than they would get if they moved. Therefore, people stay put, even if their children have moved on and they are left with empty rooms through which to wander.
Housing as a Commodity
To quote one of the many comments we read:
“The major flaw in this “Zoning” plan is the assumption that new housing will be more affordable. Why would cheap housing emerge from a process wherein everyone doing the building from developers to “flippers” is trying make as much money as possible?”
One belief underpinning our expectations for housing is that housing is a commodity. Much like sugar, lumber, or cotton, housing is treated as an object you want to buy low and sell high. The purpose, of course, is to turn a profit. This is why people choose to become landlords in the first place. It is why developers like Hall Sweeney Properties are in the game. You invest money in a project after examining the market and determining you can collect enough rent to pay your debt on the mortgage and turn a profit. Alternatively, you build your project with the intention of selling it in a few years at a higher price than it cost you to build and maintain. A great deal of wealth has been generated following these models.
Reducing zoning restrictions can help the developer by allowing them to increase density (the number of people in the property paying rent) and eliminate expenses such as the requirement to build parking. However, there are many other factors to consider. Expenses such as the price of land, environmental cleanup, labor wages, timber prices, and design fees influence your total costs. One of the most influential factors, however, is the interest rate you pay on the money borrowed to finance these costs. The rent you must charge for the project to succeed (turn a profit) is directly related to your borrowing costs.
When the subject of interest rates and the stock market comes up, many people’s eyes glaze over. They have zero desire to track the rates associated with the sale of 10-year Treasury notes. However, we would argue that interest rates play a greater role in determining rent than the 2040 Plan.
No one gets into real estate to lose money. And right now, that means fewer developers are willing to build multi-family projects in Minneapolis. Instead, people are choosing to build single-family homes in the suburbs.
For a Property like Wakpada to Succeed, It Needs a Few Things:
• First, it needs low interest rates or large amounts of cash. Most developers do not want to risk their own cash, so they borrow from regional banks.
• Second, you need a steady supply of single people or small families earning over $66,000 a year who either work from home or in a location accessible by public transportation or car. For example, if you work at the Brooklyn Park Target location and you live in Wakpada, you will need to drive if you have to be in the office. These individuals must also be willing to accept 500 square feet of living space.
Kysa McDuffie, a development associate at Hall Sweeney Properties, told Finance & Commerce in 2022:
“Wakpada Apartments has slightly smaller units of 450 to 550 square feet that rent for a few hundred dollars less than comparable but larger apartments in other buildings. “The smaller units allow us to build more density and give people a more accessible price point in the market,” she said.”
According to RentCafe.com, the average rent in Minneapolis is $1,662 with an apartment size of 775 square feet. The average rent has remained relatively flat the last few years. It may be more informative to look at the median rent, which has gone up 8% in the last year. For a city with a growing population of renters, that means more money is going toward rent, which does not build equity and wealth.
The idea that density will lead to a lower cost of living has yet to be proven on a city-wide scale. Zoning that is more conducive for apartment developers is being overwhelmed by the reality of high interest rates. More housing units of every sort are needed if Minneapolis wants to house people here, but high interest rates have slowed development. Current building permits show us the trend is for single-family homes in Woodbury, Rosemount, and Prior Lake. If this trend continues, the hope that people will drive less because they will live in apartments by transit hubs will go unfulfilled. If families in the suburbs come into the city at all, they will be driving from further away.
The average vacancy rate in the metro is below 5%, with eight renters competing for every unit. A goal of the 2040 Plan is to increase density and build enough apartments that owners of older units will be forced to keep rents at their current levels or lower. For this goal to be realized, it would require that developers oversaturate the market. Even if they were inclined to do so, high interest rates are putting the brakes on this ability. You don’t invest in real estate to lose money.
Where Do You Stand on the Plan?
The boxy and often unattractive apartment buildings that have sprouted like mushrooms around the city the past few years are needed, but it’s misguided to say reducing zoning restrictions will necessarily result in affordable housing. It seems more accurate to say that the 2040 Plan has led to the creation of more rental units, which are in tremendous demand. Minneapolis is trying to keep up with this demand while larger economic forces are undermining the efforts to create sufficient supply.
Single-family homes remain desirable, and the fear of a renter invasion into neighborhoods primarily composed of these homes seems to have been overblown. Housing will be created where it makes economic sense. Right now, until interest rates decrease meaningfully, that often means building new homes outside of Minneapolis.
Given that housing is treated like any other commodity, regardless of the impact on people involved, the government needs to be involved to ensure that the worst abuses of greed and delusion are mitigated. The city and state have invested hundreds of millions of dollars into this market, and we want to get it right. When we discuss housing, it can’t only be about good intentions; there must be room for boring facts and figures.
