CITY HIGHLIGHT, JUNE 2009

MINNEAPOLIS/ST. PAUL CITY HIGHLIGHTS
Mark F. Sims, Jeff Budish, Peter Dugan, Susan Wilson, Norma Jaeger, Scott Pollock, Lance Steiger and Dan Trebil

Minneapolis/St. Paul Industrial Market

“Ride out the storm,” may be the refrain of industrial developers, landlords and tenants, as the recession and the resulting uncertainties have all players in the Twin Cities commercial real estate industry watching carefully and exploring their options.

For starters, development has ground to a halt. This may be the silver lining, however, since it will enable the market to more easily absorb existing product and sublease space, thus allowing the market to recover more quickly when the economy begins to turn the corner. There is a small amount of spec product on the market, but this represents such a small amount that it has little to no impact.

Fortunately, restrained development has allowed the industrial market to catch its breath. During the first quarter, absorption fell in positive territory, with nearly 197,000 square feet absorbed, leading to a slight decline in vacancy from 10.1 percent to start the year to 9.9 percent by the first quarter’s end. The modest absorption has largely been driven by smaller deals.

Another side effect has been the collapse of the land market. Land prices have come down as much as 50 percent from their highs during a flurry of activity 12 to 18 months ago. Savvy developers continue to acquire land for future development, but both buyers and sellers have become more creative. Instead of buying land outright, developers are structuring purchase options, allowing the seller to proactively place its property in the market with a developer that will apply time, expertise and marketing. In turn, the developer does not have to bear any carrying costs until a definitive project is identified. In other cases, where sellers will fire-sale the property, developers are buying land with cash for pennies on the dollar.

Location has become even more important for owners looking long-term. In particular, developers and investors are focusing on the core assets inside the Interstate 494/694 Loop that rings the metro area.

Key challenges remain for landlords. Tenants are using the market’s weakness to renegotiate their current leases and to look for ways to reduce costs. Many large users are actively shopping the market. As examples, Star Exhibits is looking for 180,000 square feet and ExpedX for 150,000 square feet in the Northwest submarket.

Other large deals will play a part in reshaping the market, albeit through a game of musical chairs that still leave some seats empty.

Target recently vacated in excess of 500,000 square feet of distribution space in Shakopee, Minnesota, to occupy the 400,000-square-foot Worldwide Distribution Center in Bloomington, Minnesota. Video game distributor COKeM International will move to one of the vacated facilities in July. COKeM also will expand to 157,000 square feet in the Valley Green Business Park in Shakopee from its current 110,000 square feet of leased space in Plymouth, Minnesota. Graybar Electric will consolidate three facilities from Minneapolis and North Dakota to occupy 120,000 square feet in Brooklyn Park, Minnestoa. Finally, Superior Logistics is taking 300,000 square feet of the MDI building in the St. Paul/Midway submarket.

The wealth of space and lack of activity among users are placing pressure on rents. Bulk warehouse rates were down 2 percent from third-quarter 2008 to the end of the 2009’s first quarter, and office showroom rates dipped 4 percent during this period. Office warehouse space showed a slight increase of 1 percent during this timeframe. Rental concessions also are increasing as supply exceeds demand.

Moving forward, absorption will remain flat or trend negative over the balance of the year. Tenants will continue to use this as an opportunity to move up in quality and find better locations, or, more likely, they will utilize the threat of leaving their current location to renegotiate with their current landlord. Landlords with the right product will continue to see transactions but they must remain competitive to seal those deals.

— Mark F. Sims is a principal and senior vice president in Colliers Turley Martin Tucker’s regional office in Minneapolis/St. Paul. He specializes in industrial sales and leasing.

Minneapolis/St. Paul Retail Market

At the end of the 2008, many retailers held off closing stores until after the holiday season, leaving landlords with vacancies at record highs in 2009. While unemployment rates continue to rise, recent stock market activity and an increase in consumer spending offer signs of hope for the future. In the first quarter of the year, the Minneapolis/St. Paul metro area registered negative absorption, higher vacancy rates and lower net average asking lease rates compared to the previous quarter. Many retailers continue to put expansion plans on hold due to the uncertainty of the depressed market. The economy as a whole, however, is showing signs of recovery as financial companies begin to clear themselves of poor debt, the housing market begins to level out and consumer spending turns the corner. Economists believe these factors, sparked by drastic stimulus packages, will cause the real estate market to stabilize in the second half of the year.

