CITY HIGHLIGHT, JUNE 2006

MINNEAPOLIS/ST. PAUL CITY HIGHLIGHTS
Terese Reiling, Peter Dugan, Todd Hanson and Richard Keller

Minneapolis/St. Paul Retail Market

The Minneapolis skyline.

Fewer vacancies have led to fewer upstart opportunities and, consequently, fewer mom and pop retailers entering the market. As a result, the Twin Cities’ tenant pool is rapidly changing and becoming less diverse. Personal service retailers such as nail salons, dry cleaners and hair stylists are making up an increasing percentage of the tenant mix, as are larger, national retail chains. Online movie rental services such as Netflix have had a significant impact on the video rental market, causing many Blockbuster Video, Hollywood Video and Video Update stores to close. Burger King, Hardee’s and Fazoli’s are also closing locations throughout the metro area. Fortunately, a number of new retailers are debuting in the Twin Cities this year. Some of the new arrivals include CarMax, Data Doctors, Jason’s Deli, Mongo’s Grill, Texas Roadhouse, Moe’s Southwest Grill, Blue Sky Creamery and Cartridge World.

Throughout the first and second-tier suburbs, redevelopment is rampant, as property owners seek to increase density to maximize square footage and the value of their land. In the third and fourth-tier suburbs, a number of new developments are also underway, many of which will come online this year, adding much-needed vacancies to the inventory of available space. However, with aggressive pre-leasing teams actively marketing the new developments, the new centers will not be vacant for long.

In the southwest submarket, quality availabilities are hard to find, with vacancy at a market low of 1.81 percent. The region did, however, manage to absorb 16,800 square feet in the first quarter, and creative retailers are making the most of what the market has to offer. At Boulevard Commons in southern Minneapolis, Caribou Coffee and Anytime Fitness have snapped up and re-outfitted approximately 6,000 square feet of former office space, which had previously been leased by Edina Realty. The North Face is reportedly also contemplating reconfiguring existing space to accommodate a new store in the Uptown area. The proposed site currently houses two buildings on Hennepin Avenue that are leased by The UPS Store and the restaurant Tibet’s Corner. If the plan moves forward, both buildings will likely come down to accommodate what will be The North Face’s first Minnesota location.

Redevelopment projects for the Galleria in Edina, Minnesota, and Calhoun Square in Minneapolis recently received City Council approval. The Galleria plans call for an $85 million project to be attached to the eastern portion of the shopping center. The addition will include a 225-room Westin hotel and 82 luxury condos that should be complete by summer 2008. At Calhoun Square, the approved plans propose an expansion of the existing mall as well as the addition of two residential buildings with 108 condominium units. Once complete, the project will bring commercial space at Calhoun Square up to 246,000 square feet with approximately 216,000 square feet of retail space. The center currently totals 142,000 square feet. In Richfield, Minnesota, Ryan Companies is scheduled to break ground later this year on Cedar Point Commons, a new mixed-use development with approximately 370,000 square feet of proposed retail space.

The southeast submarket currently has the second lowest vacancy rate in the metro area at 3.60 percent, after 6,119 square feet of retail space was absorbed in first the quarter. Strong residential activity in this region in recent years has left the area primed for retail development, and in many of the southeastern suburbs, plans are about to take off.

In southeast Minneapolis, one block east of Hiawatha Avenue on East Lake Street, Wellington Management will soon break ground on Corridor Flats, a 36-unit, four-story condominium project with residential units above first-floor retail space. An Aldi grocery store is tentatively committed as the primary retail tenant. The Red Pine neighborhood in southeastern Eagan, Minnesota, may soon get a much-needed infusion of retail growth. Revestors Realty is reportedly seeking approval from the city to construct Red Pine Crossing, a 100,000-square-foot upscale, grocery-anchored retail center at the corner of Highway 3 and Red Pine Lane.

In Apple Valley, Minnesota, a 77-unit Grand Stay hotel, the first of three phases for the New Century component of Century Village, is scheduled to get underway this spring. Shortly thereafter, work will begin on two additional buildings that will include approximately 58,000 square feet of first-floor retail space, 90 to 95 condominiums and expansive underground parking. Ryan Companies is also working to get approval from the city of Apple Valley on a new development called Cobblestone Lakes. Although only in the very early planning stages, Cobblestone Lakes will include close to 230,000 square feet of retail space, and will be located at the intersection of County Road 46 and Pilot Knob Road.

