Marcus & Millichap has provided an overview of the Minneapolis market, highlighting sales and vacancy statistics, and specific influences for each property type. The company also has provided information on the Milwaukee multifamily market and the Detroit retail market.

MINNEAPOLIS OFFICE

The Minneapolis office market saw its absorption rate plunge in 2001 as the slowing economy — coupled with an overheated construction market — created a significant supply-demand gap. The vacancy rate jumped from 8.5 percent in 2000 to nearly 14 percent by the end of 2001. Absorption plunged to negative 2 million square feet, while the market added an additional 2.7 million square feet of new construction. Demand fundamentals rebounded slightly in 2002 as absorption of existing space was minimally positive, but the addition of another 2.1 million square feet drove the vacancy rate to more than 16 percent. However, new construction starts took a nosedive in 2002, which has helped the Minneapolis market bridge the supply-demand gap. The results are evident in the limited increase in vacancy in the first quarter of 2003 and early indications of another year of positive absorption.

The increased optimism in the market should help an investment market that has struggled to attract investors during the past 18 months. While many office markets have experienced strong levels of investment activity in spite of weak operating performances, Minneapolis is not one of them. The sudden spike in vacancies rattled many potential buyers, who have sought refuge in more stable properties, such as multifamily and retail. Additionally, sellers have been primarily content with refinancing their properties or enduring a few weak years as opposed to lowering their price expectations. The median price per square foot will continue to hover around $60, as quality offerings in the market remain limited. Recently, a large East Coast-based pension advisor announced plans to market several properties in the Minneapolis area. This offering will be a strong barometer of the market and will help project whether the remainder of the year will remain sluggish or see a reversal of fortune.

MINNEAPOLIS MULTIFAMILY

Although the Minneapolis multifamily market remains one of the more stable multifamily markets in the United States, on the whole, apartment owners are clearly experiencing higher vacancies and lower rent levels today than they were 24 months ago. Much like the rest of the country, many high-end multifamily properties in the Minneapolis-St. Paul area have been harder hit than some lower-end properties. In addition to widespread concessions, some owners have also lowered their asking rents in an effort to compete with some of the newer product that has come online, which has in turn negatively impacted net operating incomes levels. Some of the hardest hit areas have seen high levels of development in recent years, including Maple Grove, Minnetonka, Burnsville and Woodbury.

Even with some of the softness in the market, demand from both institutional and private investors has remained strong. With historically strong population growth, multifamily vacancy levels typically ranging from 4 percent to 6 percent, and the expectation of future rent growth, many investors from different parts of the country are showing a willingness to pay lower cap rates and aggressive prices to gain a foothold in the market.

During the next 12 months, demand for multifamily product from investors is expected to continue to exceed the supply of available product in the Minneapolis market. This excess demand, combined with other factors such as historically low interest rates and a lack of alternative investment options, is expected to keep values stable, even as operations remain on the weak side. As a point of reference, depending on factors such as location, asset quality and historical performance, most quality multifamily properties are expected to continue trading at cap rates in the 7.75 percent to 8.5 percent range.

In terms of investment activity, the lack of available for-sale inventory is expected to result in investment activity remaining constrained. In addition, soft conditions in Class A product will hinder marketability on some assets, and some owners will continue to hold older, well-performing assets. For both new and existing multifamily investors in the Minneapolis area, steady construction and the recent tax break will boost activity during the long term, as improved market conditions in new product allow sellers to bring their assets to market during the next few years.

MINNEAPOLIS RETAIL

The greater Minneapolis area continues to be one of the most in-demand retail markets in the entire Midwest. Investors, including private, regional and institutional players, have all acquired product in the market during the past year, and many have expressed an active interest in continuing to acquire in the area.

There are a number of reasons for this demand. In addition to favorable area demographics, such as historical employment, population and income growth, rent and vacancy levels in the Minneapolis area have been stable during the past several years. Although some increase in vacancy has been seen during the past 12 to 24 months, this increase has been attributed more to the national and regional economic slowdown rather than substantial overbuilding by developers.

Another trend that has emerged is that investors in existing product have shown an increased willingness to pay lower cap rates compared to levels paid for retail product just a few years ago. While this trend is partially due to low interest rates and buyers’ abilities to still achieve their desired cash-on-cash returns, it is also due to many investors continuing to view the long-term growth prospects for the Minneapolis area favorably.

As a result, they are willing to receive a lower initial yield while expecting rent growth and additional appreciation in their assets during the life of their investments. In addition, many investors, particularly those looking to purchase single-tenant product, view available risk-adjusted returns on retail properties favorably compared to their other relatively limited alternative investment options, including the stock and bond markets.

The interest in retail properties in the area, however, is not limited to investors looking for existing product only. Currently one of the most touted construction projects in the greater Minneapolis area is Arbor Lakes, a lifestyle center being developed in Maple Grove by Opus Northwest. The project, which is being developed on land formerly used as a gravel mining pit, features a combination of both local, regional and national tenants, including Panera Bread, LeAnn Chin, Funco Land, Ritz Camera, Aerial Communications, Aphrodite’s Day Salon, Best Buy, Northwest Books, Office Depot, Timber Lodge Steakhouse, Byerly’s and Babies ‘R’ Us.

