News Release
Twin Cities Commercial Real Estate Market Continues To Rebound Through Second Half 2004
United Properties Year-End 2004 ‘Outlook’ Market Study Reports Strongest Demand For Industrial, Office Space in Four Years; Retail Market Set To Deliver Record Level of New Construction in 2005; Investor Capital Continues to Flow
MINNEAPOLIS (December 14, 2004) — The Twin Cities industrial and office commercial real estate markets continued to gradually rebound during the second half of 2004, resulting in the strongest demand and the first signs of vacancy declines since 2000, according to United Properties’ year-end 2004 Outlook market study. The Twin Cities-based commercial real estate company today released a preview of its year-end 2004 report on the office, industrial, retail, medical office and investment markets. The complete report will be available in January.
“Leasing activity and absorption are up across the industrial and office markets, important signals that these two key segments of the Twin Cities commercial real estate market are on the road to continued improvement,” said Mike Ohmes, senior vice president, United Properties Brokerage Services. “We may even see in 2005 the first return of speculative industrial development.
“After a relatively quiet year for new retail development, 2005 will mark a 10-year high in new retail construction and a continuing parade of expanding and new retail brands,” Ohmes added. “We’re also projecting investor capital to continue to flow into the market next year, signaling even more sale transactions in an already active real estate investment market.”
Industrial Market Tops 1 Million Square Feet Absorption; Spec Development Projected
The Twin Cities industrial real estate market reported positive 924,000 square feet of absorption for the second half of 2004 and positive 1.2 million square feet for the year overall. The industrial market reported only positive 72,000 square feet of absorption over the previous three-year period beginning January 2001. Absorption is the difference in occupied square feet from one time frame to another.
“The industrial market is a solid 12 to 18 months ahead of the office market recovery,” said Jason Meyer, vice president, United Properties Industrial Brokerage. “The Northeast and Southwest submarkets led the way in absorption and most activity came in the form of growth by local companies.
“Manufacturing market fundamentals are improving, there’s real job growth and industrial space users are beginning to grow. With little new construction in the pipeline and fewer user buildings be offered for sale, the Twin Cities industrial market is poised to absorb 2 to 2.5 million square feet in 2005,” Meyer added. “If market conditions continue to tighten, the Northeast and Southwest industrial submarkets may yield the first speculative development — office showroom — the market’s seen since 2001.” Industrial developers delivered only 430,200 square feet of new construction in 2004, a 10-year low.
Year-end 2004 industrial vacancy rates declined only modestly, primarily due to adjustments United Properties made to its industrial property database the second half of 2004. The adjustments added approximately 7 million square feet of multi-tenant industrial space to United Properties’ industrial database. This contributed to industrial direct and sublease vacancy rates declining only slightly to 15.5 percent direct vacancy/17.2 percent vacancy with sublease at year-end from mid-year rates of 15.7 percent/17.5 percent. Year-end 2004 industrial vacancy rates were essentially flat when compared to year-end 2003 rates. “Underneath these vacancy rates, we are experiencing growth and new demand for space,” Meyer said.
Industrial rental rates remained flat from year-end 2003 to year-end 2004. Industrial office space was at $7.97 per square foot for year-end 2004, while warehouse space was at $4.33 per square foot. Landlords will continue to face concessions in 2005 — ranging from significant tenant improvement allowances to free rent — however, the level of concessions is moderating.
Office Market Continues Gathering Momentum
The office market finished 2004 with positive 522,000 square feet of absorption. While the office market recovery is lagging the industrial market, any level of positive absorption is a strong indicator of returning demand — particularly following a two-year period of negative 2.7 million square feet of office absorption.
The office market posted its first declining vacancy rates since 1997 with year-end 2004 levels of 18.3 percent direct vacancy/20.7 percent vacancy with sublease compared to year-end 2003 vacancy rates of 18.9 percent/21.6 percent. While the decline for the overall market was modest, four of seven office submarkets reported declines in direct and sublease vacancy numbers during the second half of 2004, further signaling a broad-based recovery in demand. Only the Minneapolis and St. Paul central business districts (CBD) reported year-end 2004 vacancy rates above 20 percent. The Northeast office submarket reported the lowest vacancy rate at 14 percent.
“The amount of office sublease space declined more than 10 percent over the last year, and office users are beginning to fill excess space in their current locations,” said John McCarthy, vice president, United Properties Office Brokerage. “The next step will be for companies to begin leasing new space for growth. The increased activity level we began to experience this year could translate into nearly 1 million square feet of absorption in 2005.”
On the supply side, office developers delivered only 225,000 square feet of new multi-tenant construction to the Twin Cities this year, the lowest level since 1997. Speculative development will be very limited in 2005 with the majority of construction activity occurring in build-to-suit projects and new developments with significant preleasing commitments. Both office and industrial developers will continue to focus on securing land positions through 2005 and into 2006 as they prepare for the next development period. They will face stiff competition from residential developers who are also vying for prime sites.
Office rental rates declined modestly from year-end 2003 to year-end 2004. Class A office rents at year-end 2004 averaged $13.43 per square foot, while Class B and Class C rates were at $9.93 and $8.16, respectively. Declines ranged from 4 cents per square foot in Class C properties to 26 cents per square foot in Class A properties. Office landlords will also face concessions through 2005. Tenants willing to sign long-term leases will continue to find good deals, but they’ll need to work harder to find them, especially in the suburbs.
