News Release
Office Market Turnaround Highlights First-Half 2004 Twin Cities Commercial Real Estate Market
United Properties Mid-Year ‘Outlook’ Market Study Reports Improving Office, Industrial Markets; Retail, Investment Markets Continue to Roll Office Market Turnaround Highlights First-Half 2004 Twin Cities Commercial Real Estate Market United Properties Mid-Year ‘Outlook’ Market Study Reports Improving Office, Industrial Markets; Retail, Investment Markets Continue to Roll
MINNEAPOLIS (July 26, 2004) — Sustained recovery in the Twin Cities commercial office and industrial markets began in earnest the first half of 2004, while the retail and investment markets continued to steam forward, according to United Properties’ mid-year 2004 Outlook market study. The Twin Cities-based commercial real estate company’s comprehensive Outlook market study, including analyses of the commercial office, industrial, retail, multi-family, medical and investment markets, will be released today at www.uproperties.com.
“We can say with good confidence that the Twin Cities office and industrial real estate markets are showing consistent signs of recovery,” said Mike Ohmes, senior vice president United Properties Brokerage Services. “The retail market continues to be in high demand, which is keeping vacancy rates well below the national average. And investor interest is strong across all commercial property types, especially for well-located buildings with stable tenant lists.”
New development construction among all commercial property types is on pace to be the lowest the Twin Cities market has tracked in a decade, with only 858,000 square feet being delivered to the market the first half of 2004. “We are seeing some very select speculative construction, and developers across the board will continue to exercise restraint into 2005,” Ohmes said.
Office Market: Vacancy Declining, Absorption Positive
Marketwide office vacancy rates remained high but declined slightly from year-end 2003 rates of 18.9 percent direct/21.6 percent with sublease to first-half 2004 rates of 18.3 percent direct/20.8 percent with sublease. The highest office submarket vacancy rates continue to be concentrated in the Minneapolis and St. Paul central business districts (CBDs) with both continuing to report vacancy rates above 20 percent.
Following five consecutive six-month periods of negative absorption, the Twin Cities office market reported positive absorption of 344,864 square feet during the first half of 2004. The last six-month period of positive absorption occurred the first half of 2001. Six of the seven office submarkets reported positive absorption, with the West submarket leading the way at 224,136 square feet. Only the South/Airport office submarket reported negative absorption of 46,961 square feet. Absorption is the difference in occupied space from one time frame to another.
No new construction was delivered to the Twin Cities office market the first half of 2004, which has not happened in any six-month period since 1996. United Properties is projecting about 250,000 square feet of new construction to come online the second half of the year. This will represent the lowest annual rate of new office construction since 1995 and 1996 when no new office development occurred.
“The Twin Cities office market is on firmer ground today than at any time in the past three years,” said Bob Revoir, senior associate, United Properties Office Brokerage. “Our research is signaling the beginning of a recovery in demand, although not every submarket will get out from under high vacancy rates at the same pace.”
The recovery seems to be taking root faster in some suburban office submarkets, according to Revoir. “The CBDs, particularly Minneapolis, tend to be populated by larger companies that have empty offices to fill before they expand. Add 600,000 square feet of sublease space in downtown Minneapolis to the picture, and it will be another 18 months before we’ll see the overall vacancy rate in the CBD drop below 20 percent.”
Many tenants are also tempering their real estate plans while waiting to see what happens with the six large office buildings, representing 3.6 million square feet of Class A space, currently for sale in the Minneapolis CBD, Revoir added.
Landlords’ success with the “blend and extend” approach to early tenant lease renewals has taken some of the steam out of office tenant demand, particularly in the Minneapolis CBD. Looking to bolster occupancy levels through the worst of the economic downturn, many landlords offered to rewrite existing leases for tenants in recent years at current market conditions — if those tenants agreed to extend their commitments for space further into the future. “The net result has been that many leases due to expire in 2004, 2005 and beyond have been renewed ahead of time, eliminating a substantial amount of prospective demand,” Revoir said.
Class A quoted rental rates for the overall Twin Cities office market are at an eight-year low, averaging $13.60 per square foot. This is driving some tenants to upgrade to A level space, particularly from Class B space. Conversely, the historically low rates for Class C space, averaging $8.11 per square foot at mid-year 2004, are proving irresistible to some tenants whose leases for Class B space are nearing expiration. These market dynamics have put pressure on many Class B buildings, resulting in mid-year 2004 vacancy rates of 19.8 percent/22.1 percent with sublease and first-half absorption of negative 77,171 square feet.
The Office Outlook: Another 500,000 square feet or more of positive absorption is within reach for the overall Twin Cities office market over the next six months, resulting in as much as 1 million square feet of real growth in occupancy for the year. “As demand for space increases, landlords will need to continue to be aggressive in their pursuit of tenants who have a wide range of choices in a highly competitive marketplace.”