The northeast was one of two submarkets to see negative absorption in the first quarter, placing 31,593 square feet of space back onto the market, but vacancy in the northeast still sits at a low 5.05 percent. Near the University of Minnesota (UM) campus, renovations are underway at Stadium Village Mall, a 30,000-square-foot mixed-use property. Should funding for the new UM football stadium be approved, Stadium Village Mall will be in a prime position to benefit from the new attraction, as it is situated just one block from the stadium site. Currently, the mall houses Subway, the UM Credit Union, On the Go P.C., Pita Pit and Neon Sun; Salsaritas Fresh Cantina will open a new location there later this year.

As support for mass transit along the central corridor that connects the downtowns of Minneapolis and St. Paul gains momentum, developers’ interest in the northeast increases. While neighborhood groups, politicians and businesses along University Avenue still have very different ideas about what mass transit should look like in this area, everyone seems to be in agreement that the location is ripe for improvement. Both bus rapid transit and light rail transit options are currently being explored.

At 5.13 percent, the northwest submarket lags behind the other suburban submarkets in terms of vacancy, but the region led the metro area in positive absorption this quarter, absorbing 66,760 square feet of retail space.

New developments in the area are also faring quite well. Ryan Companies’ massive medical/retail mixed-use development in Maple Grove, Minnesota, known as The Grove, signed Target and The Home Depot as anchor retailers. Target will occupy 174,000 square feet of space, while The Home Depot is taking up another 105,000 square feet. The development is scheduled to open spring 2007. North Memorial Medical Center has already broken ground on the first phase of the medical component to the center, a 150,000-square-foot facility that will include a 24-hour emergency room and a 90,000-square-foot medical office building. In Otsego, Minnesota, Ryan Companies is scheduled to break ground this month on Great River Centre, a 210,000-square-foot development that is also courting Target as an anchor.

Despite negative absorption in first quarter totaling 38,692 square feet and vacancy rates increasing to 22.96 percent, experts are optimistic that retail in the Minneapolis central business district (CBD) is on the brink of a big turnaround. Housing and condominium development continue to roll; hotel construction and conversion are on the rise; three grocery chains are working on downtown locations; new retailers are entering the market; and development and redevelopment projects are moving ahead.

Although the metro area population has outpaced retail development and, statistically, the region can support more retail growth, housing activity has begun to taper off, which may cause retail development to slow as well. With the costs of land and construction continuing to rise, retail development may soon outpace what the market will withstand for price per square foot. As long as housing values continue to increase, however, market confidence should remain steady, and retail will continue to perform well.

— Terese Reiling is a vice president of retail with Minneapolis-based Welsh Companies.

Minneapolis/St. Paul Industrial Market

The Minneapolis/St. Paul industrial market continues to improve behind strengthening fundamentals, building on the momentum of a strong finish in 2005. Several factors are behind the market’s progress. One is the diminishing number of user-owned buildings for sale across the submarkets. With fewer options, more companies will lease or build. Interest rates are expected to rise from the record lows of 2004 and 2005, which will also slow sales. In addition, the state is experiencing steady job growth. So far in 2006, vacancy is down slightly, absorption is steady and rental rates are rising slightly. While landlords are still aggressively seeking to close deals, concessions are beginning to tighten.

Industrial land prices have increased drastically, with prime locations in the most desired submarkets doubling in the last 24 months due to a constrained supply of developable land. Coupled with increasing construction costs, some new developments will demand higher pricing levels in the market. The jury is still out on whether or not demand is strong enough to support the pricing. However, some speculative building is expected in response to projected 2006 absorption of more than 3 million square feet, which would move overall vacancy to approximately 10 percent.

Rising land and construction prices will force developers to either build new projects that are higher-end office/showroom product or to differentiate new product from existing product by building 32-foot clear height ceilings, offering cost savings through higher efficiency and more modern layouts. This makes it difficult for existing buildings with lower ceilings to compete unless they can offer more floor space at lower rates. In addition, site sizes need to be large enough to accommodate deep truck courts for today’s semis as front-loading falls out of favor. In terms of location, new construction is slated primarily for third-ring suburbs and rural sites, while existing first-ring facilities are being upgraded or sold for redevelopment.

