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July 2017 
Executive Summary 

Twin Cities Commercial Real Estate Market Sees Continued Steady Demand  

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The Twin Cities multi-tenant commercial real estate market recorded a slight uptick in vacancy in the first half of 2017; however, it is a still-healthy 10.8% across all product types—office, industrial, and retail.

Part of this uptick is the result of large tenants leaving the multi-tenant market for single-user or build-to-suit facilities, which occurred in the office, medical office, and industrial sectors. In addition, some companies, particularly in retail, went out of business altogether.

Overall, the market continued to see improving economic fundamentals. Office vacancy rate levels are falling, and the industrial sector continued to boast strong demand. The retail sector experienced a more-than-anticipated number of store closings, which resulted in negative absorption and a slight increase in the retail vacancy rate.

Combined, users absorbed 332,339 square feet (sf) of space in the first half, which is low compared with 2016. However, absorption is expected to pick up significantly in the next six months. The market delivered a solid 836,000 sf of new construction, led by the industrial sector. Much of this new space was preleased or is quickly landing users. Despite some pockets of vacancy, rental rates are largely holding firm.

Insatiable Appetite for Industrial, Single-Family Residential Land 
Developers’ hot pursuit continues for industrial land including huge tracts for massive distribution centers for e-commerce retailing. Suitable sites near the coveted urban core—for the “last mile” of the distribution chain—are limited, which is pushing land prices to peak pre-recession levels. Homebuilders are scrambling to find land to meet the growing needs of the housing market renaissance. Despite growing requirements, however, homebuilders are cautious about overpaying for land as escalating construction costs take a bite out of profit margins. This has kept residential land prices in check. Multifamily land interest shifted from urban to underserved suburban submarkets. Retail land activity was primarily driven by service-based neighborhood centers, which are largely resistant to the e-commerce boom. 

Hotel Market Cycle Peaking, ‘Soft Landing’ Projected
Following a seven-year run of consistent revenue and rate growth, the Twin Cities hotel market is reaching it cyclical peak and a cooling pace is anticipated. Occupancy plateaued due to the delivery of new rooms and the outlook for key performance metrics—including RevPAR (revenue per available room) and average daily rate (ADR)—suggests more modest growth and an upcoming “soft landing.” While 2017-18 industry fundamentals should remain solid, performance may feel lackluster compared to this preceding torrid market run. Development remains robust with 3,400 new rooms completed and another 5,000 rooms in various stages of planning/development. Overbuilding concerns and rising construction costs are prompting some developers to curb plans. It remains a seller’s market, and values have likely peaked.

Healthy Medical Office Market But Some Uncertainty Lingers
The medical office market’s semi-annual checkup revealed a low vacancy rate, a slight uptick in rents, and slow, steady demand for space. However, healthcare delivery is changing, and facilities continue to adapt. Healthcare systems are pushing development away from hospital campuses to accessible off-campus locations. Single-user, system-driven projects dominate new development, which is creating more vacancy in traditional medical office buildings (MOBs), resulting in downward rate pressure. Also, systems want buildings with larger floor plates and more operational efficiency, leaving older, off-campus MOBs at risk. Additional issues impacting real estate requirements include continuing consolidation, physician shortages, and the uncertainty surrounding the Affordable Care Act.

Store Closures Continue as Retailers Navigate Challenging Environment
More than 300 retailers nationally have filed bankruptcy in 2017, leaving large blocks of vacant space and likely more to come. Store closings, downsizings, and few new concepts entering the market resulted in negative absorption and an uptick in vacancy. Retailers, landlords, and developers are grappling to find ways to operate in an environment with increasing e-commerce competition and changing shopping habits. On the other hand, store closures are creating opportunities in tight, prime trade markets. Value retailers, quick-serve restaurants, coffee shops, fitness concepts, and grocers are hot categories filling space. Meanwhile, Amazon’s announced $13.7 billion deal to acquire Whole Foods could forever change the supermarket business.

Multifamily Sector Firing On All Cylinders
The multifamily sector continued its hot streak with near-record-low vacancy and new projects that are meeting both lease-up and projected rent expectations. Higher-end development is helping drive rent growth. The construction pipeline is robust with 4,000 units scheduled for delivery in 2017 and another 4,000 in 2018. New construction is shifting to the suburbs as some pockets approach a saturation point, including downtown Minneapolis, Uptown, and St. Paul. Some properties are offering rent concessions. Despite the influx, new deliveries continue to be well-received with Millennials and empty-nesters fueling renter demand. Developers are working to balance unit size, design, and amenity features that cater to both groups. 

Industrial Sector Takes a Breather From Its Record Pace
While activity in the industrial market took a short break, it is expected to get its groove back in the second half of 2017. The market reported a dip in absorption due to some economic uncertainties—prompting users to proceed more cautiously when signing leases—and a discernible lack of large, high-quality multi-tenant space available. This supply shortage resulted in some users choosing single-tenant or build-to-suit options. However, 1 million square feet (msf) of absorption is projected by year end as several big, multi-tenant deals are completed.  E-commerce is driving many industrial projects as users need distribution facilities. Demand is solid for product near the urban core as evidenced by robust activity in the Northwest and Northeast submarkets.  A fierce appetite continues for high-quality user-buildings, but demand far exceeds supply. Build-to-suit activity dominates new construction.
 
Office Market Comeback Continues as Tenants Continue Trading Spaces
The office market continued its road to recovery. After struggling with negative absorption recently, it posted 82,000 sf of positive absorption and a vacancy rate that improved 30 basis points to 16.7%. The market is adapting to a changing environment as tenants lease less space and use it more efficiently. Companies that are trading spaces, consolidating, and downsizing, are fueling activity. Leasing momentum is expected to pick up in the second half as a growing list of users have space requirements. Also, larger firms have returned to drive some deals. Quality building amenities are a big driver as firms look for properties that offer newly renovated and creative space in an effort to retain and attract talent. The cost of replacing employees is high, and users are willing to pay for the right space—even though they require less of it. Users are also signing longer-term leases. The Minneapolis CBD continues to attract large tenants including Amazon, which could be a magnet for more tech firms.

Strong Investor Demand Continues, Although Buyers Becoming More Discerning
Not to sound like a broken record, but investor demand continues to outweigh properties for sale. Particularly, private investors are well-capitalized and highly motivated to complete deals. However, mirroring the national trend, transaction volume dropped, and the lack of inventory is a primary reason. While a pickup in sales activity is anticipated for the second half of the year and the investment market should remain solid, there are fewer buyers for most property types and bids are less aggressive. Investors are taking their time and being selective in acquiring properties that meet their specific investment criteria. Multifamily sales reached nearly $800 million, far above historic levels. Smaller deals dominated office investment sales, while industrial and retail buyers pursued the few available properties.

Outlook
Continued solid growth is projected across all sectors in the second half of the year. Much of the activity will occur in the industrial sector where 1 msf of absorption is projected.

Office absorption is expected to pick up as well with a projected 625,000 sf, while retail activity will likely remain flat as store closings continue. Retail landlords are working to backfill or redevelop prime spaces. Overall, activity should remain strong and the market competitive.

New construction will accelerate significantly compared to the first half of the year, with approximately 2.1 msf scheduled for delivery by year end.

Transaction volume is expected to increase in the second half, with the strongest demand for trophy assets and multifamily properties.  

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DISCLAIMER 
The Compass report, published since 1997, is created by Cushman & Wakefield experts using Twin Cities commercial property data from the first six months of 2017. 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, Cushman & Wakefield 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 square feet and multifamily 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.

 
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