Less was definitely more for the Twin Cities commercial real estate markets over the second half of 2010: less drastic increases in vacancy rates, less negative absorption and less uncertainty. It's a signal that the market has likely bottomed out. However, this bottom is much lower than those of recent memory—the lowest in perhaps 20 years or more—and it has left the market in a deep hole that will take a lot of work to get out of.

Overall market vacancy increased slightly, finishing the year at 15.8% for the combined office, industrial and retail markets. That was up just 0.5% on the year, however, after soaring more than 3% between 2008 and 2009.This is progress in terms of a slower pace of decline, which is also reflected in the absorption numbers—just 365,000 sq. ft. of negative absorption was posted in 2010, versus 4.3 million square feet of negative absorption in 2009.

Office Upgrades in Demand
Demand for office space began to percolate in the second half, resulting in a modest but encouraging 202,000 sq. ft. of overall positive absorption. Overall vacancy remained steady at 19.9%, with four of seven submarkets reporting vacancy rates above 20%. Vacancy in the Minneapolis Central Business District was 19.1%, but just 11.7% among Class A properties and below 5% along the Nicollet Mall corridor.

Stronger Retail Centers Benefit From Higher Demand
Retail vacancy dipped below 10% on the heels of a modest rebound in space demand, resulting in 374,000 sq. ft. of positive second-half absorption. High-quality retail centers experienced increased demand, allowing landlords to hold—and in select cases, raise—rental rates.

Industrial Vacancy Rate Inches Higher
Industrial market fundamentals remain weak, reflected by an upward tick in vacancy to 17.2%—the highest mark in more than a decade. Negative absorption totaled 216,000 sq. ft. in the second half and negative 708,000 sq. ft. for the year. But that's a far cry from the 2.4 million square feet avalanche of negative absorption that befell the market in 2009.

Medical Office Makes a Comeback
The medical office market is on the mend, evidenced by a decline in the overall vacancy rate to 11.1% and 90,000 sq. ft. of positive second-half absorption. Vacancy among hospital campus properties is 8.5%, while the off-campus rate declined to 13.8%. The off-campus market is seeing increased competition from the multi-tenant retail space universe.

Retailers on the Lookout for Land Opportunities
The market for speculative land remains cold, but user-driven land sales are increasing. Select retailers are stepping up their efforts to purchase choice locations, many of which were priced out of their reach before, at today's lower rates. Area farmland prices—seen as the low-end floor for metro area land values—rose throughout the year into the range of $5,000 to $6,000 per acre.

Buyers, Sellers Draw Closer on Investment Sale Pricing
Investment sales activity improved in the second half, although the number of transactions taking place remained well below average across virtually all property types. Indications were that buyers and sellers were drawing closer together on pricing. Buyers have reduced their long-term return expectations, placing increasing importance on bottom-line items such as predictable cash flow, good quality tenant credit and long-lived tenant rolls.

Lenders remain skittish about extending credit for all but the most desirable assets at either end of the spectrum, although there are signs of improving credit access.

Where Are Construction Costs Going?
Construction costs may increase in 2011, due both to increased activity and higher costs for materials and energy. The first signs of rising construction costs appeared in the fourth quarter of 2010, following 18 months of flat pricing. The real question is how much of an inflationary impact to expect, and when? Prudence suggests budgeting for a certain amount of inflation after the first quarter of 2011. Project managers will need to take such factors as market segments, geographic location and type of construction system in use into account for cost increases as they bid out their projects in the year ahead.

On the Horizon
The overall market for commercial real estate appears to have bottomed out in the Twin Cities. However, fundamentals are still very weak across the office, industrial and retail leasing markets. Recent economic indicators such as the unemployment rate have not been overly encouraging, setting the stage for a slow rebound in 2011.

In this environment, reflecting the stark fallout from the Great Recession, landlords are well-advised to remain on the offensive in terms of attracting and retaining tenants in the coming year. Rental rates will continue to be under downward pressure, even as demand picks up.

On the investment side, more activity appears to be on the horizon in 2011. Demand for commercial real estate is strengthening—institutional investors are committing more capital for real estate investment purposes, for one—and credit markets are easing.

The medical office market may also see an uptick in sales activity in 2011, along with a continued push by users for new off-campus space.

Overall recovery is on the way, but it will be a longer—and bumpier—ride than those of recent times, perhaps even more challenging than that of the early 1990s.

____________________________________________________________________________________________________________

DISCLAIMER 
The Compass report, published since 1997, is created by NorthMarq experts using Twin Cities commercial property data from the last six months of 2010. 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, 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.