While the Minneapolis-St. Paul market has experienced its share of high vacancy rates and slow absorption rates, the area is showing positive signs of recovery. For example, the development of lifestyle centers is on the rise in the area, and stable centers are continuing to attract retailers. Despite high vacancy rates in the multifamily market, pent-up demand is leading to a slow recovery. The industrial market is seeing better activity, and the office market is already experiencing positive net absorption this year.

Retail

Ryan Companies US is active in the Twin Cities market with several Target and Super Target developments.

The development of lifestyle centers is currently a major trend in the Minneapolis-St. Paul market. Lifestyle centers under construction, such as Arbor Lakes in Maple Grove, have heightened the architecture and landscape standards of retail centers. Lifestyle centers are tomorrow’s malls; they provide the charm of the downtown stroll but offer the quality and variety of the suburban mall.

Arbor Lakes, an Opus/RED Development, is the first lifestyle center in the state that has attracted numerous mall-type retailers, and created a special shopping and entertainment destination. Consumers have embraced the Southdale and the Eden Prairie Center redevelopments, both of which have new cinemas and upscale casual restaurants at their core.

One of the most significant/recent developments in the metropolitan area is Block e. The project has succeeded in bridging the office district with the entertainment district. Block e has provided the area’s first and only five star hotel and also offers downtown restaurants, a local cinema, a drugstore and a Borders Books & Music.

St. Paul’s riverfront also continues to flourish with the Xcel Energy Center, which offers many national attractions and provides a home for Minnesota Wild Hockey. The collection of restaurants, and the new Children’s Museum and Science Center on the riverfront have also made an impression on the area’s consumers.

The top urban/suburban development in the area is the Excelsior & Grand project in St. Louis Park, which is nearing completion by Told Development Company.

The northwest quadrant of the Minneapolis-St. Paul market has continued to show strong tenant demand. Creative developer responses in the southwest quadrant include a Super Target development in Savage, and Wal-Mart and Sam’s Club developments in Shakopee. Woodbury, located in the northeast quadrant, may win first place for the most plans in process with Super Target, Woodbury Lakes and the Shoppes of Tamarack all underway. The top urban/suburban development is the Excelsior & Grand project in St. Louis Park, which is nearing completion by Told Development Company.

Some of the busier developers in the Minneapolis-St. Paul market are Ryan Companies US, which is active with several Target and Super Target developments, and Opus/RED Development, which have continued to team up in lifestyle developments in Arbor Lakes and Woodbury Lakes. North American Properties, Told Development Company, Avalon Group, Robert Muir Company, CSM Corporation and Paster Enterprises are also active.

Retailers that are new to the area include Cost Plus World Market, Coldwater Creek, Costco, Lowe’s Home Improvement Warehouse, Mega Star- Crown Theaters, IKEA, Ultra Electronics (Audio King) and Von Maur. New restaurants that have entered the market include Krispy Kreme, Cold Stone Creamery, Bubba Gump Shrimp Company, Hard Rock Café, Melting Pot, Jimmy Johns, P.F. Chang’s China Bistro, The Cheesecake Factory, Maggiano’s, Biaggi’s, Wildfire, Punch Pizza, Baja Tortilla Grill, Qdoba Mexican Grill, Potbelly Sandwich Works and Roly Poly Sandwich Wraps.

Arbor Lakes, developed by Opus/RED Development, is one of several new lifestyle centers to be developed in the Twin Cities area.

The most recent announcement in the retail market is the IKEA store that will be entering the market in the next phase of the Mall of America. Other notable leases are Ultra Electronics and Cost Plus World Market in Arbor Lakes. In addition, Costco, Target and The Home Depot have completed large leases in the market.

The overall market midpoint vacancy dropped to 2 percent from 2.6 percent at the midpoint of 2002. This is the lowest midpoint vacancy rate in 6 years, and this statistic shows that there is more vacancy in the overall market, but the majority of stable centers continue to attract retailers.

The Maple Grove and Woodbury markets will continue to be the development hot spots in the Minneapolis-St. Paul area. The big boxes will continue to pursue sites near existing and under construction lifestyle developments. Other active submarkets include St. Louis Park, downtown Wayzata, Plymouth and downtown St. Paul.

