Recovery Continues in the Twin Cities Commercial Real Estate Market

The Twin Cities commercial real estate market continues to recover, posting more occupancy in all property types, with the exception of multi-family, which has one of the lowest the vacancy rates in the nation. Market-wide, vacancy declined to 13.02% for direct space, accompanied by 4.3 million square feet (msf) of positive absorption. After a slow first half, development and re-development activity have bounced back, nearly doubling the square footage under construction since 2011. The industrial market appears to be at a tipping point, posting its lowest vacancy rate since 2008. Likewise, with nearly 1 msf of positive absorption, the office market is in its best shape since 2007.

Landlords Benefit from Improving Industrial Market Conditions, Tenants Remain Cautious
The Twin Cities multi-tenant industrial market is at a tipping point. Vacancies have dropped to 12.8%, a 3.3% reduction from 2011. Year-end absorption exceeded 2.5 msf, the most since pre-recession 2005. A “flight to quality” continues, giving landlords of good industrial properties significant pricing power. Limited supply of large, functional space is driving interest for build-to-suit properties in select markets, perhaps prompting a few developers to start speculative projects in 2013. Despite an improving market, many are still waiting to make space decisions due to economic uncertainty, which will likely drive cautious decision-making into 2013.

Office Market Posts 1 MSF of Positive Absorption
With nearly 1 msf of positive absorption for the year, the Twin Cities office market is in its best shape since 2007 and is poised for accelerated growth in 2013. Overall vacancy was 18% for direct space across all property types, down 1.2% from a year ago. Sublease space is at its lowest level since 1997.  Although average rental rates remain flat, specific class A buildings in the West submarket and the Minneapolis CBD are driving up rates. The West submarket has emerged as the low-vacancy leader in office space, which will likely push larger users to the Northwest and Southwest submarkets in 2013. In the Minneapolis CBD, the components are in place for landlords to push rates in some class A space, including vacancy of only 9.7% and few options for large space users. However, with vacancy still above 24% and a more modest price, some of the better-positioned class B properties are attracting interest from users, which might reduce the upward pressure momentum on class A rates.

Retail Vacancy Decreases 1% as Market Shows Continued Improvement
In the strongest year of retail activity since the recession, vacancy decreased from 8.9% at mid-year to 8.3% due to 802,000 sf of positive absorption in the second half. Shifts in technology and the economy continue to spur retailers to rethink real estate strategies, pushing many big-box retailers to consider shifts toward right-sizing. Competition among grocers persists, with specialty grocers like Aldi and Whole Foods expanding as traditional stores lose market share. Optimism persists for 2013, particularly in downtown retail with several large-scale housing projects slated to begin construction. The first half is expected to be quieter than the second, but between 500,000 and 700,000 sf of positive absorption is expected by the end of the year.

Activity Picks Up in Hotel Market, Led by Downtown Minneapolis
The Minnesota hotel industry saw occupancy increase to 61.4% from 60.5% in the past year, slightly below the national average. The average daily rate (ADR) also increased, going from $90.71 to $92.75 with revenue per available room (RevPAR) increasing by 5.0%. Several properties changed ownership in 2012, and hotel owners are busy investing in their properties through renovation projects. Assuming the economy continues to improve, rates could reach 2008 highs in the upcoming years.

More National Investors Put Twin Cities on Radar Screen; Buyer Demand for Office Properties Expands
Large institutional investors such as pension funds and insurance companies continue to circle the Twin Cities for quality assets, solidifying the area as a key secondary market. Multi-family remains the hottest product while investors are still unwilling to take risks in retail. Improving fundamentals in key suburban submarkets may drive increased investor interest in suburban office product, but despite rising demand across product types, the Twin Cities new product pipeline is fairly dry except in multi-family. With new supply in check, owners of existing buildings should begin to recapture some of their pricing power in 2013.

Land Market Driven by Demand for Raw Residential Tracts, Multi-Family Urban In-Fill, Industrial Build-to-Suits and Select User-Driven Retail
The Twin Cities land market is picking up momentum as its recovery continues. Spurred by record-low apartment vacancy rates, multi-family housing developers are snapping up sites in core urban markets while expanding to include first-tier suburban markets. National homebuilders are actively acquiring raw land in favorable communities in good school districts. Industrial activity is led by build-to-suit projects for corporate users, retail activity remains user-driven, and farmland continues selling for a premium. Select speculative development is expected in 2013 with more projects expected to break ground in 2014-15.

Rents Increase as Demand for Apartments Remains Strong; Development Boom Continues
Despite the more than 1,400 new apartment units delivered in 2012, multi-family vacancy edged up only slightly from 2.3% to 2.7% over the past year. Despite slowing considerably, absorption continued to outpace new construction. Both urban and suburban properties boasted strong renter demand, which is driving up rents and may push some renters to purchase homes. Demand for apartments is expected to remain strong into 2013, especially in core urban markets and select in-fill sites in first-tier suburbs.

Industry Trends Driving Demand for Medical Office Space; New Construction Ramping Up
Overall vacancy in the medical office market is at 9.7%, the lowest since 2006, with absorption totaling 164,340 sf. Medical office space continues to outperform the general office market, which has a vacancy rate of 18%. New construction has been picking up, and while development has thus far been demand-driven, rare instances of speculative development are occurring. Uncertainty persists due to healthcare reform, but providers are moving forward with strategic plans to adapt to expected changes. Efficiency in the delivery of services continues to be a major driver in the healthcare market, leading to more system mergers and acquisitions, as well as partnerships among independent practices. Demand for medical office space is expected to stay strong.

Outlook
All sectors of the Twin Cities commercial real estate market continue to show signs of recovery, despite a lingering sense of uncertainty regarding the economy. The office and industrial markets are poised for accelerated growth when the cloud of uncertainty over the economy lifts. Several scheduled development projects offer optimism for retail and multi-family sectors. Though the broader economic environment continues to stall real estate decision-making, confidence is steadily improving.

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DISCLAIMER 
The Compass report, published since 1997, is created by Cushman & Wakefield/NorthMarq experts using Twin Cities commercial property data from the last six months of 2012. The data used for this report has been obtained from sources which we deem reliable. While every effort has been made to report accurate data, Cushman & Wakefield/NorthMarq cannot guarantee the accuracy of this market report. Furthermore, we cannot assume responsibility for any omission of data which may occur. It is our intent to provide the best possible information regarding the office, industrial, land, retail, multi-family and investment markets while leaving the reader the responsibility of further verification before using this report for business and/or financial decisions.

This report includes information for multi-tenant office, industrial and retail projects greater than 20,000 sq. ft. and multi-family for-rent properties. Not included are owner-occupied, government or single-tenant buildings. Not all information and insights we've collected can be published in any given volume.