A Race for Space: Speculative Office Building Begins

 

Increasingly limited options (particularly in Class A space), a relatively healthy economy, growing companies and some pent-up demand are spurring the launch of a speculative, multi-tenant office development cycle in the Twin Cities. Overall vacancy is 15.2%, and Class A vacancy has dipped below 12%.

 

To help meet the demand for larger blocks of contiguous space, more than 1 million square feet is under construction, primarily in the Southwest, Northwest and West submarkets, while the Northeast and South/Airport also are seeing healthy activity.

 

It's also expected that at least one new downtown Minneapolis office tower will be announced in 2007 -- the first since 2001.

 

"The Twin Cities is in the beginning stages of a development cycle," says Dan Gleason, United Properties vice president - office brokerage. "The market is tightening and there's a limited number of buildings that can accommodate a 100,000-sq.-ft. user in the suburbs. I believe we're getting ready for a slow but steady development run. I also believe we'll see a significant increase in rental rates in 2008."

 

Rates are gradually increasing, especially in suburban markets where new development is underway. Higher rates are needed to justify rising construction costs.

 

Some tenants are cautious about paying new construction rates and are experiencing some sticker shock. However, in many submarkets, growing companies will have few other options for large blocks of quality space.

 

 

 

 

Southwest kicks off development

An impressive 2 million square feet is under construction or planned in the Southwest. (The overall vacancy is 11.7%; Class A is 8.8%).

 

The first spec building completed during this development cycle was the 56,000-sq.-ft. Lake Smetana Business Center in Eden Prairie, which opened 100% occupied; Compellent Technologies Inc. leased the entire building. Another 855,000 sq. ft. is under construction, including Duke Realty Corp.'s 330,000-sq.-ft. Norman Pointe II in Bloomington and United Properties' 90,000-sq.-ft. Superior Office Center in Eden Prairie.

 

"Superior Office Center's leasing interest is brisk," says John McCarthy, United Properties vice president - office brokerage. "It is the largest block of space to be delivered in the Southwest market this summer, and it's being considered by a wide variety of users."

 

Opus Northwest is developing Excelsior Crossings on the former Supervalu headquarters site in Hopkins. This project is a 435,000-sq.-ft., two-building build-to-suit for Cargill, who will take occupancy in phases, beginning in late 2008.

 

Another 1.24 million square feet is planned, including Solomon Group's 130,000-sq.-ft. building in Eden Prairie named Windsor Plaza and Liberty Property Trust's 120,000-sq.-ft. Liberty Southwest Plaza on the former Best Buy headquarters site in Eden Prairie. Supervalu is leasing 350,000 sq. ft. of the former Best Buy facility. Supervalu recently signed a five-year lease, needing space quickly following its Albertson's acquisition.

 

 

United Properties plans to break ground in the third quarter on the 280,000-sq.-ft. 8200 Tower at Normandale Lake Office Park in Bloomington. Welsh Cos. is planning 100,000 sq. ft. at the former Fingerhut site in Minnetonka and could occupy half the building.

 

Another 950,000 sq. ft. of space is in "preliminary" stages. While the Southwest is ripe for development, not everything announced will proceed.

 

"Class A vacancy is well below 10%, market fundamentals are strong, and large corporate users are driving the demand for space," McCarthy says. "However, there's also some 'jaw boning' going on. Not all projects will move forward."

 

Net rates of $18.50-$21 are needed to justify new construction. Developers believe that as space tightens, tenants will have few options but to pay higher rates for new development, especially for highly sought-after Class A space.

 

"We've seen strong demand for Class A space," says McCarthy. "Many tenants recognize the benefits of Class A space -- even with the higher price tag. These buildings can assist in attracting and retaining employees because of the added amenities. The incremental increase in Class A costs is small when you factor in the intangibles and break it down per employee."

 

Some users are still reluctant to pay new construction rates, and uncertainty about the economy exists. Tenants who need to expand, however, will have few alternatives to meet their growing space needs.

 

Users continue to scout the submarket. "The prospect list is more serious and longer than a year ago," says Tom Tracy, United Properties vice president - office brokerage. "While there's less risk for developers in this submarket, due to pent-up demand, developers will need a good site and a solid project to drive the rental rates required. The next 6-12 months will be very telling. We believe we're at the front end of a fairly healthy development cycle. However, if there's little absorption in the next 6-12 months, it will be a shorter cycle."

 

New tower for downtown Minneapolis?

With the relatively stable economy, expanding companies and a Class A vacancy of 13.6%, at least one new downtown Minneapolis office tower should be announced this year. On or near Nicollet Mall is a logical location, as space along the Mall is just 6% vacant.

 

At least two developers are vying to be first. Opus has committed to develop on the southeast corner of Tenth Street and Nicollet Mall. Ryan Cos. US Inc. also has a viable site at 801 Marquette Ave. S.

 

Due to rising construction costs, rates must continue increasing to support new construction. (Current net rates along Nicollet Mall are $15-$20). The minimum size of a new tower would be 500,000 sq. ft., and an anchor tenant is needed to occupy one-third to one-half of the space.

 

"An anchor must step up and pay $22-$25 net rent. That's new territory in Minneapolis," says Jim Montez, United Properties senior office brokerage associate.

 

Potential anchors include Target, which occupies roughly 2.5 million square feet downtown. Capella Education Co., Fallon and Deloitte and Touche are also on developers' radar screens.

 

A large acquisition or merger also could result in an "under-the-radar" tenant unexpectedly needing space. "In a development cycle, there's always pent-up demand that's difficult to predict," Montez says.