Even though property values have diminished significantly, buyers are still sitting on the sidelines. This is both due to the difficulty in finding financing and a hesitation sparked by an unknown future. Significantly higher cap rates and a drop in operating income due to big box vacancy, have made investment sales transactions difficult to justify.

Despite all of the bad news, there are still retailers looking to expand in the Twin Cities metro area. Walgreens is buying out prime corner locations to build its stores in the heat of its competition with CVS/pharmacy. Fast food restaurants such as Dunkin’ Donuts, Five Guys Burgers & Fries, and Smashburger are entering the market. Other retailers such as Massage Envy and Home Choice are devising area expansion plans as well.

The most important issue for retail landlords today will be the ability to fill large blocks of space left vacant by big box retailers. Vacant stores from retailers such as Linens ‘n Things, Circuit City and Sportsman’s Warehouse, among others, have left shopping centers, particularly power centers, with large empty storefronts and few potential reuses. Around the country these spaces have been filled with many diverse tenants, including government agencies and medical facilities, but so far, little activity has occurred in the vacant big box spaces of the Twin Cities.

While tenants currently have the upper hand in negotiations, landlords should not be completely pessimistic. Many construction projects have been postponed until brighter times and at some point there will be a shortage of property in the market and the upper hand will return back to the landlords, assuming they have retained their anchor tenants.

The main project on everyone’s radar is the West End, which is located at the southwest corner of Highway 100 and Interstate 394 — which is the main artery connecting the western suburbs and downtown Minneapolis. The development was originally planned to house national tenants but the roster has changed due to the current pace of retailer expansion. According to the developer, the project will be a mix of upscale local and national retailers; it is currently 65 to 70 percent leased with the grand opening scheduled for the fall. Tenants signed on to the lifestyle development include Rainbow Foods Grocery store, Kerasotes Movie Theatre and DoubleTree Hotel, while the center will also include more than 1 million square feet of office space. There are also four to eight upscale restaurants proposed for West End.

— Jeff Budish is a researcher, and Peter Dugan, senior associate, and Susan Wilson, associate, are retail and restaurant specialists that are based in CB Richard Ellis’ Minneapolis office.

Minneapolis/St. Paul Office Market

As the economy remained stagnant during the first quarter, the Minneapolis/St. Paul office market saw more of the same. Not surprisingly, the area witnessed – and continues to do so – its share of pink slips, especially considering the concentration of retail and financial powerhouses that call Minneapolis/St. Paul home. Best Buy, Schwan’s and Target were among retailers paring their payrolls, while financial firms Ameriprise Financial, M&I Bank, ING and Fair Isaac also announced layoffs during the first quarter.

Many of these larger firms maintain a significant presence in Minneapolis/St. Paul and occupy either owned or leased buildings. In some cases, though, they have returned space through subleases. Others may be contemplating consolidating, such as Target, which leases space in some multi-tenant buildings, but could elect to vacate such space and maximize existing space in its corporate headquarters.

Not surprisingly, job losses are impacting the office sector. The area reported negative absorption of more than 532,000 square feet during the first quarter. Consequently, the vacancy rate rose from 17.7 percent at the start of the year to 18.4 percent by the end of March.

The Southwest submarket has been one of the hardest hit areas. Four new buildings came online in the past 18 months, adding more than 921,000 square feet of space. Duke’s Norman Pointe II opened late in 2007, with 322,000 square feet. Ryan Companies US has completed Two MarketPointe in September 2008. United Properties completed the 8200 Tower in Normandale Lake Office Park, which is a 274,000-square-foot building owned by TIAA-CREF. Solomon Real Estate’s Windsor Plaza Development in Eden Prairie includes a 130,000-square-foot office building.

This new space, coupled with tenant relocations from existing buildings in the Southwest, increased vacancy in the submarket to 20.7 percent by the end of the first quarter. Already home to numerous Fortune 500 companies, the Southwest continues to be a favored market but it will take some time to absorb the glut of space.

On the plus side, SuperValu is showing some strength, bringing many of its vendors closer to its headquarters located in Eden Prairie.