MINNEAPOLIS INDUSTRIAL

The Minneapolis industrial market ended 2002 at an all-time high as the industrial vacancy rate reached its highest level in recent history at 13.5 percent. Obviously, the slowing national economy has impacted the local market, but the reasons for such a precipitous fall in occupancy have other roots.

During the last several years, there has been significant construction in the Minneapolis market. Most of the construction has focused on build-to-suit, single-tenant properties for warehousing and distribution. Many of the tenants that subsequently occupied these properties exited space from multi-tenant facilities, in many cases consolidating to smaller spaces. The result has been an abundance of multi-tenant space on the market.

Similar to the office market, the industrial market’s decline also predated the general national decline and, therefore, has already initiated the recovery process. New construction activity of large build-to-suits is almost at a standstill, with few plans even in the pipeline. Owners also have witnessed increased traffic at their properties, due to stable rents and increased tenant improvement allocations. In the first quarter of 2003, the market data reflects minimal improvement as absorption was a positive 99,000 square feet, and only approximately 193,000 square feet was delivered to the market. The prognosis is increasingly positive for the remainder of the year, albeit heavily dependent on a recovery in the national economic picture.

The investment market can be aptly described as sluggish, with little national buyer interest and significant hesitation among more regional investors. As operations begin to show improvement later in the year, expect more buyer interest as well as increased comfort from sellers in the ability to achieve their price expectations. Finally, due to the strong build-to-suit construction during the last several years, expect some sale-leaseback activity as companies become increasingly motivated to remove debt from their balance sheets.

MILWAUKEE MULTIFAMILY

The Milwaukee multifamily market has felt the impact of low mortgage rates, as renters turn to homeownership. The vacancy rate rose from 7.6 percent at the end of 2001 to 8.1 percent at the end of 2002 and has further climbed to 8.3 percent through the first quarter of 2003. Supply in the majority of the Milwaukee market has remained in check, with the one exception being the Brookfield area, which has seen substantial construction during the past 12 to 24 months. In response, rent growth has been minimal, limited to 1.8 percent in 2002, slightly below the inflation rate.

Rent growth should maintain its current course through the first half of the year, with a possible bump towards the end of the year. Regardless, rent growth most likely will register below 2.5 percent for 2003, not necessarily a negative statement in these challenging times.

Multifamily investment activity has remained stable during the past 12 to 24 months, as capital has migrated from Chicago to the Milwaukee area. Many potential investors have eschewed the sub-8 percent cap rates being offered in the Chicago area and capitalized on the 9 percent cap rates available in the Milwaukee area. Due to this imported capital and the relative stability of the multifamily market, the average price per unit broke the $40,000 barrier in 2001. That momentum has carried forward as the price per unit increased further in 2002, partly as a result of the lower cost of debt.

Transaction velocity has not experienced a significant increase, but has remained stable through the soft rental market. Many owners have been content to refinance their properties to achieve higher returns or to weather the storm, rather than parting with their assets. Investors, although appreciating Milwaukee’s strong cap rates, have witnessed more accelerated growth in other Wisconsin markets such as Madison, the Fox Valley and Kenosha. Therefore, without recognizable improvement in the general Milwaukee economy, investors may reserve most of their capital for these secondary markets.

DETROIT RETAIL

Although retail investors in the Detroit market continue to most actively seek properties with a grocery component, other types of retail centers, including strip center, drugstore and restaurant properties, have also continued to garner attention from investors. In addition, big box retailers such as Lowe’s Home Improvement Warehouse, The Home Depot and Target are also creating high levels of investor interest as these companies continue their expansion plans.

With the economy in the Detroit area slowing much in line with the national economy, fundamental demand for retail goods — and in turn retail space — is not as strong today as it has been in the past. Although economic challenges do remain, key drivers of the Detroit economy, such as the manufacturing sector and specifically the automotive sector, have posted better than expected results, leading many to believe that as the economy recovers, demand for both retail products and retail space will improve.

To compound the reduction in demand, additional retail space in the form of new construction has been coming online. This combination has led to increased vacancy levels and generally flat rent growth. However, actual average rents in the suburban market are expected to increase slightly this year due to the shifting of some tenants from older, more obsolete retail centers charging lower rents to newer space at higher rent levels.

In terms of development, submarkets in suburban Detroit such as Northern Oakland, Macomb and Livingston counties are seeing substantially more development than the city itself. Depending on factors such as the specific location, quality of the tenants and duration of leases, some of the best retail properties are trading at cap rates in the 9 percent to 9.5 percent range, while unanchored retail centers in less attractive but still highly viable locations are trading at cap rates in the 10 percent to 10.5 percent range.

©2003 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.