Downtown Minneapolis, despite current headlines in real estate and news articles, remains a major driver of our economy and state. We need a thriving downtown economic engine. It spills out into every aspect of the economy and beyond. With many great speakers, here are my top distinctions from the Downtown Minneapolis Summit hosted by the Minnesota Real Estate Journal on October 26, 2023.
Sports Impact to Downtown Commercial Real Estate
Major sports have a significant impact on downtown Minneapolis commercial real estate. Members of the Minnesota Twins, Timberwolves and Lynx, and Vikings spoke about the exponential growth the sports industry has experienced over the last 30-40 years.
Driven in large part by the growth of media, television contracts and also, scarcity. When you think of the four major sports, there are only 120+/- sports franchises in the entire United States. We also now have Major League Soccer and Minnesota Lynx. Scarcity increases demand.
Lester Bagley with the Minnesota Vikings spoke about the development occurring around U.S. Bank Stadium and also the Eagan practice facility. The big trend is mixed use real estate/entertainment development around stadiums. Seeing neighborhoods developed around stadiums continues.
Target Field, home of the Minnesota Twins opened in 2010. The stadium was funded by Hennepin County and the Pohlad family. A lot of the ongoing capital expenditures up to this point has been paid for by the owners. Looking ahead, more public investment will be needed over the next 15 years to maintain a viable, cutting-edge stadium. Great facilities and teams lead to great partnerships.
The Minnesota Timberwolves and Lynx have entertainment/facility needs coming. A big driver is about enhancing the gameday experience and attracting the next generation of fans as committed, long-time season ticket holders’ age.
Transforming Downtown for Viability and Sustainability
Transforming downtown Minneapolis for viability and sustainability was moderated by former mayor R.T. Ryback, President of Minneapolis Foundation. There has been significant headline news about the doom and gloom of downtown Minneapolis. It’s important to realize and remember the Minneapolis CBD is comprised of many smaller neighborhoods or what Ryback referred to as villages. The primary area facing the greatest challenges right now is the four or five block area at the core of the CBD comprised mostly of high-rise office buildings. This is where most of the pain is occurring in terms of lower property values, higher vacancies and properties going back to the lenders. Many of the downtown CBD buildings, even the “Class A” properties are 30-40 years old.
Yet, many smaller nodes are performing well such as Downtown East, North Loop, Warehouse district. There was a call to action for everyone in the room to do what you can with time, energy and financial investment to continue to find ways to innovate and repurpose properties, and generate new ideas to accelerate the next phase of growth. To look for the opportunities and stop waiting for the major companies to come back and interest rates to come down.
Downtown Office Market
Russ Nelson moderated a large panel of office market experts. Bob Pfefferle, with Hines noted small pockets and nodes are doing well. Restoring safety and security is key.
Jim Freytag, CBRE shared the perfect storm of events have impacted the office market. Starting with COVID, this accelerated the work from home trend and employees who don’t want to commute to the office need a stronger, compelling reason to return. There are real or perceived safety concerns being considered by employees. The big unknown is how long will it take for the office market to fully recover.
Hempel Properties has been an active local investor making big bets downtown. Josh Krsnak shared more details about the recent purchase of LaSalle Plaza, a 650,000 SF, 30 story office building. Two reasons they bought it. First, they acquired the property at a very low basis at $75 per square foot. Most of the other office buildings in the CBD have cost basis exceeding $200 per square foot. From a pure breakeven occupancy and competitive standpoint, LaSalle Plaza is able to operate at a much different price point. Second, the owner was able to acquire the adjacent 850 stall parking ramp. This is important because they’re offering something that’s never been done before in downtown Minneapolis. On any new leases, the landlord is offering tenants free parking. One of the motivations is to help attract younger workers downtown. For younger employees in their 20s, they have higher student loan payments coming and have never paid for parking. Free parking is a way to entice younger people downtown. This is a new innovative strategy and will seemingly put pressure on other buildings to compete.
On the landlord side, landlords are working hard with tenants and employers to find ways to help bring employees back to the office. Piedmont Office Realty Trust has tripled their investment compared to pre-pandemic in this area to engage employees. Repurposing retail space and building amenity space are crucial.
On the leasing front, JLL and Newmark provided insight. Brent Robertson, JLL noted a common theme compared to pre-pandemic is to think of everything in terms of one-third. Overall activity is about 1/3. Tenant size is about 1/3. 1/3 of the buildings are crushing it. 1/3 of the buildings are holding their own. 1/3 of buildings are going to need to reposition or become obsolete.
