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CITY HIGHLIGHT, NOVEMBER 2011
TWIN CITIES HIGHLIGHTS
Terese Reiling-Holden, John Ryden, Armand Brachman, Jon Segner, Richard Keller
Twin Cities Retail Market
Like the entire country, the retail real estate market in Minnesota has been affected by the overall economic slowdown since 2008, with low consumer confidence on one side and a lack of financing options for retail business expansion on the other.
However, we have experienced a strong and healthy increase in local retail activity in 2011. I expect this trend to continue, especially for projects that are located in strong, dense urban trade areas. Some positive absorption has occurred in Edina, a traditionally strong regional mall trade area in the Twin Cities that began the year with a strip retail vacancy of nearly 22 percent due to national store closings such as Ultimate Electronics and Circuit City.
With several leases signed this year at existing retail centers, as well as ones under construction, vacancy rates for this submarket look like they will fall well under 10 percent by the end of 2011.
These vacancy rates exclude the regional mall in this trade area, Southdale Mall, and pertain only to the ancillary strip retail properties of the immediate surrounding submarket.
The unemployment rate in the Twin Cities in August stood at 6.7 percent compared with 9.1 percent nationally. The metro area boasts an educated work force supported by a base of strong local companies such as UnitedHealth Group, Target, US Bancorp, 3M, Medtronic, General Mills and Cargill, to name a few.
However, low consumer confidence, the stagnation in residential housing growth and the decline in residential home values, which impacts a household’s “wealth effect,” seem to have had the most direct impact on the commercial retail market.
Retail markets that feature strong residential demographics and daytime population are currently faring much better overall than less densely populated trade areas that are farther out.
For example, the Edina trade area has experienced strong interest from national retail anchors to open stores in the market. These tenants are forecasting healthy store sales based on the dense demographics of the market, both in population and household income to support opening these new stores.
The investment sales market year to date also has been slow, but the overall market conditions continue to improve. Buyer and seller activity will gain momentum heading into 2012 as more favorable financing options become available and market confidence stabilizes.
There continues to be demand on the investment side for “A-grade” retail-anchored properties. The sale of owner-occupied retail is also showing improvement now that financing options are opening up and retail sales figures are trending upward.
In the wake of the economic downturn, the amount of new retail development slowed dramatically over a three-year period. Now several new projects are underway.
Meanwhile, redevelopment of an existing urban site is also a viable option because of the proven long-term success of a particular trade area.
It is likely that a lower amount of strip retail space as an overall percentage of a project will be incorporated into future retail developments. The trend over the last 10 years has been a decline in the number of strip retail candidates (smaller-sized retailers) for retail developments.
Today, prospective tenants for smaller retail spaces are often in the food or service categories rather than the apparel, gift and specialty retailers that previously occupied a large percentage of strip retail space in a traditional retail strip-anchored development.
Retail sites that are well located in dense, urban trade areas adjacent to larger pockets of office space seem to be the current hot spots for both new and redevelopment opportunities.
The traditional requirements of excellent visibility, convenient access, prominent signage and abundant parking are necessary for retailers to approve a specific site.
Centennial Lakes Plaza, a 195,000-square-foot retail center in Edina, is an example of a strong urban redevelopment project.
A new, 32,000-square-foot Whole Foods is opening in April 2012 at this development built in 1989, and which includes more than 29 tenants. Centennial Lakes Plaza features Old Navy and OfficeMax as anchors.
Looking forward, I suspect that a year from now everyone will be talking about how fast the retail market actually improved over the past 12 months.
— Terese Reiling-Holden is vice president of retail in the Minneapolis-St. Paul office of Colliers International.
Twin Cities Industrial Market
For the past four quarters, the industrial sector in Minneapolis/St. Paul has experienced growth and new construction is on the rise. There also is increased institutional capital in the marketplace, which is putting downward pressure on cap rates.
Net absorption was positive in both the single-tenant and multi-tenant market in the third quarter. The majority of positive activity was in the north central and south central submarkets of the Twin Cities. The Southwest and St. Paul submarkets experienced the most significant negative net absorption, with more space coming on the market than was leased.
Companies in the Twin Cities are expanding, making improvements and extending leases. Locking in at today’s rates for the longer term has been the trend. Financing is readily available outside of speculative development, and most properties are at relatively high occupancy levels. Investors are willing to pay a premium price for well-leased buildings.