Industrial Market: Vacancy Up Slightly, Absorption Strong
The Twin Cities industrial real estate market posted its second consecutive six-month period of positive absorption with 318,193 square feet for the first half of 2004. This is significantly lower than the 1.1 million square feet the industrial market absorbed the second half of 2003. However, it is a significant one-year reversal from the mid-year 2003 marketwide absorption rate of negative 1 million square feet.
The industrial market vacancy rate essentially held steady the first half of 2004 with a direct vacancy rate of 15.7 percent/17.5 percent with sublease. This is up slightly from 15.2 percent direct/17 percent with sublease at year-end 2003.
The State of Minnesota* in March released a survey of more than 160 Twin Cities manufacturing and technology companies in which the large majority said they were “very likely” or “somewhat likely” to make new investments this year in employment, capital equipment and/or new or expanded facilities. “This is good news for a market sector that has been hit so hard by the economic downturn,” said Jason Meyer, vice president, United Properties Industrial Brokerage. “The prospect for additional real estate growth in this sector looks good.”
Office showroom and office warehouse properties reported marketwide vacancies at 11.2 percent and 14.4 percent, respectively, holding steady from year-end 2003. However, the bulk warehouse market is dragging the industrial market down with vacancies of 20.6 percent, up from 18.6 percent at year-end 2003. Much of the empty space is the result of companies downsizing or going out of business. Thirty-five bulk buildings with spaces of 50,000 square feet or larger, totaling nearly 10 million square feet, are available across the Twin Cities market.
“Many of the obsolete properties will be torn down or repositioned,” Meyer said. “The remaining bulk buildings will either be acquired by users or piecemealed off to smaller tenants. Big tenants are kicking tires in the marketplace, and some spaces eventually will be absorbed. We expect entrepreneurial investors and developers to get creative with some of these buildings, either converting them to multi-tenant properties or completely redeveloping the sites.”
The Northwest submarket, the second largest, is poised to be the first to recover and could see its vacancy drop from 11.4 percent to 10 percent over the next year. Proof of the submarket’s health is the speculative development occurring in Rogers and Brooklyn Park.
There will be no rush of new industrial construction in the foreseeable future, as industrial developers continue to be faced with the rising price of steel and other building materials. These additional costs will force a higher adjustment in future rental rates. Currently, rates are flat and landlords are offering concessions to draw tenants.
Another development hurdle is the lack of industrial-zoned land. “Some cities that historically welcomed industrial development now want higher-finish, higher-image commercial development, forcing industrial developers to look elsewhere,” Meyer said. “Industrial developers are also finding themselves competing with housing developers who are moving further and further out and acquiring land once designated for industrial. And they’re willing to pay twice as much for the land.”
The Industrial Outlook: A slow, controlled recovery is expected to continue in 2004, with the industrial market absorbing as much as 1.2 million square feet by year-end. Much of the recovery will come from expanding small and mid-size companies. The medical device/bio-tech industry also is expected to continue to grow. Rental rates will remain flat, but concessions should begin to taper off. There will be more activity in the multi-tenant leasing market as a result of a slowdown of single-user buildings on the sale block this year.
Retail Market: Vacancy low, absorption strong, development slows
Fueled by strong demand, a recovering economy and healthy population growth, the Twin Cities retail market continued to thrive the first half of 2004. The retail vacancy remained flat and very tight at 5.2 percent/5.5 percent with sublease. This is the third consecutive year Twin Cities retail vacancy rates have remained in the 5 percent range, well below the national average of 7 percent.
First-half 2004 absorption was just under 570,000 square feet and absorption by year-end 2004 is projected to be less than 1 million square feet based on projected 2004 new construction of 1.4 million square feet. In 2003, the Twin Cities retail market reported positive absorption of 1.9 million square feet driven largely by the completion of a record-high 2.2 million square feet of new retail construction.
“The drop-off in new retail construction this year is due to the complex retail development process, not slowing demand by consumers or retailers,” said Tricia Pitchford, senior associate, United Properties Retail Brokerage. “Retail construction tends to follow two-year cycles, and 2004 is the first year in this cycle. Developers are ramping up now to complete a projected 2.2 million square feet of new retail construction in 2005.”
Community centers reported the lowest retail vacancy rate at 3.3 percent, holding steady from year-end 2003. Neighborhood centers edged up from 7.3 percent to 8.1 percent, while specialty centers dropped from 7.5 percent to 4.3 percent.
Regional centers experienced an increase from 2.3 percent at year-end 2003 to 3.6 percent at mid-year 2004. “The majority of regional centers in the Twin Cities are nearly fully leased, with the exception of Brookdale in Brooklyn Center and Northtown in Blaine,” Pitchford said. “In the case of Brookdale, the new owner is still working to reposition the center with the right mix of retail and entertainment. At Northtown, the owner is developing a strategy to replace three anchor tenants while the city’s retail core continues to migrate to the north and east to new developments.”
