United Properties Year-End ‘Outlook’ Study Reports Dynamic Twin Cities Commercial Real Estate Market

Commercial Developer Demand for Land Increasing; Investor Appetite for Twin Cities Remains Healthy; Return to Speculative Development in Office; Industrial Poised to Increase Supply

MINNEAPOLIS (December 14, 2006) — The Twin Cities commercial real estate market enjoyed a strong year in 2006, posting nearly seven million square feet of positive absorption in multi-tenant properties. According to a preview of United Properties’ year-end 2006 Outlook market study, notable trends indicate that land prices are correcting to support commercial development, with investor activity and interest remaining high in all sectors of Twin Cities real estate. The Twin Cities-based commercial real estate company will release its year-end 2006 market study on the office, industrial, retail, land and medical office markets in January. 

“The market remains very dynamic. We’re seeing the return of select speculative development in the office sector. The industrial market is poised for new development, but higher rental rates must be achieved to justify the cost of new construction. The retail sector’s current development pipeline for 2007 will provide yet another record-setting year, although our small-shop retail demand is slowing,” said Mike Ohmes, senior vice president, United Properties Brokerage Services. “All of this will need to be watched closely as most economic experts predict continued growth for 2007, but at a much slower pace than the past two years.”  
 

Absorption in the Twin Cities multi-tenant market (Click image to enlarge)

Land Prices Undergo Correction as Housing Market Cools
The land market has undergone a major transformation in the past 8-12 months due to a slowdown in the residential market. Prices are now stabilizing, though competition for industrial parcels remains hot. Prior to this period, residential and commercial developers were competing for land positions in high-growth markets like Maple Grove, Chanhassen, Chaska, Shakopee, Rogers and St. Michael. Land prices in these areas and elsewhere increased and developers entered into contracts at extremely high prices to win competitive bidding situations.

Some residential developers currently have an unprecedented 18- to 36-month supply on the books, versus the typical four-to-six-month supply. With average industrial and office projects demanding much smaller parcels and few residential developers in sight, land prices for over-supplied residential tracts are trending down as much as 30 percent or more in certain areas. Many residential developers are looking at purchase prices they agreed to and are now trying to either sell land at significant discounts to investors or refinance, bringing in partners to help stabilize their hold. Some prospective buyers may wait until pricing drops further or wait to see how low prices will go.

“The tides have turned for residential developers, and as a result we are seeing a land price correction. Prices will correct as sellers adjust to the lower prices being offered in the market,” said Jon Rausch, senior associate, United Properties. “We are currently seeing an increase in industrial and office developer activity as residential developers begin to shed parcels.”

The market for land in the Twin Cities and its outer-ring suburbs has already begun to shift away from residential development. With increased supply and appealing land prices, industrial developers will continue to jockey for position in more rural, less populated areas. Currently, a number of industrial users in those areas are looking for land parcels for build-to-suit projects rather than multi-tenant lease projects.

Redevelopment of inner-ring sites is occurring as office developers raze obsolete buildings to obtain prime parcels in desirable areas. The industrial segment of the market is increasingly bullish, and the higher rents needed to spur development will likely come sooner rather than later.  The market currently lacks confidence and needs assurance that tenants will pay higher rental rates.

CBD Office Properties Dominate Strong Overall Investor Activity
Investment sales activity was at a record high across all sectors in 2006, with notable suburban office, multi-family and retail activity. St. Paul and Minneapolis CBD office sales activity was strong. Several significant buildings sold in the Minneapolis CBD, continuing a trend that began in 2004. The St. Paul CBD doubled its amount of square footage that changed hands from 2005.

Investor interest in multi-family properties during 2006 pushed prices to unprecedented levels. This asset class is expected to remain hot in 2007 due to the recovery in the apartment leasing market.

“The supply of attractive properties remains steady and will continue to lure new investors to the Twin Cities,” said Scott Pollock, vice president, United Properties Investment Sales. “Demand remains highest for Class A office and multi-family, in which investors are seeing the strongest opportunity.”
New capital is being marked for medical office, a new asset class increasingly catching investors’ eyes. Medical office properties are attractive to investors because of the long-term leasing stability of the property type.

Tightening Office Market Conditions Drive Build-to-Suit and Speculative Development Resurgence
The overall office market experienced another solid year in 2006 with positive absorption of 1.35 million square feet for the year—slightly less than 1.46 million square feet in 2005. Demand will continue to reduce excess office space at a brisk pace in 2007, with a projected 1.3 million square feet of absorption. Though the office market will continue to improve, delivery of new speculative office buildings will slow the reduction of vacancy levels.

Historical vacancy in the Twin Cities multi-tenant market (click image to enlarge)

Large space users are driving growth and speculative new office development. “Larger users continue to look for much-needed space, and pockets of low vacancy in highly desirable submarkets are getting serious attention from developers,” said Bill Rothstein, vice president, United Properties Office Brokerage. “Expect to see speculative development increase as demand for larger blocks of space continues.”

Nearly one million square feet of speculative office space will be delivered in 2007, all of it in the suburbs. The Southwest market is poised for development with the year-end Class A vacancy rate at 8.8 percent and only a handful of larger blocks of Class A space available to meet the needs of the submarket’s larger users. While the Southwest and West submarkets will command the largest share of new construction, the Northeast and South/Airport submarkets will be more active than usual. The Minneapolis CBD also has pockets of vacancy below 10 percent, specifically in the upper floors of Class A buildings and in the Nicollet Mall area. Expect a new Minneapolis CBD office tower to be announced in 2007.

The Minneapolis CBD has seen an increase in the number of employers who are trying to attract a new generation of employees with the “work, live, play” lifestyle available downtown. In the effort to lure emerging talent, three notable office users moved into new Minneapolis CBD space, including suburban office users Wacovia and Colle+McVoy, and Carmichael-Lynch, which moved from owner-occupied to new multi-tenant space.

Landlords will continue to reduce their reliance on concessions such as free rent to attract and retain tenants; rental rates are expected to steadily rise, especially in submarkets where new development is taking place. The average net rental rate rose to $12.38 per square foot at the close of 2006, versus an average net rate of $12.25 per square foot one year ago.

Retail, Industrial, Medical Office Snapshots
Overall retail market absorption remains strong, and intense competition among big box users will continue throughout 2007. Responding to pent-up demand, the concentration of big box competition will surround infill development and redevelopment. Demand for small-space retail construction will continue, though it may begin to soften mid-year as small-space users feel the effects of the residential slowdown.

The industrial market experienced a drop in absorption in 2006 due to decreasing supply, reduced landlord concessions and the rising costs of tenant relocations. Industrial users are currently extending leases for the short-term, wanting to assess the market before signing new, long-term leases. Aggressive industrial development is on the horizon though, as supply becomes more constrained and rents creep higher. Developers will drive the market and move forward with pending projects as they gain further confidence that the market will support the increased rates necessary for successful new construction.

As the current phase in medical office construction is completed, the market will settle. Vacancy rates for off-campus properties may increase somewhat as the market adjusts to absorb new construction. Physician recruitment will continue to be challenging when staffing new facilities. As a result of recent development activity in Maple Grove, the submarket could go from being underserved to oversupplied in a short period of time.

More information on residential, industrial and medical office will be available in the complete 2007 Outlook Report released in late January.

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 2006 report will be published in January 2007. The July 2006 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 450 employees and 22.5 million square feet of office, industrial, retail and multi-family properties under management.  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, the largest retail-only full-service real estate organization in North America.  United Properties is located on the web at www.uproperties.com.