Robertson also noted the recent new office buildings are doing well. RBC Gateway, with 550,000 square feet of Class A office space only has 6,000 square feet of vacancy. It has a good mixed-use configuration of office, restaurant, hotel and condominium space. Another new building, North Loop Green is under construction with a scheduled 1st Quarter 2024 completion. The building is 65% pre-leased. With the right location and amenities, it shows the demand exists for the new Class A type office product that has not existed for many years downtown. Lastly, the analogy he shared was the light switch isn’t flipping right back on but it’s coming back.
Leasing trends shared by Cassie Ronkowski, Newmark indicated tenants on average are shrinking by about 20% or 1/5 of their prior average space. Termination options are being utilized and considered important to tenants. Right now, tenants are exercising and want termination options. They’re being used more frequently as a trend or as a negotiation tool to downsize.
On the positive side, tenants are more committed again. Over the past few years, tenants have been non-committal with so much uncertainty. The trend now on leasing activity is tenants are moving away from one to two-year terms to five-to-10-year terms.
A question was raised on the typical occupancy breakeven occupancy requirement on downtown office buildings. While difficult to pinpoint as it varies by building, Hempel Properties provided perspective on the LaSalle Plaza acquisition. The owner roof shared their breakeven occupancy rate is 48% because of the low acquisition basis. The property was purchased at 68% occupancy and is now at 72%.
This session concluded that demand for new office exists, but financing is not available. Another item to watch is the probable resetting of assessed office property values and the greater impact on city tax rolls, etc.
Multifamily in Downtown
Multifamily vacancy downtown is 8-9% with one to two months free rent concessions being offered. Rents have been pretty flat over the past year. Of note is the downtown population has about doubled from 30,000 to about 60,000 people since 2010. Rent concessions are reduced for rents in the $1,500 to $2,500 range and greater for rents exceeding $3,500. Penthouse units are most difficult to lease up. Josh Grunnet, DRG, reported leasing brokers are getting more calls from landlords asking, how do we retain tenants right now?
According to Sherman Associates, the market challenges are property specific. While revenue has increased modestly in past years, rent growth is expected to increase further over the next year and keep in line with rising expenses. Across their portfolio, expenses have increased 10% over the past 2.5 years. Expense growth is anticipated to slow in the next year.
Does the math work to build new apartments right now? The short answer is no. Kraus-Anderson stated construction has slowed significantly. Interest rates have more than doubled over the past 18 months and LTVs are down.
The topic of office conversion to multifamily space was discussed. One developer estimated 10 to 15% of the existing office inventory could be redeveloped into multi-family. This would equate to about 1,500 to 2,000 units. Office buildings that work for conversion need the right footprint and operable windows. The age of the building is important as well as that can help for historic tax credits. The new changes to the 4D tax classification rate helps.
On the sales side, some of the recent cap rates on existing downtown multi-family sales have been lower than expected, but still trading well below replacement costs
Rent control is a constant topic with Minneapolis apartments. While strong opposition exists and evidence (see 67 page report) supports that rent control is not effective, it’s unlikely to go away. The key is to continue to find ways for public-private partnerships to work together instead of being facing opposition and to help support office to multifamily conversions. With the slowdown in new construction, it will help stabilize property values and help bring up market occupancy because people continue moving downtown.
From a public safety standpoint, Minneapolis Police Chief Brian O’Hara reported the Minneapolis Police Departments lost one-third of the police officers over the past three years. It’s forcing the department to innovate on recruitment, and get people committed to joining the police force while changing the culture to attract the next generation. A big emphasis from the department is changing the police narrative for both the community and police officers.
Tenants Commitment to Downtown Impacting the Market
Major employers including Wells Fargo and Xcel Energy shared strategies on bringing employees back. Wells Fargo started about 18 months ago by gently asking employees to come to the office for different events. This year, the requirement was raised to three days a week.
Xcel Energy started with three days a week mandate in September 2023. It’s about reestablishing the culture and knowledge transfer of retiring employees to new hires. The focus has been on culture and innovation in raising the bar to get tenants and employees recommitted downtown.
About the Author
Mitchell Simonson, Founder, Simonson Appraisals
With a wide range of commercial appraisal experience and real estate consulting, Mitchell Simonson’s 19 years of experience, knowledge, and ‘boots on the ground’ attitude are invaluable assets that have helped countless clients make smart business decisions. As owner and founder of Simonson Appraisals, he leads the firm in delivering credible valuation services for financial institutions and attorneys specializing in the areas of condemnation, property tax appeal, foreclosure and estate planning.