Key market forces in area keep rental numbers up

The Brewery Creek project was initially planned to include low-income rental housing, retail and office space. However, access, parking and other issues have made a mixed-use option cost-prohibitive

Rental units of all shapes, sizes, ages and prices abound in Duluth.

There’s Chester Terrace and its charming, Romanesque Revival architecture gracing the neighborhood near St. Luke’s Hospital. And the lake views of Les Chateaux along London Road. Or the glossy new upscale units like BlueStone Lofts and Boulder Ridge, which seem to be popping up everywhere in the city. And aging triplexes and duplexes are perched on the Central Hillside and scattered around Lincoln Park and West Duluth.

Indeed, recent statistics from the U.S. Census and city of Duluth show that roughly 40 percent of Duluth households live in rental units.

Does that seem high? Well, it is when compared with the rest of the state, where a quarter of all Minnesotans, about 1.3 million people, rent rather than own, as MPR recently reported. Yet it’s not that high when compared, for example, with Minneapolis, where about 53 percent of residents are renters, according to data from the American Community Survey and reported last year by MinnPost.

Whether or not Duluth’s rental-to-ownership ratio should be considered high or not, property managers and other industry observers cite several key market forces at work influencing the ratio. These include:

• A lingering impact from the Great Recession of 2008 and its housing crisis. Many homeowners at that time could no longer afford their homes and became “accidental landlords,” as one Duluth property manager put it, or, worse, lost their homes to foreclosure and became renters themselves. The effect of policies like tightened lending regulations emerging from that recession have put a financial squeeze for some on home ownership.

• Affordability, which is related to the aforementioned, but also includes a host of other issues such as individual incomes, limited real estate inventory at lower price points, an aging housing stock, a tight rental market, and so on.

• A demographic that includes college students and young working adults, which skews heavily to renting rather than owning.

• COVID-19’s impact. In May, when this edition of Business North went to press, it was still too early in the pandemic to determine just what kind of impact this public health and economic crisis was going to have on rental markets. Some Duluth property managers reported a fairly standard April for rent collections while others saw a roughly 5 percent drop in rental income during April. Statewide, data from a survey by the Minnesota Multi Housing Association, a trade group of apartment owners and managers, which was recently reported by MinnPost, showed a drop in all property classes and especially in Class B and C properties, those that are older and less expensive. For Class B, non-payment and late payments of rent between March 2020 and April 2020 increased from 7 percent to 15 percent. For Class C units, numbers increased from 9 percent to 15 percent. The group surveyed its members on the level of non-payments on or around April 1, compared to March 1. The data represented around 28,000 housing units. In another statewide survey, rental income declined by 16 percent on average in April 2020 as compared with March 2020, according to data collected in mid-April by the Greater Minnesota Housing Fund. The rental property survey by the St. Paul-based non-profit affordable-housing lender included rent-assisted housing units (55 percent) and non-rent-assisted units (45 percent).

Great Recession created 

‘accidental landlords’ and more renters

The housing crisis in 2008 put many homeowners “underwater, and they had to rent out their homes to cover their mortgages,” recalled Alex Rogers, a principal of East West Property Management in Duluth, which manages about 550 rental units in the Twin Ports area, from apartment buildings to single-family dwellings. “These homeowners became accidental landlords and created a larger number of rental units” in the area. Additionally, in other cases, foreclosed homeowners became renters, also adding to the rental ranks.

The recession of 2008 created more barriers to home ownership, several sources said. A major change was that banks altered their lending practices, including a requirement, for example, of a 20 percent down payment, said Blake Shippee, an owner of property management firm ShipRock Management, which manages 1,300 rental units in the region. “Consequently, a lot of people can’t make that, so they get into a rental cycle.”

One bit of good news on the real estate side, in 2018, Duluth had the lowest number of foreclosures (57) in a decade, according to City of Duluth statistics. The peak of foreclosures was in 2010, with a total of 270. Still, affordable housing remains an issue. 

Affordability can be an

ownership barrier

Duluth’s shortage of affordable housing – both rental and owner-occupied – has been well documented.  

On the home-ownership side, those with lower incomes simply can’t afford to buy a house these days. In other words, “the current housing market doesn’t work for poor people,” said Jeff Corey, executive director of the non-profit One Roof Community Housing. One Roof has developed recent projects such as the 44-unit Steve O’Neil Apartments on Fourth Street near the Damiano Center, and the renovation of Gateway Tower near the public library downtown. 

“A lot of jobs in our community don’t pay enough for people to afford housin One potential answer is to raise incomes, another is to do things like lower the cost of housing. It’s a really complicated question but it’s important for us to be honest” about these core issues beyond looking only at the tools his and other organizations use to create affordable housing, such as down payment assistance and other programs.

Duluth does have a fair number of residents in that lower-income category, according to the American Community Survey cited by the City of Duluth. For example, poverty levels in the city have remained consistent for the last decade. In 2018, about 20 percent of Duluthians lived below the federal poverty line. In 2018, the U.S. Department of Health and Human Services determined that the federal poverty level for individuals started at $12,140, increasing by some $4,320 for each additional person – so the federal poverty level for a household of two members would be $16,460.