Retail Market Remains Strong, Construction Surge On Tap For ’05
The sale and subsequent closing in July of nine Twin Cities Mervyn’s stores skewed the retail market’s year-end 2004 performance. The closings put 1.3 million square feet of regional mall space in the vacant column and was the main driver behind the market-wide vacancy increase from 5.2 percent at mid-year to 7.8 percent at year-end 2004. The vacancy rate for regional malls, where the Mervyn’s stores were located, increased to 14.9 percent at year-end from 3.6 percent at mid-year 2004.
The Mervyn’s closings, plus a modest amount of new construction, also drove the absorption rate to its first negative number since 1996. Following positive 567,286 square feet of absorption the first half of 2004, the retail market finished the year at negative 49,602 square feet of absorption — a six-month swing of more than 600,000 square feet. Retail rental rates also softened in 2004 to an average $28.18 per square foot versus $29.45 per square foot in 2003. The decline can be attributed primarily to short-term tenant transitions at the regional malls.
Some regional mall landlords have purchased the former Mervyn’s sites, which average 180,000 square feet, and are exploring a range of opportunities from creating entertainment complexes to dividing the space among retailers looking to enter the market. Other sites are being eyed and leased to new mall anchors, including J.C. Penney in Woodbury and Maplewood.
Retail developers delivered just over 1.3 million square feet of new construction to the Twin Cities market in 2004, the lowest level since 2001. “The drop-off is really more of a ramping up,” said Tricia Pitchford, senior associate, United Properties Retail Brokerage. “Retail developments are extremely complex and have very long lead times. Two to three years from proposal to opening is not unusual.”
Hang on for 2005 as developers are projected to complete an historical high of 2.5 million square feet of new retail construction. Nearly 1.5 million square feet of new construction will be community center space. “Since most retail development is preleased and the repositioning of the Mervyn’s sites will be substantially complete, absorption will soar by year-end 2005,” Pitchford said. “Early projections also have 2006 shaping up to be another 2 million-plus year of new construction.”
As retail development sites become more and more limited, the trend toward converting well-located office and industrial buildings to retail will continue in 2005, further fueling strong absorption. Several retailers in 2004, including Costco, Lowe’s, Schneiderman’s Furniture, ALDI, Best Buy and Sam’s Club, acquired existing commercial properties and redeveloped or renovated them for retail use.
New Money, New Investors Entering Twin Cities Market
Despite continued softness in the industrial and office rental markets, sellers were more active in bringing properties to the market in 2004. Even so, buyers continued to outnumber sellers, especially for well-located, well-positioned properties. “Continued strength in real estate demand, combined with today’s low interest rates, is driving down cap rates and buyer yield expectations,” said Scott Pollock, vice president, United Properties Investment Sales.
National institutional investors and funds, pension fund advisors and life companies are increasingly turning their attention to the Twin Cities in search of better yields than those available in first-tier real estate markets. “Individual investors and private equity groups also are bringing fresh capital to the market through traditional partnerships and through the increasingly popular tenants-in-common entities,” Pollock said.
Office, industrial and retail properties were all in high demand in 2004 and the trend is projected to continue through 2005. More than 10 percent of the multi-tenant office space in the Minneapolis CBD was brought to market in 2004. Led by the high-profile IDS Center, seven Class A properties in the submarket either sold or are being marketed. Suburban office properties also were in high demand with approximately six either selling or on the market.
Investors in 2004 purchased 19 retail centers that were 100,000 square feet or larger. The most sought-after retail property type was grocery-anchored centers with a record nine projects changing hands.
Given the strong demand, well-leased industrial properties of all types were also in demand, with the higher finish office showroom/flex buildings commanding the most attention and the best pricing.
The only property category showing any caution was apartments, where sales slowed the second half of 2004. While investor interest remains high, some geographic areas are struggling with rising vacancy rates.
Assuming that capital continues to flow, the Twin Cities investment market will continue to be very strong in 2005. Prices are expected to continue climbing provided interest rates remain relatively low.
Healthcare Providers Continue Competitive Repositioning
Population growth and changing consumer demands continue to be key drivers in the medical office market. The overall vacancy rate dropped nearly a point to 9 percent at year-end 2004 versus 9.9 percent at year-end 2003. The market reported positive 78,334 square of absorption in 2004, approximately half of the positive 152,682 square feet of 2003 absorption. Rental rates nudged up to $16.29 per square foot in 2004 from $16.13 per square foot in 2003.
Only 48,000 square feet of new medical office construction came to the market in 2004 versus 123,000 square feet in 2003. Look for the construction pace to pick up in 2005. More than 400,000 square feet of new and expanded medical office space is either in the planning stages or will break ground the first two quarters of the year.
“Healthcare providers are increasingly following retailing models for site selection,” said Stephen Brown, vice president, United Properties Healthcare Real Estate Group. “Physician groups and hospitals are both competing and collaborating to fill unmet demands in on- and off-campus markets throughout the Twin Cities, which is forcing continued discussions about how the two groups will interact in the future.”
As all healthcare providers continue to search for alternative sources of revenue, watch for the continued development of specialized healthcare centers targeting both conditions and segments of the population. Projects are currently under development for subspecialty “centers of excellence” in cardiovascular, oncology and orthopaedics.
In addition, healthcare providers are increasingly turning their attention toward women, who make 75 percent of all healthcare decisions for their families. Women’s specialty centers are being developed or expanded by North Memorial, West Health, Medical Advanced Pain Specialists and Ridgeview Medical Center. A women’s health center at Southdale shopping center is also in the planning stages, representing a completely new concept for healthcare delivery. Look for this trend to continue to play out in 2005.
About Outlook
United Properties issues 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 commercial real estate investment trends. The complete year-end 2004 report will be published in January. The July 2004 report is available on the web at www.uproperties.com.
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. 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.
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