Chicago multifamily real estate is struggling with flat rent growth in downtown submarkets, a packed pipeline through 2019, and rising construction and labor costs. Those same issues are being grappled with by developers across the Midwest.

CoStar Market Analytics Economist Brandon Svec said that as more Class-A apartments are being delivered, pre-leasing percentages at new buildings are declining, even as the pace of lease-ups remains the same. This is a sign renters recognize they can shop the market for the best abatement packages and keep their rental costs down over the term of a lease.

The flexibility that renters have to chase abatements is coming at the expense of Class-A buildings delivered earlier in the cycle. Svec confirmed observations by developers like Fifield Cos. CEO Steve Fifield and Golub & Co. principal Lee Golub that lease retention rates are on the downswing.

This is not unique to Chicago. Apartment rent growth is flat across the Midwest and, depending on existing supply and what is being delivered, is resulting in a bifurcation in Midwestern multifamily real estate. Milwaukee and Minneapolis are on the upswing as supply is catching up to demand. Minneapolis, in particular, has 6,000 new units ready to go online.

Svec sees the bifurcation continuing along with slowing rent growth. Long term, the fundamentals of multifamily across the Midwest are strong and will remain so, as long as homeownership rates stay low.

Svec said that would take a substantial amount of new starter home and second-tier home supply, and permitting numbers indicate that is not happening. And while baby boomers account for more than half of the country's rental growth in the past decade, the sizes of the homes they are selling are larger than what millennials and Gen Xers are willing to take on.

The bifurcation is affecting transaction volume across the Midwest. There was a slowdown in multifamily trading volume nationally in H1, and even after a relatively robust Q3, trading volume for the year is 13% below 2016's rate. Svec said compressed cap rates and slow rising interest rate hikes were contributing factors in the slowdown. Couple that with more supply and static rent growth and it is harder to realize the yields investors seek.

There are healthy investor markets. Svec said multifamily transaction volume in Minneapolis through Q3 eclipsed last year's numbers, while in Milwaukee trading volume is already higher than all of 2016.

Investors are also flocking to the suburbs across the Midwest for opportunities. Svec said the explosion of activity in the Chicago suburbs during 2017's second half is a result of investors chasing yield, and a value-add play is a surefire way to attain that. Although the value-add landscape in suburban Chicago is tighter than it was a couple of years ago, investors continue to find quality assets in well-populated suburbs with easy access to downtown Chicago.

The search for yield is even reaching to older suburban Class-A product, which Svec said is an indication investors believe there is still some runway for rent growth.

To learn more, attend Bisnow's Big Midwest Multifamily Event, 8 a.m. Nov. 29 at the J.W. Marriott Chicago hotel.