I attended the 2020 Minneapolis/St. Paul Commercial Real Estate Valuation and Appraisal Forecast Summit held at the Golden Valley Country Club on Friday, January 17, 2020. This year had a slight twist as I was invited to speak on the multi-family panel. Topics centered on valuation trends for the retail, industrial, office and multi-family property sectors. This article shares the best insights and trends from 2019 and expectations into 2020.
- The gap between retailers that are doing well and those struggling is widening. My personal take is this parallel’s income trends in the United States as well.
- Labor costs continue to climb for retailers, both from cities and states raising minimum wage requirements and tight labor market.
- World of relevancy in retail is key.
- Most successful retailers have omnichannel sales
- Recent examples that did not have offer omnichannel sales include Shopko and Pier1.
- 3-legged approach needed for success in retail with bricks and mortars, internet sales, and social media
- Billboard properties (think crazy high rents or acquisition prices), particularly in upper demographic locations are being sought out by national retailers seeking very specific locations. Often times, the tenant is able to rationalize these locations with part of the costs allocated for marketing.
- Health ratio or occupancy costs – always an important metric in retail.
- 1st question from all investors on NNN sales, what are sales revenue for that location? This has changed from even 10 years ago. Investors want to have a stronger comfort level with the probability the tenant will renew.
- The City of Minneapolis implemented a drive thru ban ordinance that no longer allows the building of drive-thrus for banks, restaurants and other businesses in August 2019. Any perceived climate benefits are greatly diminished by the real economic risk to business owners and investors. For instance, Burger King has several closed Minneapolis locations and the city recently denied a new franchisee the right to open because restaurants had been closed. This poses greater risk to investors and owner users, especially if a tenant vacates and a drive thru is denied when re-tenanting the building. Hard to sell a vacant fast food restaurant in January in MN with no drive-thru!
- Blackstone and Prologis control 10% of the industrial market nationally.
- 2 general investor trends – Large investment firms are growing in size.
- Local, regional investors are creating more niches. Riches are in the nices!
- Even with industrial space, amenities continue to become more prevalent in the race to secure the best employee talent. An example is the Hydes Development in Fridley industrial property where they put together food truck Fridays, happy hours, etc.
- Generational changes are occurring with industrial owner user buildings. Historically, these family owned businesses also owned the real estate and as families transition, brokers are seeing more of the real estate being sold off.
- General valuation trend – seeing higher prices and compressed cap rates.
- 5.5% cap rates for Amazon type distribution centers.
- Flex buildings with 40%+ office finish pushes up cap rates probably 100 to 150 basis points. Flex buildings are often the first to vacate and last to fill.
- Seeing a spread of 75 to 150 basis points for outstate deals. A function of location and credit risk profile of tenant.
- With companies such as Amazon leading the charge, there is a for fresher produce. Cold storage space is seemingly full, but freezer cooler space is expensive to build.
- Old office buildout costs inside warehouse buildings used to be $55.00/SF. Now $85.00/SF which is requiring longer lease terms.
- Low vacancy metro wide in Minneapolis/St. Paul resulting in fewer options for tenants to relocate or achieve cost savings.
- Minneapolis/St. Paul metro region had about $1.5 billion In 2019 transaction volume. About 50% was portfolio based and remaining was one off purchases.
- Urban infill redevelopment – Can you find a site?
- Maple Grove and Brooklyn Park have done well in the past several years building out along the Highway 610 corridor.
- Rogers, which had a few million SF of vacancy a few years ago has mostly filled up.
- Starting to see mini storage operators buy old obsolete buildings and convert.
- Sam Maguire capital markets team expect a strong 1st half, and slightly slower 2nd half with election coming up.
- The panel along with most market reports I’ve read are bullish on the industrial market for 2020.
- Cap rates -No real measurable change in past year.
- Cap rates for single tenant, well located properties in the Minneapolis CBD are in the range of 5.5%.
- Cap rates for multi-tenant office properties with a good tenant mix in the Minneapolis CBD are about 5.75% to 6.5%.
- Class A suburban office cap rates are 7.5%+/-, Class B buildings are trading from about 7.75% to 8.5%+. Class C buildings are higher and can range from about 8.5% to upward of 9%+.
- Class C, mid 8s to upward of 9%+
- Amenities are not always used by actual tenants, but remain vitally important from a marketing aspect to get tenants in the door. The panel reported R/U factors and CAM charges have gone up on buildings to help pay for this.
