Commercial real estate investors are increasingly coming to the Twin Cities in search of yields higher than those available in larger, more expensive top-tier markets. Some investors are being “priced out” of these markets, or they can’t find product to meet their investment needs. Either way, they are looking to the Twin Cities for potentially higher returns. The market is experiencing an influx of new capital from private equity groups, institutional investors, REITs and foreign investors, and there is also a deeper pool of lenders including banks, life insurance companies and CMBS.
Investor demand continues to outpace supply. There is simply more capital chasing deals than available product on the market. The most in-demand product types include class A core office buildings in downtown Minneapolis (with increasing interest in the North Loop) and select suburban locations. Capital is also chasing apartment properties, grocery-anchored retail centers and modern industrial distribution buildings with minimal office finish. Flex industrial product is also gaining favor.
Office Market Sees Record Sales
Demand for class A product continues, and the market is hitting new territory for best-in-class assets with some investors willing to pay a premium. For example, 50 South Tenth Street in downtown Minneapolis is reportedly under contract for $164.5 million ($330 psf), and the 601 Tower at Carlson Center in Minnetonka sold for $75 million ($260 psf)—both are high-water marks.
Investors who made strategic purchases during the downturn are beginning to reap gains. One example is AG 800 Washington LLC’s sale of the TractorWorks Building for $54.8 million. It paid $26.8 million in 2008, renovated it and increased occupancy, taking advantage of rising rental rates and increasing interest in the up-and-coming North Loop district in Minneapolis.
Grocery-Anchored Centers Remain ‘Sweet Spot’
Investor demand for retail among institutional and private capital far outpaces the supply. Grocery-anchored centers remain most attractive. If a center is anchored by a Whole Foods or Trader Joe’s and is performing well, cap rates could push into the 5%-plus range.
REITs are the most active, while institutions have been relatively quiet as few institutional-quality retail properties were for sale. The only notable institutional sale to close in the first half was the sale of Calhoun Square in Minneapolis to The Ackerberg Group. However, four institutional-grade properties came on the market in the second quarter. Activity is likely to increase as Roundy’s is exiting the market and selling 18 Rainbow Foods stores in a $65 million deal. Nine additional Rainbows are also for sale.
Industrial Is High on Priority List
The industrial market is seeing strong investor demand and an influx of new capital. However, supply remains low. While investors continue to favor traditional core product—well-located, low-finish distribution space—demand is increasing for higher-finish “flex” properties. Greenfield Partners paid $67.5 million for a portfolio of eight office/flex properties. The best bulk industrial assets are trading in the low 6% cap rate range. The market could potentially see a deal in the sub-6% cap rate range in six to 12 months.
Apartments Remain Red Hot
Roughly $220 million in apartment sales closed in the first half, and sale volume is expected to pick up significantly in the second half of the year. Investors are lining up, including REITS, pension funds, private equity investors and institutional groups. While all classes of product are drawing interest, some investors are being selective by targeting high-quality, core product. Heavy bidding is occurring for urban class A properties.
In the past six months, cap rates have been surprisingly low due to increasing investor demand. The Vue Apartments in Minneapolis sold for $30.8 million, a record-high $258,823 per unit. Cap rates for “perfect” deals—such as new downtown Minneapolis high-rise developments that are transit-oriented and amenity-rich—could drop to new record lows.
Fundamentals remain very strong. The vacancy rate has been below 3% for three years, and average rents recently crossed the $1,000 mark. Rents in downtown and Uptown Minneapolis continue to rise, even with new supply. The market delivered 1,500 units so far this year and another 5,000 are expected to open by year end. Five downtown Minneapolis towers are under construction.
Investor demand is expected to remain strong. Increased transaction volume is projected across all product types; however, some downward pressure on cap rates is anticipated with increasing investment activity. If interest rates remain unchanged, yields should trend lower.
Several new downtown Minneapolis class A apartment developments are expected to sell. The Nic on Fifth high-rise apartment tower is for sale and will open in August. Several existing apartment portfolios, including Doran Co.’s five-building student housing portfolio, could also be sold.
Among office properties, a couple of notable transactions are expected to close, including 50 South Tenth Street in downtown Minneapolis. In retail, the shake-up from the Roundy’s decision could possibly bring more store sales, and several institutional-grade retail properties that are currently on the market should close.
Industrial will likely remain a hot commodity; however, the lack of product will hinder transaction volume.
To read more, visit the July 2014 edition of Cushman & Wakefield/NorthMarq’s Compass report, now available online. Visit the web site: www.northmarqcompass.com