The challenges are typically with smaller spaces in the 10,000 to 30,000 square foot range because significantly more options are available.
Construction Activity
There is limited availability of industrial space in the Twin Cities and the first-ring suburbs. More space is available in the outer-ring communities such as Rogers and Shakopee.
There are three significant construction projects under way, including a 300,000-square-foot distribution center in Rogers, an 80,600-square-foot design/build lease in Maple Grove, and a 60,000-square-foot speculative office showroom in St. Paul.
There should be a substantial increase in Twin Cities build-to-suit activity for larger users in the coming year, but less activity in outstate Minnesota due to tax abatements being reduced in rural communities.
The availability rate declined in the third quarter in both the multi-tenant and overall market. The multi-tenant available rate decreased from 11.54 percent to 11.44 percent and the overall market declined from 16.68 percent to 16.44 percent.
These figures represent all space on the market in the Twin Cities, including sublease space. Sublease space availability declined slightly from 1,494,490 square feet to 1,485,680 square feet.
The Twin Cities multi-tenant bulk warehouse available rate decreased from 21.98 percent to 20.98 percent in the third quarter. The south central, southwest, north central and midway submarkets still have bulk warehouse available rates of more than 20 percent.
Multi-tenant office showroom rates declined slightly from 17.44 percent to 17.4 percent. The highest office showroom available rates at the end of the third quarter were in the southwest and south central with 21.97 percent and 18.72 percent, respectively.
The multi-tenant office warehouse available rate also dropped slightly from 16.11 percent to 16.06 percent. Only the Minneapolis submarket ended the quarter with an office warehouse available rate below 15 percent.
Long-term effects of the recession could be positive for new development as many municipalities loosen up on what types of projects can be built. Cities that are invested heavily in their infrastructure will need to relax development restrictions, given today’s economy.
A year from now, we expect to see a substantial increase in both build-to-suit activity for larger users and speculative development.
— John Ryden is senior vice president at CBRE Minneapolis-St. Paul, specializing in the sale and leasing of industrial properties.
Twin Cities Multifamily Market
The Minnesota apartment market is approaching healthy levels not seen in more than a decade, with rents on the rise and vacancy on the decline. In Minneapolis, 13 new multifamily projects have either been recently completed or are under construction, totaling more than 1,800 units. Forty-eight additional projects are proposed, potentially adding 8,174 units to the market .
Considering that developers typically only consider new construction when rents justify adding product, the number of new projects proposed indicates the local apartment market is thriving. The only caveat is the lender requirements for developers.
Securing financing is complicated, and it won’t be easy for developers to bring new units to market. Lenders remain reluctant to open the financing floodgates and have tightened underwriting standards substantially over the past three years, focusing heavily on the quality of the borrower.
The good news for developers who can secure financing is that interest rates are at or near all-time lows, resulting in increased mortgage proceeds to finance new projects. Developers can justify new construction due to strong apartment fundamentals, a lack of lending in alternate asset types and larger macro shifts in housing trends.
There are many trends affecting the Minnesota apartment market in today’s uneasy economy. Lenders seem more reluctant to fund real estate product in the retail, office and industrial sectors.
This reluctance has led to increased lender interest in the multifamily sector, especially affordable housing, which has remained strong throughout the recession.
This strength is evident in a group of 6,000 stabilized units managed by Dominium (representing the majority of Minnesota properties). The increase in net rental income from 2009 to 2010 was 1.1 percent, all due to improvements in rent loss.
From 2010 to 2011, net rental income increased 4.25 percent through a combination of gross potential increases and improvements in rent loss. The recovery in 2010 has turned into real rent growth in 2011.
The trend appears poised to continue, with Dominium expecting to see virtually all rental income increases to come from rental rate gains versus improvements in rental loss. In 2012, the expectation is for a 4 to 5 percent increase in net rental income with almost all of that coming from increases in gross potential.
While it appears that a perfect storm of success is brewing for the apartment industry in Minnesota, there are limiting factors. Should the uneasy economy dip into another recession, household contraction is a real possibility that could decrease demand and consolidate renters into fewer units.
