Minneapolis CBD Office Market: Traditional Market Cycles Are Gone

Minneapolis CBD Office Market: Traditional Market Cycles Are Gone
by Reed Christianson, CB Richard Ellis

The 22 million square foot Minneapolis CBD office market has historically followed the same cycles and produced the same results over my 20-year career. Vacancy declines, rental rates increase, concessions decrease and developers fight to be the first one to produce the newest, greatest building mankind has ever seen. Upon securing several new leases by luring tenants from the last great new building, the market starts to cycle as vacancy is created in both the older buildings and some portion of the new building. Vacancy rates rise along with an increase in concessions and an eventual deterioration of net rental rates. The office market has been relatively easy to forecast as it has been based on the most basic economic paradigm of supply and demand, until now.
A strange phenomenon is occurring that does not follow any sort of logical economical principles. Within the Minneapolis CBD, demand or prospective tenant activity has all but stopped over the last 10 months leaving absorption of vacant space flat. Vacancy rates have remained steady but not exactly healthy at just over 14%. Recent lease expirations and consolidations in 2008 have contributed to the availability of three contiguous blocks of office space over 200,000 square feet with another three blocks over 100,000 square feet.
This is where it starts to get strange, average net rental rates within the Minneapolis CBD have actually been steadily rising with no foreseeable end in sight. Obviously there has to be some explanation for this which has been thought about and discussed at length within the ranks of downtown commercial real estate practitioners. Two conclusions have been drawn from these discussions. The first one is that practically ever major CBD office complex has traded hands during the investment sale frenzy over the last 36 months at top of the market price structures. Therefore the new institutional owners have exceedingly high rent expectations to achieve the required returns necessary and will not and cannot “buy” a deal with high concessions and low rents even though demand is off.
Secondly, pricing vacancy in regards to where it is in the building is something that was never done before but is now here to stay. Net rents for space above the 20th floor which afford panoramic views and perceived status exceed $20 net per square foot, where rent in the same building lower down is at a 15-30% discount. The net effect of this new pricing trend is that the “average” rental rates market wide are rising due to historically high rents for top tier space. 
Even with a bad economy, unhealthy vacancy rates and stifled demand, the days of a normal commercial real estate cycle are gone.
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Posted at: 9:30 pm on December 1st, 2008

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