In the first half of 2014, demand for office space in the Twin Cities clearly favored high-quality properties. Class A space had a strong first half, while both class B and C properties experienced more muted activity. The overall vacancy rate remained unchanged at 17.4%, which is still the lowest rate since 2009. Vacancy rates varied around the metro: the West submarket is tightest at 11.7%; the Minneapolis CBD posted 17.2%; the Southwest is at 16.5%; and the St. Paul CBD is at 23.6%.
Absorption dropped to negative 111,324 sf; however, four of the seven submarkets reported modest positive absorption during the past six months, led by the South/Airport submarket with 34,085 sf. The West submarket posted 28,745 sf of positive absorption, and the submarket’s class A space continues to outperform with a 10.1% vacancy rate and only a few large blocks of space available.
Users Pursue Higher-Quality Spaces
Users continue to pursue high-quality space. Class A space in many submarkets remains in high demand and is showing strong occupancy and some rent growth. Overall, class A vacancy is 13.8%, and the average net asking rate increased to $16.01 per square foot (psf). One of the most sought-after office corridors in the Twin Cities is the West End area at I-394 and Highway 100 in the West submarket, which reported 15% rent growth for class A space during the past 18 months.
Two premier assets in the Southwest submarket are experiencing high occupancy levels and are increasing rates accordingly. Starting net rates at Normandale Lake Office Park increased from $18 psf in late 2013 to more than $20 psf today. Centennial Lakes, another class A property, is also pushing rates. In the Minneapolis CBD, upward pressure exists for prime space along Nicollet Mall and in the North Loop.
For users seeking class B or C space across the metro, many options are available and concessions are often on the table. Class B vacancy is 20.9% overall, and C is 18.8%. It should be noted that C space outperformed the other classes with 131,870 sf of positive absorption; much of that activity was in the West and Southwest submarkets. The renovation of some of the buildings at Pentagon Office Park in Edina has resulted in more than 80,000 sf of new leasing in the first half of 2014.
Shrinking Footprints Continue
The historical relationship between job creation and absorption of space is no longer applicable because firms are reducing their space per employee and utilizing more collaborative workspaces. According to a survey by CoreNet Global, companies allocated 225 sf per employee in 2010; that has dropped to 150 sf or less. Space in the Minneapolis CBD is a prime example: the absorption rate dropped and the vacancy increased as many professional services firms continue to reduce their leased space by 10-20% or more as they evolve to new workplace environments.
From an optimistic perspective, given the downsizing trend, it is encouraging that absorption was just nominally negative. Further, there appears to be evidence that some tenants are gravitating to higher-quality buildings since they are taking less space. This has led to outstanding results for best-in-class office properties.
Corporate-Owned Campuses Will Have Major Impact
In downtown Minneapolis, Wells Fargo, Xcel Energy and CenterPoint Energy are building new corporate facilities. Combined, these companies expect to vacate 1.46 million square feet (msf) of multi-tenant space in 2015-2016. While that negatively impacts the multi-tenant market, these companies are growing and investing in downtown Minneapolis.
The anticipated rise in the CBD vacancy rate does not reflect the overall health of downtown. In addition to the corporate build-to-suits, new development downtown includes the redevelopment of Block E into Mayo Clinic Square, the Vikings Stadium, Target Field Station, Be The Match build-to-suit in the North Loop, Target Center, Wells Fargo in Downtown East, new light rail, public spaces including the renovation of Nicollet Mall and the creation of The Yard in the Downtown East area, and new apartment development.
In the suburbs, UnitedHealth Group continues to build more office space at its Optum campus in Eden Prairie and may vacate up to 600,000 sf in the Southwest and West submarkets by 2017. Although this negatively impacts multi-tenant space, the campus represents a $250 million real estate investment.
Class A space should continue to perform well with strong occupancy and future rent growth. Landlords of class B and C properties may look to reinvent their properties; expect more repositioning of office space and conversion into residential and other uses in both CBDs to increase the relevance of B and C properties.
Market fundamentals appear to remain healthiest for the West submarket, but the Minneapolis CBD should hold its own as companies look to urban offices with proximity to amenities and housing to attract employees who are seeking live-work-play environments.
Modest leasing activity is projected for the balance of 2014 for class B and C assets due to continued downsizing of space as professional services firms reduce their per-square-foot allocations in an effort to work more efficiently and the shrinking amount of quality class A space available. Also impacting absorption will be corporate users vacating multi-tenant space to occupy their own campuses. Approximately 75,000 sf of positive absorption is projected for the next six months, leaving the overall market with flat absorption for the year.
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