Buyers Are Plentiful for Twin Cities Commercial Real Estate Product

• Improving fundamentals will trump any change in capital markets
• Value-added office, industrial properties in the investment limelight
• Suburban office building sales set to sizzle
• National investors tracking down higher yields in Twin Cities properties 

Volatility in the capital markets is having minimal effect on the Twin Cities commercial real estate investment market. Investor demand, spurred by the pursuit of higher-yielding properties by national investors, continues to grow for virtually every type of Twin Cities commercial real estate property.

The Twin Cities totaled $5.5 billion in commercial real estate sales during the past 12 months, with another $2.3 billion of property currently under contract for sale according to Real Capital Analytics.

However, investor priorities have shifted. Multi-family is becoming more of an investor target as the apartment market strengthens. Healthy demand also exists for the limited supply of medical office properties in the Twin Cities. Meanwhile, investors have scaled back their demand for retail properties.

The Twin Cities continues to attract growing interest from investors from outside the market, including large institutional investors seeking to broaden their exposure in the Midwest.

Higher interest rates and increased volatility in the capital markets—as evidenced by a recent rapid rise of more than 50 basis points in yield on 10-year U.S. Treasury notes—is seen benefiting the large institutional investors who don’t rely on debt capital for funding investments.

Private equity investors, who often rely on debt capital for a significant portion of their capital stack, either have to accept a lower yield or lose a competitive bid. Lenders have tightened their underwriting requirements for all types of real estate investments in light of the challenges in the subprime market in the residential mortgage industry.

Office Market on Course for Record Sales Year

Deal flow in the overall office investment market is on the upswing, putting the Twin Cities on track to see a record number of sales transactions in 2007.  Investors purchased 1.5 million square feet of office space in 56 office buildings during the past 12 months. Total sales volume during that period was $1.9 billion. The average weighted cap rate for all office building sales was 6.57% in the Twin Cities, versus a national average cap rate of 5.77%, according to Real Capital Analytics.   Read more

Office, Industrial Turn-Around Candidates Wanted

Properties with upside potential are attracting the strongest investor interest. Institutional investors in search of higher yields on their investments are attracted to the Twin Cities industrial and office markets in particular, on the assumption market fundamentals will improve significantly during the next few years. Occupancy levels in both the industrial and office markets are steadily improving, and rental rates are rising, giving investors added reason to look favorably upon Twin Cities product.    Read more

Retail Moves Off the Front Burner for Investors

Demand for Twin Cities retail properties may have peaked, following several years of unprecedented demand. Many investors have, as a consequence, met their portfolio needs for retail product. Even so, the market saw $2.3 billion worth of retail property sales during the past 12 months at an average weighted cap rate of 6.59%, according to Real Capital Analytics. Investors paid an average $158 per square foot for Twin Cities retail space during that time period, with 5.7 million square feet of space exchanging hands.  Read more (also includes Medical Office and Multi-Family information)

The Outlook

Investment interest will remain robust for Twin Cities commercial real estate over the next six months, with national, regional and local investors all competing for product. Capital available for real estate investment will be in abundant supply as commercial real estate remains a favored asset class. As a result, new pricing levels are likely to be achieved for select property types such as Class A suburban office product.

If the existing upward trend in pricing for suburban properties holds, the market may see its first suburban office building selling for more than $200 per square foot by year end. Several properties in the St. Paul CBD will likely be sold during the second half, and suburban office building sales will surge, especially in the West and Southwest submarkets where Class A vacancy rates are below 10%. Activity in the Minneapolis CBD may increase in the second half, consistent with the frenetic sales pace of recent years.

On the industrial side, investors will be keeping a close eye on the rental rate picture, especially for bulk warehouse properties. Many investors anticipate that rental rates for bulk warehouse may reach $4.50 per square foot and office showroom could see $11/$6 per square foot. Rental rates are rising due to higher land and construction costs.

Office and industrial buildings with current vacancy may also be excellent candidates for sale, given the aggressive value-added investor in the market willing to pay sellers for their property’s upside potential. Many investors are scouring the market for properties that they can purchase, renovate and re-market to space users in time to catch the rising tide of demand for space—and in time to beat the wave of new product that is expected to come on line during the next few years. The window of opportunity for selling such buildings is wide open today and will remain so for the balance of the year. Owners of such properties will have to decide whether it’s in their best interest to reinvest significant new capital in their buildings or put them on the market. A majority of such buildings will be found in the Class B office and industrial markets where vacancy rates continue to lag the stronger Class A markets.

Retail transaction volume will likely remain stable over the next six months with some overall easing in pricing for the various property types. A peak in retail real estate pricing is behind us, following several years of upward momentum in the midst of an unprecedented build-up in Twin Cities retail space.

Medical office development has taken off in the Twin Cities. This increase in supply will ultimately result in more product available for sale. Investor demand for product in this category is expected to remain strong for the foreseeable future as demographics support continued growth in health care services.