Over 80% of the U.S. population now lives in an urban area, with that number expected to rise over the next few years. Influenced by a millennial population that continues to choose to rent over homeownership and a desire to live and work in areas with accessible transportation and entertainment options, multifamily has grown to meet demand.
While multifamily activity continues — and makes headlines — in gateway cities like New York, Los Angeles and Chicago, some of the fastest-growing cities have been smaller urban areas in states where population booms are triggering an increased need for apartments.
It is a phenomenon Penny Bradbury, a vice president in Hunt Real Estate Capital’s Denver office, sees daily.
“Smaller cities are attractive to young professionals because they present similar employment and entertainment prospects of a mid- to large-sized city at a more affordable price point,” Bradbury said. “Many individuals who move to smaller cities often want the flexibility of renting, either to test out the waters before a purchase or to remain free for another potential move.”
Below is a list of expanding small cities that generally don’t come to mind when thinking about apartment investment:
Some parts of the U.S. have seen a welcome flurry of construction activity and in-migration. In Missoula, Montana, wage growth outpaces the rest of the state, as construction activity from new multifamily development has increased demand for construction workers. Despite new construction, healthy in-migration from other states — over 59% of new Missoula residents are transplants — has kept vacancy below 3%.
Colorado Springs is another market that is experiencing a flurry of activity. According to the Brookings Institution, “The Springs” is the top market in the country for millennial in-migration, seeing a 14.7% increase from 2010 to 2015. Rents that average $400 less per month than Denver — for properties about an hour north — play a part in the city’s attractiveness, Bradbury said. With over $750M in development in recent years, it is evident Colorado Springs developers aren’t having any issue making things pencil out.
But city officials and community groups within smaller cities are not always welcoming of the change a growing population brings. After multifamily permits in Murfreesboro, Tennessee, increased from 445 units in 2016 to 1,233 in 2017, the city council placed a moratorium to cap new apartment developments at 100 units and limit multifamily construction to rezoned districts.
There are also obstacles when it comes to financing. While demographics present a strong case for establishing a presence in a smaller apartment market, existing or prospective owners and operators in small cities face limited capital sources compared to gateway cities. “Larger-market multifamily owners have a larger menu of debt options,” Bradbury said. “National banks are typically not familiar with the dynamics of smaller real estate markets, and the local banks may be conservative without a long-standing relationship. Luckily, Fannie Mae and Freddie Mac are both active on a national basis, regardless of market size.”
Compared to large cities, which have seen more interest in high-rise, Class-A multifamily development, the size of apartment communities and cost-per-unit in these secondary cities puts most transactions into the $1M to $7.5M, small balance loan range. While both Fannie Mae and Freddie Mac’s small loan programs offer streamlined, cost-effective financing, borrowers need to understand how the two programs differ, and how this can impact financing in smaller markets, Bradbury said.
“Though the industry recognizes Freddie Mac’s small balance loan solution as an extremely attractive solution, some competitive features emerge in Fannie Mae’s program when transacting in these smaller markets,” Bradbury said. “It is worth closely examining how these two loan programs work in smaller markets, and depending on the owner’s business plan, pricing and loan amount results can be significantly different.”
A key factor in receiving an attractive small loan offer from either agency depends on the affordability profile of the property and the number of units. For market-rate properties with five to 50 units, both Fannie and Freddie offer extremely attractive terms.
For more information on how to finance a multifamily property in a smaller market, reach out to Hunt’s Penny Bradbury at Penny.Bradbury@HuntCompanies.com or (720) 639-5715.
(This article was originally published on Bisnow.)