There is a long-term trend away from home ownership, adding substantial numbers of renters to the Minnesota apartment market. The downtown Minneapolis and St. Paul submarkets are particularly strong, driven by high rents and low vacancies.
In addition, the lack of new supply over the past three to five years in Minnesota has resulted in pent-up demand, and apartment owners are finally realizing the benefits.
These fundamentals are propelling the velocity of apartment sales for the Class A market, with bidding wars ensuing in some cases. The Class B market also is trading at elevated levels.
Still, high seller expectations could limit sales volume as buyers contemplate new construction and rehabilitation as alternatives to pricey acquisitions. Three
such projects are underway. Dominium is converting three historic sites into affordable housing, including the former homes of Schmidt Brewery, Lehman Center and the Pillsbury factory.
The Pillsbury and Lehman projects, located in the prime development areas of St. Anthony Main and Uptown, respectively, will continue to add to their bustling neighborhoods.
The Schmidt Brewery project is expected to be a catalyst for growth in the surrounding neighborhood southwest of downtown St. Paul near West 7th St. and Fort Road.
All three deals include multiple layers of financing in the form of local financial assistance, federal low income tax credits, federal historic tax credits and state historic tax credits.
Increasing rents and decreasing vacancy will give way to new supply being delivered to the market and the beginning of an apartment boom.
— Armand Brachman is co-managing partner at Minneapolis-based Dominium.Jon Segner is president and COO of the property management division.
Twin Cities Office Market
The Minneapolis-St. Paul office market is continuing its long march toward a return to pre-recession levels. With 242,368 square feet of overall absorption in the third quarter, the vacancy rate in the Twin Cities metro area now stands at 17 percent, a full 3.2 percent lower than where it stood one year ago.
The trend toward positive absorption for the third straight quarter is a good indicator of the metro’s traditional capacity to withstand economic hardship. Home to 19 of the state’s 20 Fortune 500 company headquarters, the Twin Cities is teeming with support services such as finance, creative services, publishing and more.
The average vacancy rates for Class A space in the central business districts (CBDs) of Minneapolis and St. Paul are below 10 percent. However, both CBDs are experiencing Class B vacancy rates above 22 percent, which indicates a flight to quality among tenants who have taken advantage of attractive leasing rates to move into Class A space during the last two years.
The outlying suburban submarkets in the Southeast, Southwest, St. Paul Suburban, and West/Northwest, however, are quite the opposite, with Class B vacancy ranging from 13.7 percent to 18.9 percent and Class A vacancy ranging from 13.9 percent to 22.1 percent.
Given the corporate downsizing that has occurred since the beginning of the economic downturn, many companies have excess space that they can grow back into as business rebounds. This phenomenon is called “shadow space.”
While shadow space is a reasonable barrier to more absorption, many companies that have already consolidated space have left behind more vacancy than they occupy today.
Compared with other major metropolitan areas in the nation’s heartland, Cassidy Turley’s U.S. office market report for the third quarter indicates that the Twin Cities are faring well with respect to vacancy and gross asking rents.
What will it take to reach a 15 percent vacancy rate overall for the Twin Cities office market? In a word — jobs. With stagnant job growth and incentives from surrounding states threatening to woo leading companies, Minnesota faces a significant challenge moving forward.
To this end, Minnesota is examining ways to improve its business climate, which is an important step in the right direction for commercial real estate. The creation of GreaterMSP, an economic development partnership focused on the 13-county Minneapolis-St. Paul region, helped set the process in motion.
The goal of GreaterMSP is to provide a strategic vision for regional economic development, brand and market the greater Minneapolis-St. Paul region, and leverage local resources and incentives to attract, retain and expand current and new businesses.
Minnesota has been motivated by the success of Pittsburg, Denver and St. Louis, which have all recently adopted a similar strategy with positive results.
All in all, Minnesota is poised to end the year on a positive note in terms of office space absorption. And there is more reason for optimism. In 2011 alone, the state ranked as the No. 7 state in CNBC’s “Top Places for Business”. The Twin Cities were ranked in the top 15 on Forbes’ “Best Places for Business and Careers” and was touted as the “best city in the country for finding employment”.
— Richard Keller is principal andsenior vice president in the Minneapolis office of Cassidy Turley. He focuses on the office sector.
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