By Mitchell Simonson,
Here are the top highlights I pulled from the office panel of speakers at the June 15, 2017 Commercial Real Estate Forecast Summit, put together by Jeff Johnson and the MN Real Estate Journal. Thanks for the great panel of speakers which included Jim Damiani, Michael Salmen, Matt Angleson, James Freytag and Rich Reynolds.
The first question posed to the panel was: What is scaring you right now in the Minneapolis/St. Paul office market? Here is some of the feedback.
- A lot of space coming back on the market, especially with several recent new build-to-suit office buildings for corporate users. The challenge is how will that space be repurposed?
- There is heavy demand on institutional investors to place capital. That is increasing valuations and thus real estate taxes.
- Some brokers are seeing more uncertainty among investors. One factor is the potential for changes in 1031 exchanges. Investors like certainty and when there are unknowns not yet worked out, it creates uncertainty.
- Finding good, skilled workers is a challenge to help spur continued job growth. Landlords need job growth to fill vacancy rates.
Additional relevant points are as follows.
- The ability to offer in-building amenities are vital for office space in the current market. Tenants are demanding training centers, fitness centers, in-building collaboration areas and even outdoor amenity areas.
- A recent example of a property owner taking action to backfill vacated space is the Baker Center office building in downtown Minneapolis. Wells Fargo vacated and the owner spent millions to renovate and add several amenities. The space is now reportedly generating a lot of activity.
- Landlords and new buyers are coming in and renovating with amenities. One benefit that is different from past cycles is buyers are not as highly leveraged with debt.
- In addition to amenities, tenants are looking for quality landlords. The experience of the building and being able to tell a story to the market is helpful to attract new tenants.
- The Colonnade Class A office building in Golden Valley is on the I-394 corridor and listed for sale with office rents at $23-$24/SF, net. Stabilized operating expenses are forecasted at about $18.00/SF, resulting in gross rents approaching the low to mid $40’s.
- Tenants are looking at ways to attract and retain employees and looking more closely at price per employee versus purely Rent/SF. The thought here is if a company can keep employees by being able to offer the best amenities, they sometimes are willing to pay a bit more. The higher cost to replace employees can quickly offset rent savings caused by being in an inferior location or building with limited offerings.
- Large buildings with large vacancies, particularly in suburbs are tougher to fill.
Where are we at in the current office market cycle?
- Using a baseball analogy, the office panel generally agreed we’re in the 5th or 6th inning. The capital markets which generally help support the office market are still strong.
- A lot of professionalism coming to office real estate. Buyers are well leveraged.
- Where will new office tenant demand come from is a question in the market.
- Why no new office spec on I-394? Hot spots tenants want to be at right now include the intersection of I-394/State Highway 100, the North Loop, or downtown Minneapolis
- The two most recent speculative office buildings built in the Twin Cities are the T3 timber frame office building developed by Hines in the North Loop neighborhood and Offices at MOA, a 10-story office building at the Mall of America. It was reported both buildings took longer than expected to lease up and likely didn’t achieve pro-forma rents. These recent developments were identified as reasons why people remain skittish to go spec. Furthermore, it’s tough to get enough high enough rents to justify the new construction.
- Building amenities will continue to be a driver.
- Record setting trend of office sales will continue in 2017.
- Suburban office buildings will likely begin to add amenities and promote free parking to try attracting tenants from downtown Minneapolis.
- The St. Paul office market is pretty quiet with several dated buildings.
Mitchell Simonson, MAI is an expert commercial real estate appraiser and investor. If you have a market related question, please feel free to call at 612-618-3726 or email mitch@cwrea.com.