- Metro wide transaction volume down to about $1.3 billion from $2.0 billion prior year. Lowest volume since 2013.
- Xcel Energy building constructed in 2016 totaling 222,000 square feet sold for close to $500/SF with a mid-5.5% cap rate. Best I can tell, this would appear to set a new highwater price when analyzed on a $/SF basis for Minneapolis/St. Paul.
- Medical office, on campus properties are more desirable in terms of rents, vacancy and cap rates. Life insurance companies use $/SF as one of the valuation loan metrics for medical office. This can make them pause on medical office buildings.
- Hot office submarkets – West End in I394/West submarket continues to shine. Even seeing spec new office.
- Midway Field, with Allianz Field development. Will tenant be drawn to this market?
- Northeast Minneapolis is the current draw for funky office space.
In most years, you’ll find me in the audience pecking away on my phone in an effort to take copious notes to help retain some of the best insights from the day. This year was different as I had the privilege to serve on the Multi-Family panel as one of five speakers. Enjoy the photo below as it appears the photographer caught me in what looks like a deeply engrossed pre-game prayer (head down/hands crossed) as we were getting started! Phew, it’s a good thing I survived!
Photo Credit: Jay Kodytek
We talked about value trends both in the metro and outstate markets as well as affordable housing trends. Other options included real estate tax trends, how to select the best rent comparables, inclusionary zoning in Minneapolis and value-add opportunities. Simonson Appraisals performs a lot of apartment valuation work across outstate Minnesota. Here is a recent article I wrote on outstate Minnesota http://simonsonrealestate.blog/2019/10/2019-greater-mn-apartment-trends/.
The week prior to the MREJ Appraisal Summit, the Minnesota Real Estate Journal hosted a half-day Apartment Summit to talk all things multi-family. I was out of town that day so missed the event. Thankfully, Ike Hoffman with Tactica Real Estate Solutions (https://www.tacticares.com/) compiled several great insights from that event and he graciously allowed me to share them here. If you are in the multi-family space, I encourage you to check out his website as he is putting together some great content.
• 2010 – 2019: 40,000+ units delivered (market/affordable)
• 2020 – 2021: 12,000 units under construction
• 2010 – 2019: 31,000 affordable unit deficit
• Market Return on Cost: 6.00% – 6.50%
o High 5.00% frequently seen with rising construction costs and Inclusionary Zoning
• 18% project-level IRR target (unlevered) on new projects
• 2010 – 2019: 40% rent growth
• 2020 – 2024: 1.5% rent growth (projected annually)
• Concessions: 3+ months in certain submarkets
• No job growth in 2019 (widely considered a blip, not a trend)
• 17 Fortune 500 companies in Minnesota
• Income up 6.2% in 2019
• Average Rent to H.H. Income = 19%
o Very favorable from a national perspective
• 2019 – 2019: Wage growth 27% (rent growth same period 40%) Sales Metrics
• Cap Rates – Class A (Core Locations): 4.25% – 4.50%
• Cap Rates –Class B/C: 4.50% – 5.00% (note the Appraisal Summit panel was in the 5.0% to 5.5% range for Class B and 5.25% to 5.75% for Class C)
o Value/Add thought to push the cap into +/- 6.00% range
• $1.7 billion in sales volume in 2019
• Cities with a medical center and college can be opportunities for investors
Opportunities Going Forward
• Inclusionary Zoning
o Constrained supply and increased rent growth for current owners
• Developing product with limited amenities, no parking, small unit footprint, targeting a rent significantly below typical luxury properties
• Traditionally bad neighborhoods turning the corner
• Cross management/economies of scale for owners increasing their holdings in the submarket
Caution Going Forward
• Inclusionary Zoning
Less development, potential to exacerbate affordability dilemma
• Municipal regulation in general
• Rising construction costs
• On-Site talent / trades
• Corporate relocation and the attractiveness of the Twin Cities for businesses
• Affordable housing supply
• The current supply pipeline (certain submarkets will likely see a supply glut)
Mitchell Simonson, MAI has been in commercial real estate for 16 years and founded Simonson Appraisals on January 1, 2019. Mr. Simonson enjoys writing about and discussing commercial real estate, personal development and business. Do you have questions on these topics? Contact him today!