Beyond the income issue, home ownership in Duluth also is influenced by having some of the oldest housing stock in the state, said Jill Keppers, executive director of Duluth’s Housing and Redevelopment Authority (HRA). 

“Existing houses are old. There are lots of houses in Duluth over 75 years old.” So, beyond a livability issue that aging homes present, there are added construction or repair or redevelopment costs. On the other hand, Keppers added, “someone could get into one of these homes fairly affordably with their own sweat equity.”

Contributing to that scenario, though, is yet another barrier-to-ownership issue that can emerge.  Even if a person could do the sweat equity, and “even though a person may be able to afford a monthly payment, other elements will be looked at before that person gets approved for a mortgage,” said Keppers, including “factors such as credit score, amount of existing debt and so on.”

On the rental side of the housing issue, there’s also a lack of affordable units because of the area’s low vacancy rate, Keppers said. She said the vacancy rate in Duluth has been consistently under 5 percent, and in fact, for 2019, it was 2.6 percent, according to the City of Duluth Housing Indicator Report. “So, we need to find incentives for developers to build affordable housing and for landlords to keep their rents affordable.”

Those on the front lines of property management seem to agree. The rental market in Duluth is indeed tight, said Tyler Bystedt, office manager for ShipRock Management. 

“Well-maintained, clean, market-rate homes and apartments typically lease pretty quickly,” he said. 

As a result, a long list of housing efforts are aimed at supporting and adding to the city’s stock of affordable units: various down payment assistance programs, community land trust programs, tax-credit projects, HRA-coordinated home ownership opportunities, HRA homeowner and rental rehabilitation options for private homeowners and landlords, and community organizations such as One Roof Community Housing and Central City Housing Corporation. Recently, the Minneapolis Star Tribune reported that a task force created by Duluth Mayor Emily Larson recommended, among other suggestions, that the city create a housing trust fund and a loan guarantee program as other ways to address an affordable housing shortage.

One industry observer wonders about all of these efforts. 

“Sometimes I worry that we build too much…do we have more than we need, and are we keeping people in a rental situation when there’s no incentive to get out of it,” said Greg Follmer, owner of Follmer Commercial Real Estate. “I don’t want to be against it, but I want to right-size it for our community.”

As a commercial real estate broker, he is especially concerned with where some of these affordable housing developments have been placed – the land-usage aspect. 

“Stop putting some of these units on valuable taxable land where there could be viable commercial real estate,” he said.

One example he cited was Garfield Square Apartments, which opened in January. He acknowledged it is providing a needed affordable housing solution for a population that had been living in deteriorating, less-than-desirable housing such as the Seaway Hotel, but Garfield was “built on a prime corner of developing Lincoln Park.” It’s also located in a food desert, another problem the city is addressing.

Follmer said one solution could be to opt for more mixed-use development.

One potential mixed-use project was planned for One Roof’s Brewery Creek, on Sixth Avenue East and Fourth Street. The project was initially planned to include low-income rental housing, retail and office space. However, access, parking and other issues have made a mixed-use option cost-prohibitive, said One Roof’s Corey, so it will now be strictly housing. Construction of Brewery Creek is set to start in 2021.

A younger demographic: College students, others choose to rent

With UMD, CSS, UWS and Lake Superior College all in the area, student housing is a large part of the area’s rental market, said ShipRock’s Bystedt. “Very few students decide to purchase property while working their way through school.” He estimates about 35 percent of ShipRock’s units are rented to college students.

Added Follmer, “A lot of guys have been making money doing college rentals for years, and this has expanded beyond just the UMD area, too, to the Central Hillside and even West Duluth.”

Beyond students, though, young working adults are also often opting to rent rather than own, said Frank Rush, a principal at East West Property Management. 

“Millennials have been less in favor of being tied down to a mortgage. Renting offers increased mobility and flexibility. Millennials may also have bad memories of their parents in 2008 going through the housing crisis.”

Realtor begs to differ

So, what’s the view from the real estate side of things? Call it the minority opinion.

Doug Kman, a Realtor for Coldwell Bank East West Realty, is the current president of the Lake Superior Area Realtors Association. He said barriers to housing “are psychological. I feel people don’t seek out educational opportunities with real estate agents to see what ownership opportunities are out there.”

There are options beyond the 20 percent down payment requirements for instance, including first-time home buyer programs that allow for as little as 2 percent down.

Additionally, he noted that millennials are indeed interested in buying homes. 

“The market is showing us that for four or five years now, they are the single largest portion of the home buying market.” Kman said his property management colleagues may be thinking of those in Generation Z, who are younger than millennials and are just now in college or just getting out of college, who are still renting rather than owning.

Kman did acknowledge that when the economy is as good as it has been – up until the recent pandemic – property investors have been taking advantage of their existing capital and buying up “deteriorating housing stock and increasing the rental pool, thus decreasing the inventory of single, owner-occupied family homes.”

Ultimately, the key market forces identified here will continue to influence Duluth’s rental and real estate outlook and that outlook will likely be dramatically affected by the public health and economic impact of the current COVID-19 crisis.