— Richard Grones, principal; Liz Picking, senior associate; and Amy Barth, managing director of Edina, Minnesota-based Cambridge Commercial Realty wrote this section.

Multifamily

Minneapolis-St. Paul has bad timing in the multifamily market. Throughout the 1990s, the Twin Cities had an apartment shortage crisis with vacancy rates averaging less than 2 percent with almost no new construction.

Now, with vacancy rates climbing to more than 5 percent, the Twin Cities has approximately 4,000 apartments that are under development in 2003. The combination of an economic slowdown, and the new units coming online, has created an imbalance of supply and demand that could push vacancies higher by year-end.

In just 18 months, the overall metropolitan vacancy rate has risen from 1.5 percent in the fourth quarter of 2001 to 4.7 percent in the first quarter of 2003, according to Apartment Profiles, a division of RelocationCentral Apartment Search. Assuming no new absorption, these 4,000 units will increase vacancy by 3 percentage points.

Of course, absorption is the key to the market rebounding. The majority of units under construction are being built in the southwest and northwest suburbs of Minneapolis due to available land and high demand in these markets. In addition to the units under construction, there are approximately 5,000 units on hold until the market rebounds. Therefore, it will be a while before the Twin Cities market sees vacancy rates well below 5 percent.

Rental rates have remained steady with many landlords offering free rent effectively lowering the net rental rates in the market. According to Apartment Profiles, the average rental rate in the first quarter of 2003 was $836 per unit, slightly down from the peak of $841 per unit in the third quarter of 2002. However, the number of units offering concessions is down from 43.7 percent in December of 2002 to 37.5 percent in March of 2003 — suggesting that the market rental rates may be stabilizing.

The financing market for apartments is strong even in light of deteriorating fundamentals. This activity is due to apartment fundamentals being stronger than the office and industrial fundamentals; no defaults on apartment loans; and interest rates being historically low.

These factors — combined with Fannie Mae’s and Freddie Mac’s insatiable appetites for new loans, and strong competition from life insurance companies and Wall Street — form a borrower’s market. Interest rates are in the mid-5 percent range for 10-year fixed rate terms and in the high 3 percent to 4 percent range for floating rate debt on institutional quality deals.

The investment markets go hand-in-hand with the financing markets, and investment activity in apartments remains strong despite rising vacancies. Recently, MetLife sold the 334-unit Vicksburg Village in Plymouth to AEW; Eagan Promenade, a 282-unit apartment complex in Eagan, was sold by Healey Ramme to Boston pension fund advisor GID Corporation; Equity Residential placed the 216-unit Woodlane Place in Woodbury on the market; and Avalon has placed its entire 1,362-unit Twin Cities apartment portfolio on the market.

According to Scott Pollock of United Properties, there is more institutional product in the market now than in the last 10 years. “There continues to be interest in the Twin Cities multifamily market due to unsatisfied pent-up demand that is finally being realized,” he says. “Non-institutional deals that have low interest rates, and a lack of investment alternative, are also keeping this end of the market vibrant.”

— Doug Dolliff is vice president with Minneapolis-based NorthMarq Capital.

Industrial

The vacancy rate in the Minneapolis-St. Paul industrial market has increased annually during the past 4 years, according to the Minnesota chapter of the National Association of Industrial and Office Properties. However, vacancy rates have stabilized at 13.5 percent. Activity is on the rise, showing signs that better days are ahead. Yet, despite these positive signs, the road to recovery will be gradual.

Although activity levels have improved, multiple options for industrial space remain for tenants in the marketplace. This competition has forced landlords to lower asking rates on all product types. In addition, higher levels of concessions, including free rent, higher tenant improvement packages, increased commissions, and moving allowances, have become commonplace for larger, good credit tenants. These higher concessions packages — coupled with landlords lowering their quoted rates — have resulted in significantly lower net effective returns.

The availability of space, and the aggressiveness of landlords, has sparked a noticeable trend in the Twin Cities industrial market: tenants are pitting the market against their current landlord. For example, tenants who have leases expiring are doing their due diligence by soliciting multiple proposals from multiple landlords to use against their current landlords. If the current amount of activity continues, landlords may draw a line in the sand by calling the tenants’ bluff.