The outlet mall vacancy rate plummeted from 16.1 percent to 8.1 percent as a result of the struggling Prime Outlets of Woodbury being converted to a community center. The Minneapolis CBD’s vacancy decreased from 12.7 percent to 11.4 percent, however, retail continued to struggle in the St. Paul CBD due to a lack of consumer demand. St. Paul’s vacancy is double that of Minneapolis’ at 23 percent.
Retail continued to keep pace with the metro’s booming residential growth. Like the suburbs, Minneapolis and St. Paul are experiencing strong housing development, and with the trend of people moving back to the cities, national retailers are eager to locate in healthy urban markets. “As a result, big-box retailers, which traditionally have been located in the suburbs, are thinking ‘outside the big box’ and are willing to compromise their prototypes in an effort to locate near untapped urban customers,” Pitchford said. For example, Menards is building a two-level store at University and Prior Avenues in St. Paul’s Midway. New retail also is chasing housing in fast-growing, outer-ring suburbs.
Big news happened in June when Minneapolis-based Target Corp. announced it found a buyer for its 62-store Marshall Field’s chain and would close its nine Twin Cities Mervyn’s stores. St. Louis-based May Department Stores Co. will pay $3.24 billion for the stores. Speculation is that May will use the real estate to expand the Marshall Field’s brand name. The remaining 257 Mervyn’s stores remain up for sale, and the chain likely will be acquired for its significant real estate.
The Retail Outlook: National and international retailers are continuing to explore the Twin Cities market. Newcomers, which have found sites or are looking, include Lowe’s Home Improvement Centers, CVS/pharmacy, jeweler Tiffany & Co., Swedish furnishings retailer IKEA, German grocery chain ALDI and T.J. Maxx’s HomeGoods Stores. New restaurant concepts include upscale Italian restaurant Bellanotte and fast-casual dining concepts, such as Zyng Asian Grill, Baja Fresh Mexican Grill and Pei Wei Asian Diner.
Approximately 723,000 square feet of new construction is scheduled to be completed during the second half of 2004, highlighted by the July opening of the 330,000 square foot IKEA store across from the Mall of America in Bloomington.
Investment Market: Strong demand outpacing supply
Investment capital continues to pour into the Twin Cities commercial real estate market, making for one of the most active real estate investment markets since the heyday of the late 1990s. With investment demand exceeding the supply of for-sale properties, investors are increasingly willing to lower their yield expectations to close transactions.
With demand on the rise, the number of properties on the market is also on the upswing, however, demand still exceeds supply by a wide margin,” said Scott Pollock, vice president, United Properties Investment Sales. “That makes for a much more active and less price-sensitive market. Because of the increased competition, investors in general are willing to consider investing in a wider array of property types and in a more varied range of buildings within the individual property types.
Grocery-anchored retail continued to hold the top spot as the most preferred investment vehicle the first half of 2004. Investors recognize that the Twin Cities retail market has more than held its own over the past few years, with marketwide vacancy rates hovering in the 5 percent range. This may be contributing to sellers pricing their properties aggressively. Buyers have been willing to accept lower yields to get into the market, resulting in sales of some properties at capitalization rates in the 7 to 7.5 percent range.
The second quarter brought a surge of high-profile office buildings to the sale block in the Minneapolis CBD, West and Southwest submarkets. Although this suggests a trend, the reality is that the motivations for selling vary on a building-by-building basis. “Investors generally favor suburban office product over buildings in the Minneapolis CBD today, as the suburban submarkets appear to be recovering at a faster pace,” Pollock said.
“Most of the major office buildings on the sale block are recent listings, making it difficult to pinpoint an exact pricing trend for office properties. As the competition for investment properties heats up, investors are willing to give more consideration to a greater number of properties, including those which may have some significant challenges like dated construction and higher vacancy rates,” Pollock said. “The additional competition is giving owners more bargaining power, which in turn is helping keep pricing levels relatively high throughout the office market.”
Demand for industrial properties is also strong, especially for leased bulk warehouse buildings. Cap rates on industrial properties are as low as 7.5 to 8.5 percent — relatively low by recent Twin Cities standards but still more favorable to buyers than in some other parts of the country such as Chicago and the major East and West coast markets.
The Investment Outlook: Although the market fundamentals for other Twin Cities commercial real estate markets have not been nearly as strong as for retail, investors are looking to the future when putting capital into office, industrial and multi-family properties.
