I attended the 2015 St. Cloud State Real Estate Alumni Banquet on Thursday, February 5, 2015 and the 2015 Commercial Real Estate Valuation and Appraisal Forecast Summit held at the Golden Valley Country Club on Friday, February 6, 2015. Below are a few key highlights from the evening event and half-day seminar.
Retail Trends
Most retail properties, particularly the net leased sector and Class A retail properties have seen cap rate compression over the past 12 months. The general consensus is capitalization rates for single tenant net leased properties have compressed about 25 to 50 basis points. Tenants with excellent credit quality such as Walgreens have traded with cap rates as low as sub 5.0%. Strong grocery anchored retail centers in the Minneapolis/St. Paul metropolitan area have traded in the cap rate range of 6.0% to 7.0%.
Cap rates remain bifurcated for the older Class B and C properties which tend to trade in the 8.0% to 10.0% range. Weaker retail centers are more challenged and some have seen a different tenant mix starting to occupy formerly vacant space. This includes medical and faith institutions occupying traditional in-line space designated for retail users. This can impact the other retail tenants in the center that depend on synergy from the foot traffic generated by typical retail users.
A developer/owner stated national tenants with a desire to grow their national footprint are often times less fickle on price versus local “mom and pop” tenants. This can lead to significant spreads in rental rates within the same center. He noted it’s important to be aware that rental rates for brand new space leased to a national tenant may see a significant decline if the tenant decides to move to a different center at lease expiration and the vacancy needs to be filled with a local tenant.
Rental rates for retail strip centers with excellent locations have fully recovered from the downturn of three to six years ago.
Industrial Trends
One panel speaker stated an education process is required for institutional and foreign investors seeking to acquire industrial product in the Minneapolis/St. Paul market. Most of these investors have generally focused on the coastal markets and larger cities such as Chicago. Minneapolis/St. Paul offers fewer bulk warehouse building options in excess of 200,000 square feet compared to other larger industrial markets. This is attributable to historically being more reliant on manufacturing than distribution.
Most large investors are looking for office finish less than 20%. Column space requirements are becoming more important with 50’ by 50’ being developed in newer buildings. Most new speculative development has 24 or 32 foot warehouse clear height and are predominantly office/warehouse or bulk warehouse buildings. It was noted about 90% of the two million-plus square feet under construction is speculative. This could impact the supply/demand equation.
The owner-user market has seen a lot of sales movement in the past 12 months. Owner users are willing to purchase buildings with lower ceiling heights in the 16 to 20 foot range if it fits their business needs.
Office Trends
Cap rates continue to compress for well-leased properties in strong submarkets. The gap between the haves and have-not’s persists as some operators who purchased value add plays a few years ago continue to wrestle with minimal tenant demand in some suburban locations.
Other sub-markets such as downtown Minneapolis, the North Loop area, I-494 and France Avenue in Bloomington and the I-394 corridor continue to perform well.
Fewer value-add opportunities are available in the office market at present time. One panel member stated to more accurately account for lease-up cost assumptions, it’s best to estimate the lease-up time and cost and double the time and cost estimate for a more accurate depiction. Construction costs continue to escalate. It was recommended that contingency costs for office rehabilitation projects be increased from 10% to 15% or 20% to better account for hidden challenges.
Multi-Family Trends
The hottest, most desirable property sector in Minneapolis/St. Paul is the multi-family market. Over the past 12 months, capitalization rates have continued to compress and cap rates are forecasted to go even lower because foreign and institutional investors are chasing deals. A few transactions have reportedly closed recently with cap rates below 5.0% and Class A cap rates are routinely in the 5.0% to 5.50% range. Class B/C multi-family buildings are selling in the 6.0% to 7.0% range. Despite all of the new apartment construction in the market, new units continue to be absorbed and vacancy rates have not seen a notable change. This is partially attributable to lack of new units being added in the 2007-2011 period.
One interesting observation reported by a panel member is that value-add opportunities are working right now because rents are growing. It was stated most capital expenditure items being completed are more cosmetic related and the pricing of these assets does not fully account for future required expenditures such as new roofs, siding, etc. This will be an interesting component to keep an eye on over the next few years.
Other potential near-term challenges noted from the ownership side included rising real estate taxes and the continued recent increase in market rents is nearing the point of causing strain on tenants. Historically, the Minneapolis/St. Paul metropolitan area experiences about five-year rent trends. We are in year four of an upward trend. While market fundamentals remain very strong, the question remains how long will the upward trend continue?
As long as interest rates remain low, most market participants anticipate demand to remain strong in the multi-family sector.
Thank you for taking the time to read this article. Mitchell Simonson, MAI is an expert commercial real estate appraiser and investor. If you have any valuation questions, please feel free to call at 612-618-3726 or email [email protected].