 By Mike Ohmes, Senior Vice President & Director – United Properties Brokerage Services
Twin Cities office and industrial property landlords are in a position to raise rental rates at an accelerated pace over the next six to 12 months, with higher-quality Class A office properties and office-showroom industrial properties leading the way.
New demand for space, supported by continuing economic growth, will quicken the pace of rental rate increases. New construction activity is also impacting rental rates: in addition to higher land costs, construction costs are 25-30% higher than a decade ago, and the new properties coming to market are priced accordingly.
Class A, suburban office construction is coming on line at net rates of $18-$21 per square foot. Meanwhile, landlords of existing Class A properties have raised rates 10-15% during the past 18 months. Landlords of the best-positioned Class A buildings could raise rental rates another 10% during the next 12 months and still be competitive with the new properties coming on line.
Rental rates for new industrial properties also are significantly higher than those for existing space. New product in the office-showroom market, for example, is being priced at $12-$14 per square foot for office space and $6.50 per square foot for warehouse space. Average quoted rates for existing space are $9.34 per square foot for office space and $5.13 per square foot for warehouse space. Overall vacancy in the office-showroom market is 11.2%. These tight conditions, coupled with minimal vacancy in the best properties, have set the stage for additional rental rate growth.
With a moderate supply of new construction in the pipeline and continued—albeit “tempered”—economic growth expected, we do not expect the creation of speculative space to change this current market dynamic through the middle of 2008. With that in mind, landlords should be making the most of this opportunity to raise rates, with one important caveat. The ongoing recovery in market fundamentals is unevenly spread throughout the Twin Cities area—landlords need to be in touch with the unique aspects of their property relative to its primary competitors. Some properties will be relegated to following this trend upward, not leading it.
The industrial submarkets with the strongest prospects for rental rate growth are:
- Office-showroom product in the Southwest, Southeast and Northeast submarkets, where vacancy is approximately 10%;
- Bulk warehouse in the Southwest and Southeast submarkets; and
- Newer, clear-height office warehouse properties in all submarkets.
Within the office market, the outlook for rental rate growth is strongest in the following areas:
- The West submarket, which appears particularly well positioned for rate growth, with Class A vacancy below 8% and no new product coming on line for at least 12 months;
- Select Class A properties within the Roseville and Woodbury/Lake Elmo areas, the Minneapolis CBD, and the Maple Grove area in the Northwest; and
- The Southwest submarket, where the Class A vacancy rate is 7.4% and the Class B vacancy rate is 10%. A number of new speculative buildings are underway with more to follow into 2008-09. Class A vacancy is expected to increase by several percentage points as these buildings come on line, adding new vacancy to the market.
Today’s numbers seem to present a case for strong rental rate growth: demand for new space exists (real job growth will need to continue into 2008), vacancy is declining, the cost of new construction is setting a new benchmark for rental rates in both the office and industrial markets, and the economy continues to grow, albeit at a slowing pace.
For tenants, the number of high-quality Class A options is decreasing, but good deals can still be found in pockets of the market in properties that have struggled to lease during the past few years. These landlords remain the most aggressive and will still get creative to write leases. Older Class B and C office buildings and lower-clear-height industrial properties are still ripe with attractive lease rates.
Today more than ever, landlords are managing their rental rate structures for the 85-95% of the building that is occupied versus the 5-15% that is vacant. This mentality, coupled with the high prices being paid for buildings over the past three years and the new capital improvements going into their properties, will likely mean patient, optimistic landlords into the foreseeable future.
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