 

Some large blocks exist downtown. Rider Bennett law firm is closing, leaving behind 100,000 sq. ft. at 33 South Sixth. Blocks are available at 225 S. Sixth, 701 Building, Fifth Street Towers and others. The only large space along Nicollet Mall is an 80,000-sq.-ft. sublease at Piper Jaffray Tower. In 2008, Fifth Street Towers and 225 S. Sixth could have blocks of 200,000 sq. ft. or more.

 

Montez also points to a trend of traditionally suburban tenants relocating downtown. "More than a dozen suburban tenants moved downtown in the past year," Montez says. "They fall into two categories: Target vendors and those who want the downtown 'energy.' Target vendors include Colgate, Clorox and Revlon. Those that want to be part of the downtown excitement, which aids employee and recruitment and retention, and capitalize on business opportunities include Colle+McVoy, Foster Klima & Co., Griffen International Advisors and Dunham Associates. Others exploring downtown include Virchow Krause."

 

Few, if any, tenants recently relocated from downtown to the suburbs. Transportation is a growing factor. "Tenants today are saying it's easier to get downtown than crossing many of the suburbs," Montez says. "Downtown is centrally located, and light rail is making it more accessible."

 

Developers poised in West

Class A space is at a premium in the West -- no blocks larger than 50,000 sq. ft. are available -- which will spur development. Class A vacancy is 10.3%; overall the West market is 11.9%. Five leases totaling 190,000 sq. ft. recently were signed, and tenants will take occupancy later this year.

 

"Users continue scouting the West," says Bob Revoir, United Properties vice president - office brokerage. "Christopher & Banks is looking for a 100,000-sq.-ft. build-to-suit, and two 30,000-sq.-ft. users are looking to relocate there in fourth quarter."

 

While nothing is under construction, developers are in the "starting blocks." Four projects are planned totaling 1.24 million square feet. The largest is the former Novartis site in St. Louis Park, dubbed West End. Duke will demolish existing space and develop mixed-use, which could include 1 million square feet of office. Also planned are the 165,000-sq.-ft. Bassett Creek Office Center, proposed by Industrial Equities in Plymouth, and the 114,000-sq.-ft. Plymouth Woods Office Center Phase II, proposed by St. Paul Properties. Also, Hempel Properties will break ground in the third quarter on the mixed-use, 55,000-sq.-ft. Golden Village in Golden Valley, of which 35,000 sq. ft. will be office.

 

Northwest developers pull trigger

As vacancies continue dropping, the Northwest is seeing strong demand for development. Five projects are under construction, totaling 386,973 sq. ft. Opus is developing a 150,000-sq.-ft. facility for Select Comfort at Bass Creek Corporate Center in Plymouth.

 

Also under construction by McGough Development is a 150,000-sq.-ft. "green" building in Maple Grove for Great Lakes Energy Development.

 

"Land is still available in Maple Grove, which continues to lead this submarket's leasing activity and new construction," says Greg McMillan, United Properties senior office brokerage associate. "Nearly half the new construction underway is in Maple Grove. There's also land available in Brooklyn Park. The Highway 610 corridor, running through the northern metro, will drive future development." Class A net rates are averaging $16-$17. New construction demands rates in the $19-$20 range.

 

St. Paul may see project

Despite high vacancies, a potential downtown St. Paul office development was reported for a vacant parking lot at 415 Wabasha St. Dean D. Johnson, a St. Paul native and partner with Brussels, Belgium-based WingField Corp., reportedly purchased the site where the Wabasha Court office building once stood and plans to develop mixed-use, including office, hotel and retail.

 

South/Airport remains solid

The South/Airport is the smallest office submarket, but developers are not overlooking this very stable market. It boasts the lowest vacancy of 11.3%; Class A is 8.8%.

 

Two new buildings were completed in first-quarter 2007: the 90,000-sq.-ft. Grand Oak X by Interstate Partners in Eagan, and the 40,000-sq.-ft. Mendota Place by United Properties in Mendota Heights. Underway is the 30,000-sq.-ft. Centre Pointe VII in Eagan by Roseville Properties.

 

 

In addition, 1.9 million square feet is in preliminary stages, including 1 million square feet of speculative office space as part of McGough's Bloomington Central Station.

 

"There's continuing tenant demand, but it's a small submarket," Gleason says. "I expect the market to continue to tighten, but I don't believe we will see any more speculative development this year. Any new project will probably need a 50,000-sq.-ft. tenant before breaking ground, and that's a large transaction in this submarket."

 

Northeast is strong

The Northeast submarket boasts 208,005 sq. ft. under construction and 855,205 sq. ft. proposed. Woodbury and Lake Elmo lead development.

 

"The Woodbury market became really tight in 2006," says Tom Stella, United Properties vice president - office brokerage. "You couldn't even find 3,500 sq. ft. Subsequently, developers pulled the trigger, so now there will be some vacancy, but absorption as well. Most Northeast leases are new to the submarket, so it'll be true absorption."

 

Projects underway include Welsh's 95,000-sq.-ft. Oakdale Tech Center, United Properties' 40,000-sq.-ft. Eagle Point Office Park Phase III in Lake Elmo, MSP Commercial Management's 53,500-sq.-ft. City Centre Professional in Woodbury and Commercial Equity Partners' Tamarack Hills in Woodbury. Also, Keller Williams will anchor MSP's 35,000-sq.-ft. North Central Professional Center in Roseville."

 

"There are not many quality blocks of space larger than 50,000 sq. ft.," Stella says. "This submarket, like many others, is well-positioned for development."