The amount of competition for deals, lower net effective returns for landlords, and higher vacancy rates have caused speculative development to halt. With a few exceptions, developers are requiring significant pre-leasing thresholds to be met prior to construction commitment on new developments. The only significant speculative development is by CSM Corporation, which is moving forward on a 98,000-square-foot office/warehouse facility in the Midway market located between the Minneapolis and St. Paul central business districts (CBDs).

The most significant development affecting the Twin Cities’ industrial market is Best Buy Corporation’s new 1 million-square-foot corporate headquarters developed by Opus Northwest. Best Buy is consolidating from multiple locations, which will add three multi-tenant buildings to the market. This move, along with other former corporate headquarters being added to the multi-tenant market, will drop nearly 1 million square feet of vacant multi-tenant office space on the southwest metropolitan area market.

The office showroom market also will be affected by the additional space on the market. In the past, office users have looked at office showroom space because of the cost savings. However, with the competitive office market, the price gap between office showroom space and traditional office space will shrink, if not disappear completely.

Despite these factors, the Twin Cities industrial market is poised for a slow and deliberate recovery. Developers will continue to require pre-leasing before moving forward with new developments, and vacancies will lease up slowly with some submarkets taking longer than others.

— Joel Torborg is senior associate with Minneapolis-based Equity Commercial Services.

Office

While a remedy for the ailing Twin Cities office sector has yet to materialize, there are signs of an improving marketplace in the form of approximately 460,000 square feet of net office absorption through the first quarter of 2003. This is good news when compared to a negative annual absorption figure of 1.7 million square feet for the 2002 calendar year.

As the second quarter of 2003 unfolds, some new tenants are entering the market, and a handful of tenants are expanding. Medica, Minnesota’s second largest provider of health maintenance plans, is moving to Plymouth and expanding its space. In addition, mortgage and title companies, who have seen a strong growth in business activity, are among the new or expanding tenant prospects.

Owner/user sales have increased in 2003 as a result of the low interest rates. The Twin Cities market has also seen a surge in office and condominium development, as well as an increase in the development of multi-use facilities. For example, Welsh Company’s General Manager, Dick Zehring, recently purchased the Lowry Professional Building in downtown St. Paul and plans to invest $25 million to turn the space into condominiums and commercial space.

Following positive absorption activity, direct vacancy in the Twin Cities office market fell to 15.7 percent as of the first quarter of 2003. However, sublet space accounts for an additional 2.4 million square feet raising the vacancy factor to nearly 19 percent. The increase of sublease space, much of it fully furnished, has caused owners to offer enhanced incentive packages to remain competitive.

With so many landlords vying for office users, it has become critical to retain tenants. Many landlords have adopted a “whatever it takes” approach to lease renewals. This is especially true in downtown Minneapolis where Class A space represents nearly half of the submarket’s overall vacancy.

The volume of Class A availability in the Minneapolis CBD can be attributed to various corporate maneuvers. The lower rents and increased concessions found in the CBD are attractive to some tenants. For example, Fair, Isaac & Company, in an attempt to upgrade its image and attract workers, is relocating nearly half of its employees from Arden Hills into a 72,000-square-foot space at the AT&T Tower.

The St. Paul CBD — faced with state government cutbacks and little business expansion — appears to be more vulnerable than its Minneapolis neighbor. This submarket recorded negative absorption of 49,000 square feet, resulting in a vacancy factor of 20.9 percent at the close of the first quarter of 2003. On a positive note, Arch Insurance Group has established its first Minnesota office in St. Paul. The end result is approximately 14,000 square feet of space leased in the Minnesota World Trade Center.

While deals seem to be taking longer to complete, there is better activity in the marketplace. As the market continues to improve, more tenants will be competing for space thus shortening the deal process and spurring increased activity. The outlook for 2003 seems more optimistic then it did in late 2002.

— Jim Damiani is vice president in the Bloomington, Minnesota, office of Minneapolis-based Welsh Companies.

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