Capital is likely to remain abundant throughout the balance of the year, even if interest rates increase. “Interest rates are so low today, by historical standards, that an increase between now and the end of the year will have little impact on the investment market,” Pollock said. “There is still a very large supply of pent-up investor demand for commercial real estate in the country, and that will provide plenty of momentum to keep the market active throughout the next six months and into 2005.”
Medical Office Market: On-campus versus off-campus, increasing competition
Population growth and changing consumer market demands continue to be key drivers in the medical office market. The overall mid-year 2004 vacancy rate for the medical office market is 9.1 percent, a drop from 9.9 percent at year-end 2003. Off-campus properties, those not connected or immediately adjacent to a hospital or major ambulatory surgery center, reported a mid-year 2004 vacancy of 16.4 percent. Among the submarkets, the Southwest reported no vacancy, followed by the Southeast at 13.3 percent. The Northwest and Northeast submarkets report the highest vacancies at 22 percent and 16.2 percent, respectively.
The vacancy for on-campus space is substantially lower than off-campus property at 6.3 percent at mid-year 2004. The vacancy for on-campus “connected properties,” those buildings connected by a tunnel or skyway to a hospital or major ambulatory surgery center, is 6.8 percent. The vacancy rate for on-campus “not connected properties,” those properties located in a distinct area immediately adjacent to a hospital or major ambulatory surgery center but not physically connected to the center, is 2.6 percent at mid-year 2004.
Overall medical office rates rose slightly from $16.02 at year-end 2003 to $16.13 per square foot at mid-year 2004. The current quoted rental rate for on campus/connected properties is $16.94. On campus/not connected properties are at $17.76, and off campus properties are at $13.24.
A number of markets have seen increased activity in the last six months, including Burnsville and Maplewood. Competition is particularly intense in the fast-growing Northwest submarket as major medical groups jockey for position. North Memorial Health Care, Fairview Health Services and Park Nicollet have all secured or identified sites near the future Highway 610/I-94 in Maple Grove for expansion.
“They’re competing to be first in the ground, as well as competing for physician groups,” said Stephen Brown, vice president, United Properties Healthcare Real Estate Group. “The strong interest in the Northwest is driven by its growing demographics, including a lot of young families and a large number of double-insured rooftops, which make for clean, higher reimbursement business.”
Medical groups also are attracted to this submarket because of its wide service area, including western Brooklyn Park, northern Plymouth and the entire I-94 corridor from Maple Grove to St. Cloud.
A new trend hitting medical office involves developers building professional services buildings and leasing space to medical tenants to take advantage of the strong off-campus market. “This trend, however, may end once the industrial and office markets rebound, because these developments are complex to put together,” Brown said. “Developers, for instance, need more money for tenant improvements, and they’re dealing with tenants that don’t have traditional credit.”
The Medical Office Outlook: More professional services buildings will be developed to take advantage of pockets of unmet demand in the off-campus market throughout the Twin Cities and as medical practices follow retailing models for location selection. Within the next year, another medical office building will likely be developed in the Northwest quadrant in Maple Grove. The location will depend on a variety of factors, the most critical of which are specialty practices’ hospital affiliations. Physician groups will continue to expand off-campus and add services to help generate revenue, forcing continued discussions regarding how physician groups interact with hospitals.
About Outlook
United Properties releases its Outlook report twice annually and is the only Twin Cities commercial real estate company to publish comprehensive market data at the calendar mid-year and year-end marks. Outlook includes information for all commercial property types, including office, retail, industrial, multi-family and medical office. The report also features an up-to-date overview of the Twin Cities economy and an analysis of the market's investment trends. The complete report is available on the Web at www.uproperties.com. A printed summary of the report may also be requested at the Website.
About United Properties
United Properties is a full-service commercial real estate company with more than 400 employees and 26.5 million square feet of office, industrial, retail and multi-family properties under management. The company specializes in diverse real estate services, including brokerage, property management, corporate real estate, healthcare real estate, construction, development and investments. The National Association of Industrial and Office Properties have named the company national 2004 Developer of the Year. Based in the Twin Cities, United Properties serves other markets through its affiliations with ONCOR International, an organization of commercial real estate companies serving more than 200 markets throughout the world, and ChainLinks Professional Resource Network, the largest retail-only full-service real estate provider in North America. United Properties is located on the Web at www.uproperties.com.
EDITORIAL NOTE: Complete Outlook data sets are available immediately either electronically (PDF and Word formats) or via fax. Contact Lisa Hannum at lhannum@kolrudhannum.com or call 651 488 6818. Full Outlook content will be available online Monday, July 26. Printed executive summary copies of the market study will be available in early August. Please contact Lisa Hannum to request a copy or visit www.uproperties.com to subscribe online.
* Study released by the Minnesota Department of Employment and Economic Development’s Center for Rural Policy and Minnesota Technology/March 2004.
Media Contacts
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