We’re in the midst of a perfect storm in terms of developing downtown rental housing.

The demand is growing, the supply is stagnating. And the prospect for condominium development is almost nonexistent.

“If you’re a condominium developer these days, you’re out of luck,” says Phil Scherer, president of Commercial Kentucky. “You can’t get construction financing and your buyers can’t get mortgages, so nothing’s getting built. Would-be buyers have become would-be renters.”

River Park Place

Steve Poe’s River Park Place

But it’s as if the pause button were hit at the very top of the storm’s wave. Nothing is happening.

“There’s a great deal of interest in the development community – including some out-of-town parties – and the builders want to build,” Scherer told me. “But they need to make money.” That’s a peculiarity of the capitalist system.

So the idea is to find the sweet spot of the market: that intersection of apartment size and rent that attracts renters, has the density of units that will produce sufficient revenue and is located where land is available and the developer can get financing.

To switch metaphors, it’s a classic three-legged stool: Remove any one of the legs and the whole thing collapses.

Scherer references a couple of projects where the legs of the stool seem to be in balance. At developer Steve Poe’s WaterSide at River Park Place, the riverfront location in Waterfront Park walkable to downtown and NuLu, the units are small – mostly one and two bedrooms, and almost all of them are less than 1,000 square feet. The rents, too, are mostly below $1,000 a month.

310 at NuLu

Bill Weyland’s apartment property between NuLu and the hospital district

At developer Bill Weyland’s 310 at NuLu, at South Hancock and East Jefferson streets on the eastern edge of the official CBD boundary, there are studio and one-bedroom units at 600 square feet and below. Here, too, rents are mostly below $1,000 a month, except for the few two-bedroom apartments. While the location is meant to appeal to those wanting to live close to downtown and East Market Street, it also capitalizes on its proximity to the nearby medical centers and hospitals.

In both cases, the target market is younger, probably single, 20-and-30-somethings who like the idea of living within walking distance of the action of Fourth Street Live, the Yum Center and the Main Street bar and restaurant scene. And, in the case of 310 at NuLu, it’s three blocks from the nearby medical centers and hospitals, aiming at med and dental students, residents, interns, young physicians, nurses and staff members.

“I think today’s young people, especially in Louisville, are more willing to spend a little bit more to live by themselves,” says Scherer. “The privacy, the independence, the peace and quiet.”

He notes that Louisville is a relatively new urban rental market. “In New York or Chicago, young renters are accustomed to squeezing into small apartments with lots of roommates; it’s often the only way to get available, affordable downtown apartment space. But in Louisville, where people are used to larger living spaces, young renters are more likely to want to live by themselves – so the smaller, more affordable, units work.”

That’s good for the renters, but also good for the developers. Because the size and rent of the units are not arbitrary. According to Scherer, all the analysis says you need to charge rents of about $1.25-$1.40 per square foot to maximize your profits. That’s the sweet spot.

“So if that demographic is looking to spend about $700 a month in rent, you do your arithmetic and the ideal apartment becomes a 500-square-foot studio or one-bedroom,” he says. “Less than that and the developer won’t make enough money. More than that and he’ll price himself out of the market.

“If you can’t get that $1.25 or so for a new rental project today, the project won’t get built. The market is thin at the $2,000-a-month level, and developers always shoot for where the market is fat.”

But size of the unit is not only being driven by the desire and willingness of the market. Land is expensive and construction costs are high – especially, says Scherer, on East Main and East Market, where developers have to compete with commercial users, which makes the property costs that much higher.

“It’s difficult to make a project work if the price tag for land starts at $35 a square foot.”

It’s also difficult to make a project work unless you pack as many units into a building as possible to achieve the density necessary to reach the profit level.

“You’re not going to find those 1,000-square-foot apartments in this market,” Scherer says. “It’s going to be small, or it isn’t going to be developed.”

He says you won’t see many 30-unit developments in Louisville. “These guys want to do 100 units and they’d really prefer 300 units. It’s the economies of scale. The more smaller units you can get into a building, the better your financial model.”

So the market is booming, steam shovels and cranes operating at maximum capacity in every corner of downtown Louisville?

Uh, no.

“Actually, we’re in a bit of a standoff right now,” Scherer acknowledges. “There’s not a lot of available land, and what is available is expensive. And the closer to the CBD, the more expensive the land becomes. The more expensive the land, the greater the density you have to develop. And the greater the density, the greater the risk. The developer has to ask how long it will take to rent 100 units?”

There are serious discussions going on right now between interested developers and the mayor’s office and the Downtown Development Corp., but there’s only a limited amount of things they can do, he says: “The city’s bag of tax credits is empty.”

Still, Scherer says, “We’ve identified the demand and we’ve identified the product to meet that demand. We have a lot of developers eager to get into this market, and banks eager to make some loans.

“I think we’ll see the logjam break and things start to happen. There’s a pretty simple rule in real estate: Developers always go where the money is.”