In the more affluent western submarkets, activity is strong in the office/showroom and office service industries. Examples of recent transactions include Delphax Technologies’ 10-year lease of 45,000 square feet in Bloomington, Minnesota, and a new 20,000-square-foot, 7-year lease by Avtex.  Supply is particularly tight for this property type in the northwest submarket.

The eastern submarkets, traditionally more conservative areas, have shown the heaviest activity in distribution, warehouse and manufacturing uses. Recent transactions in these categories have come from BTD Manufacturing, which expanded to 95,000 square feet from 45,000 square feet and signed a 5-year lease at the Performance Office Papers building in Lakeville, Minnesota, and Normark, which signed a 7-year lease for 130,000 square feet at Aldrin distribution center in Eagan, Minnesota.

Despite strengthening activity, overall industrial rental rates remain flat, with industrial office space averaging $7.99 per square foot in the last 6 months, while warehouse space averaged $4.39 per square foot. Tenants should expect to see rental rates increase at renewal, as the supply of space options dwindles and concessions begin to disappear.

— Todd Hanson is a vice president of industrial brokerage with United Properties in Minneapolis.

Minneapolis/St. Paul Office Market

Richard Keller Senior Vice President/ Principal Colliers Turley Martin Tucker

This absorption enabled the office market to take approximately 1 percentage point off its vacancy rate, as it dropped from 17.5 percent fourth-quarter 2005 to 16.7 percent during the year’s first quarter. In the past 15 months alone, the office sector has enjoyed steady gains, paring down the vacancy rate by more than three percent.

Office tenants have continued their flight to quality. Class A vacancy rates have declined nearly four percentage points since the start of 2005, reaching 12 percent at the end of this year’s first quarter. Class A space is quickly becoming a premium, particularly for tenants looking for large blocks of contiguous space.

The Minneapolis central business district (CBD) saw increased activity during the first quarter, building on its momentum. As the largest office market in the Twin Cities, the Minneapolis CBD experienced 358,000 square feet of new absorption, with Target Corp. leading the charge with its 172,000-square-foot expansion.

With Class A vacancy at 12.9 percent, downtown landlords are beginning to regain some pricing power in Class A buildings. No new buildings are underway in the CBD, so Class A landlords can be patient and wait for higher rents and tenants with stronger credit ratings.

Other areas showing strength included the southwest and western sectors, which posted absorption of 122,752 square feet and 108,183 square feet, respectively.

Duke Realty Corp. is developing Norman Pointe II, a 332,000-square-foot spec office building in Bloomington, Minnesota.

But developers are beginning to see opportunities due to the scarcity of Class A space in the southwest and western sectors, where Class A vacancy rates stand near 8 percent and 12 percent, respectively. Duke has broken ground on Norman Point II, a 332,000-square-foot spec building in Bloomington, Minnesota, which is in the southwest sector. Duke expects to complete construction in the fall of 2007. Additionally, Opus Northwest plans to move forward with its 600,000-square-foot speculative development on the vacant Supervalu site in Hopkins, which lies in the western sector. These western suburbs offer solid demographics from affluent residents and easy accessibility from the area’s major interstates and roads.

We also expect to see further developments around the airport and the Mall of America. Light rail stops in these areas have attracted interest, so leasing activity should gain steam and new office development may follow.

The proposed Bloomington Central Station is an example of new metro area development. Locally based McGough has plans to develop more than 1 million square feet of office space and 50,000 square feet of retail located across from the Mall of America. The long-range plan calls for developing to occur throughout the next 10 years, creating a new urban core for the tri-city area.

As the office market continues to improve, landlords will increase lease rates and decrease concessions on tenant improvements and free rent. Many tenants, though, may explore Class B options to avoid rent increases in Class A buildings when their leases expire.

Leasing rates vary widely by submarket and building quality. As an example, Class A product in the Minneapolis CBD commands anywhere from $15 to $27 per square foot and from $12 to $18 per square foot in the southwest sector. Class B office buildings range from as low as $5 to as high as $20 per square foot.

— Richard Keller is senior vice president and principal of Colliers Turley Martin Tucker’s Office Sales and Leasing Division in Minneapolis/St. Paul.

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