Twin Cities: it's a transition year for office: St. Paul is a bargain, while Minneapolis talks of new towers

The Twin Cities saw a flurry of speculative office tower development in the 1980s lead to the office market bust of the early 1990s. But now it appears that market is on its way back.

With office building vacancies at a 12-year low in the Twin Cities, many real estate brokers and developers expect this year to be a transition for the commercial office market. According to a second quarter study from Towle Real Estate Co., a Minneapolis-based commercial real estate firm, the vacancy rate for the Twin Cities market is about 9.6%.

The Minneapolis market has the second lowest vacancy among downtown markets in the nation, according to Colliers International, a Boston-based network of real estate companies including Towle. The Class-A market is particularly tight, with Minneapolis at 3.9%, according to the Towle report.

Among the signs of resurgence are strong leasing activities and high occupancy rates, confident owners holding out for higher rents, rising sales prices of properties, and new development is on the horizon. There are preleasing efforts under way for about a dozen sites in the Twin Cities market, according to Steve Chirhart, an office market expert with Griffin. Redevelopment of older Class-B and C properties has also picked up.

"We have gone from a tenant's market, experiencing high vacancies and low rents, to a landlord's market where low vacancies have become the norm," Chirhart says.

St. Paul office is a bargain

Even the sluggish St. Paul office market is showing signs of revival, and there is even talk of one or two new office towers among city boosters. More than a half million square feet of office space was absorbed in the last year in St. Paul - about half of that in downtown St. Paul and half outside downtown in such areas as Midway, according to Towle's report. That accounts for 44% of the net new office space leased in the Twin Cities in the last year, according to the report.

Real estate brokers attribute the recovery to several factors, including a tight office market in downtown Minneapolis, growth at several major St. Paul employers, and a generally strong Twin Cities economy. Towle's survey showed that of equal weight were a variety of smaller leases spread out among a broad range of buildings.

"The key to the success is the broad positive absorption in all types of buildings - a lot of folks are enjoying success," says Cindy Bagaus, a spokeswoman for Towle.

At least some of that success is due to tight conditions in downtown Minneapolis, where there is little space available, and what's left is renting at a premium. On the average, net rents are about 30% higher for Class-A space in downtown Minneapolis than they are for similar space in downtown St. Paul, according to the Towle report.

"We're definitely benefiting from a tight Minneapolis market," says John Mannillo, who owns the Gilbert Building in downtown St. Paul. "People are concerned about rising rents in downtown Minneapolis, and they are looking at St. Paul as a bargain."

Office towers planned for Minneapolis

But St. Paul still has a long way to go to catch up to the rest of the Twin Cities office market. Downtown St. Paul's vacancy rate of 16.8%, while down from 20.7% last year, is well above the 9.6% average for the Twin Cities. So is the 18.3% vacancy rate in the rest of St. Paul, although that is down dramatically from 32.3% last year, according to Towle.

Real estate brokers also point out that St. Paul could suffer again if plans go through for new high-rise office buildings in downtown Minneapolis. Opus Corp. and Ryan Construction have big towers in the works.

* The Minnegasco site, now occupied by the 707 Building, is projected to be anywhere from 750,000 to 1 million sq. ft., according to Opus Corp.

* The Powers site, on Fifth Street between Nicollet Mall and Marquette Avenue, is designed to be a less ambitious structure, possibly in the 500,000 to 700,000 sq. ft. range.

* The Conservatory block, between Eighth and Ninth streets on Nicollet Mall, could be cleared to make way for a 42-story building that could offer from 700,000 to 750,000 sq. ft. This building, which would be built by Ryan, would not likely be ready until 1999.

* Ryan also is working with Target discount stores to be a retail anchor for the bottom levels of a high-rise office tower in a spot on Nicollet Mall.

Suburbs see new development

But the first markets to see new development will likely be the Twin Cities suburbs, which also show among the tightest suburban office markets, according to Houston-based ONCOR International. Conditions are especially tight in the southwest and western office markets, where office vacancy rates hover around 5%.