Bucking a trend in many other cities, the Minneapolis central business district (CBD) remains relatively stable. The area’s largest submarket, the CBD basically held its own during the first quarter, with its vacancy rate staying at 15.8 percent. However, the recent layoffs, coupled with consolidations and Target’s lease renewal for its headquarters, essentially assure that any plans for development downtown will be put on hold.

The St. Paul CBD, though, has not fared as well. Educational Credit Management Corporation has vacated the US Bank Center, in a move comprising the bulk of the submarket’s 122,825 square feet of negative absorption during the first quarter. The vacancy rate increased to 28.2 percent during the first quarter, up 1.7 percent since the start of the year.

Needless to say, it has become a tenant’s market. Sublease space has given companies an opportunity to upgrade without incurring additional expense or to make a lateral move in quality while reducing rent expense. In fact, sublease space is being absorbed quickly, dampening its impact on the overall vacancy rate. This condition will not continue indefinitely and such space will no doubt place pressures on the office market.

Overall, rents have dipped slightly from $15.58 to $15.47 per square foot for Class A space, and remained steady for Class B rates at $11.86 per square foot. Many landlords, though, are giving concessions of 6 to 9 months of free rent. The increasing vacancy rate and the looming sublease space uptick will make it difficult for landlords to hold the line on rent. 

On the plus side, such renewals are for shorter timeframes, which means landlords can ride out the storm and be positioned for expected improving conditions in a year or two.

There is another silver lining in these dark clouds, too. Development has been restrained, all but stopping as the market assesses the excess inventory and financial factors tie developers’ hands. Only small developments that have a minimum of 50 percent pre-leasing or build-to-suits for financially strong companies will move forward in the near future.

As an example, Wellington Management expects to begin construction on a 110,000-square-foot, Class A mixed-use building in St. Paul. The LEED Gold-certified building will be named 2700 The Avenue, with the building’s first floor anchored by a 14,000 square-foot Riverside Market.

— Norma Jaeger, CCIM, RPA, is a second vice president in Colliers Turley Martin Tucker’s regional office in Minneapolis/St. Paul. She specializes in office sales and leasing.

Minneapolis/St. Paul Multifamily Market

Last year, the Twin Cities multifamily sector ended with a 0.7 percent increase in rents and a quick jump in vacancy from 4.2 to 4.9 percent in the fourth quarter. Basic fundamentals still look favorable but the it appears that the first half of the year will be the first time in 5 years that the Twin Cities market will feel downward pressure on rents. After a metro-wide loss of nearly 25,000 jobs in the first quarter, suburban Class A properties will feel the most pain, as renters begin to double up, purchase a home or gravitate toward more affordable Class B properties. Additionally, as home values depreciate, the relative cost gap between renting and owning will continue to shrink. For these reasons, Class B and C properties are well positioned to weather the economic storm.

Construction plans have changed dramatically in recent months. In October 2008, 1,300 new units were planned for 2009. Currently, only 500 units are planned, due to financing difficulties and decreasing demand. Well-located, urban infill projects are the most likely to reach completion this year, while suburban projects are likely be stalled until market conditions improve.

Currently under construction:

• The Ellipse: 132 units, St. Louis Park, Minnesota; Bader Development

• 2838 Fremont: 237 units, Uptown submarket; Opus/Greco

• Maple Village: 102 units, Maple Grove, Minnesota; Sand Companies

During the past 2 years, the number of multifamily lenders has been considerably reduced. Conduits and life companies have virtually abandoned the market. Today, local and regional banks are competitive lenders for loans under $3 million, while Fannie and Freddie dominate the market for properties above $3 million. Local and regional bank loans still offer attractive interest rates and loan-to-value ratios, but most are requiring shorter terms and borrower guarantees.

As the federal government continues buying treasuries, commercial loan rates are well-positioned to stay low through the end of the second quarter. Additionally, Fannie Mae and Freddie Mac will benefit from the U.S. Federal Reserve’s willingness to add liquidity to the agencies by purchasing billions in debt.

With transaction volume slowing, investors and lenders continue searching for the “new” price of real estate in this deleveraged market. While buyers wait in a “you go first” mentality, cap rates continue to edge upward, due to a reduced demand for new investments and soft leasing market fundamentals. We expect cap rates to remain relatively stable through the second quarter, as transaction volume remains below average and agency lenders stay aggressive with rates.

— Scott Pollock, Lance Steiger and Dan Trebil with the Minneapolis office of NorthMarq.

©2009 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.