The tight market has helped spur a spate of new office projects, including Zeller Realty's 300,000 sq. ft. second phase to the Norwest Financial Center at Interstate 494 and Xerxes, MEPC American Property's 265,000 sq. ft. second phase to Travelers Express tower on Highway 100 and I-394, and the 130,000 sq. ft. first phase of the United Properties, Centennial Lakes project at and France Avenue.

One of the hot development spots in the Twin Cities is the St. Paul suburb of Woodbury - a boom town where major shopping centers and office complexes are following hard and heavy on the heels of a pace-setting population surge.

In the process of opening late this year, with a second phase this spring, is the 750,000 sq. ft. Tamarack Village, the largest shopping center to be built since the Mall of America opened four years ago @ and the third regional center to be built in the suburb in five years.

And across Radio Drive, State Farm Insurance recently opened a regional headquarters office, which - at nearly one-half million sq. ft. - houses 1,300 employees and is the third substantial commercial complex in Woodbury in recent years.

"It wasn't long ago that Radio Drive was just a quiet little two-lane road," says Steve Wellington, a St. Paul-based developer who has been working on commercial projects in Woodbury since 1988. "Eventually, there will be six lanes in front of Tamarack Village."

Retail is slowing

Projects such as Tamarack Village may be coming at the tail end of an impressive boom in retail development in the Twin Cities that began with the opening of the Mall of America and continued with an explosion of power centers.

Although demand for retail real estate remained strong in the Twin Cities - there was about 800,000 sq. ft. of absorption last year - it hasn't been strong enough to keep up with the 1 million sq. ft. of new retail space that was built last year, according to Griffin Cos., a Minneapolis-based commercial real estate firm.

This year, there will be more than double last year's mark - 2.2 million sq. ft. - and that could well be matched by new centers opening in 1997, according to Ross McGinty, a Griffin retail specialist. Meanwhile, old or outmoded shopping malls are being redeveloped to accommodate the category killer tenant.

"Minneapolis/St. Paul continues to be an attractive market to national retailers due to a stable, growing economy, low unemployment and high purchasing power," says a recent commercial real estate survey from Bloomington-based United Properties.

But there are signs that things may be slowing down. For instance, the average vacancy rate of 8% last year crept up to 8.5% this spring, according to the Griffin report. Twin Cities retailers have been hit by flat sales and rising labor costs. While there are still many projects in the pipeline,new commitments" for projects have dropped off sharply, says Jim McComb, a retail consultant based in Minneapolis.

"Permanent financing (for new retail centers) has all but dried up," agrees Towle's Linda Zelm.

Industry on verge of a boom

The Twin Cities is on the verge of a boom in industrial space, as record-low vacancy rates have prompted developers to plan 7.4 million sq. ft. of new office showrooms and warehouses. Vacancy rates among industrial properties dropped to 7.1%, the lowest rate in 11 years and down from the high of 18.4% in 1990, according to Towle. Towle lists 37 projects planned for the metro area in its report.

Many of the new projects under construction are being done on speculation, or without lining up tenants first, a trend not seen since the heyday of the mid-1980s. Banks are easing up on financing requirements, and institutional investors are buying up all the commercial industrial property they can get their hands on.

Multifamily development on the rise

Multifamily development activity is on the rise, too, reports United Properties, first half '96 Real Estate Outlook. A 2.7% overall vacancy indicates need for new construction, notes United Properties, which reports that several large apartment projects have been announced for future development.

During the first half of 1996 there were 11 multifamily property sales, according to the report, including RREEF's purchase of the 394-unit, Class-A Chasewood Gates apartments in Minnetonka for $23.76 million.

Hotel market tightening, too

Minneapolis, hotel market is tightening as well, with PKF Consulting reporting a 1.8% increase in occupancy from first half 1995 to first half 1996 and a 9.3% increase in average daily rate during the same period. The occupancy rate rose from 66.2% to 67.4% during the first half of the year, and ADR rose from $85.58% to $93.50.

PKF expects continued hospitality market tightening, estimating 73% occupancy and $95.25 ADR for 1996 and projecting 74% occupancy and $100 ADR for 1997.

The Minneapolis office market, as seen from the Walker Art Center sculpture garden, has the second lowest vacancy in the country, and several new towers are in the works.

Jim McCartney is with the St. Paul Pioneer Press.

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