business

Foreclosures of office buildings, apartments, warehouses and other commercial property rose sharply in Hennepin County in 2008, a trend that, if replicated across the metro area, could have troubling budget implications for Minnesota cities and counties.

As recently as last year, metro-area assessors relied on rising commercial and apartment property values to soften the financial blow that came from big declines in home values. If commercial property foreclosures accelerate in 2009, as many commercial real estate analysts expect, values for those properties could begin to decline as well.

Home values first began to fall in the wake of a surge in foreclosures. In 2008, 4,184 homes in Hennepin County were foreclosed upon, an increase of 34 percent.

At 51, the number of foreclosed commercial or industrial properties pales in comparison. But that's up 60 percent from 2007, and given that those properties can include everything from street-level storefronts to office towers and warehouses, the potential economic impact of one commercial foreclosure can far outweigh that of a single home.

Foreclosures on apartment buildings, another major segment of the commercial market, increased by about 16 percent, to 87 in Hennepin County last year.

The commercial real estate market in the Twin Cities area and across the country has been feeling the effects of the tight credit market for a couple of years. Prices for all types of commercial buildings, as well as land slated for development, have fallen. Investors that bought at the top of the market with short-term debt are having trouble refinancing and in some cases wind up in foreclosure.

Meanwhile, vacancy rates for office, retail and industrial properties have risen and will likely move higher as the weak economy forces businesses to reduce or vacate space. That could continue to hurt building owners' income that can be used to pay mortgage loans.

Some hotels in downtown Minneapolis that opened during the recent building boom also could find themselves vulnerable to foreclosure because of the sharp downturn in travel, said Patrick Todd, Minneapolis assessor. "If you put a lot into your building, you might not be meeting your business model," he said.

No public agency systematically tracks the number of foreclosed commercial properties across the Twin Cities area. Counties typically record foreclosures using property identification numbers, and in the past haven't classified them by property type.

Last year, Hennepin County began trying to sort foreclosures by property type to provide more information to its foreclosure task force. Its data are only for 2007 and 2008 but for the first time make year-to-year comparisons possible.

Richard Palmiter, a broker who specializes in distressed properties for the Twin Cities office of CB Richard Ellis, said the initial wave of commercial foreclosures was tied to the housing market. That includes a site he is marketing at 1010 Park Av., where a mixed-use project that was to include 382 condominium units was planned but never built.

Palmiter said the next wave is expected to have more nonhousing related properties. "It's anybody's guess how large that will be," he said. "Job growth will be the key and will determine how rapidly we stabilize."

And, just as in housing, a sharp-enough increase in commercial foreclosures could help pull down the values of other commercial properties.

Todd said one of the challenges in figuring values now is the dearth of transactions. Both Todd and Hennepin County Assessor Thomas May have said that if commercial property values were to decline and foreclosures increase, the distribution of the tax burden would change. Exactly how would depend on what happens to other property classes.

Minneapolis has the largest share of Hennepin County's commercial foreclosures, but they're also showing up in suburbs. Most are small properties, such as storefronts. But last year's foreclosures also included a nursing home and a motel in St. Louis Park. Neither of those properties' owners could be reached for comment. Recent customer reviews of the motel on the TripAdvisor website carried headings such as "Nasty" and "Don't Go Here!"

The building that housed the North Country Co-op on Minneapolis' West Bank was among the better-known properties in last year's foreclosures. Representatives of the co-op, which closed in 2007, declined to comment on the future of the property, which went through foreclosure this past September.

The Penn Avenue Business Center in Bloomington was among the county's larger commercial properties to go through foreclosure last year. Ownership of the 218,000-square-foot office/industrial complex transferred from one investment partnership to another as a result of the foreclosure proceedings, said Russ Crawford, senior vice president of Standard Holdings, an Edina firm that is overseeing leasing.

Crawford said the new owners have invested in improvements and boosted occupancy to about 60 percent. The current owners paid about $4.8 million for the property and have listed it for sale at $8.8 million.

Area real estate experts say they don't believe the Twin Cities will experience the surge in commercial property foreclosures that's occurred in some other parts of the country. They say that's partly because of lower levels of speculative development than in markets such as California, Texas and Florida.

Realpoint Research, a Pennsylvania-based credit analysis company, recently reported that through the end of October, Texas and Florida accounted for almost 30 percent of delinquent commercial mortgage-backed securities, which are repackaged loans on hotels and retail, office and industrial properties.

The overall delinquency rate for commercial mortgage-backed securities began moving up last January and jumped last fall when the credit markets tumbled. As of October, it was at the highest level since December 2005.

What's unclear is how much of an indicator those defaults will prove to be of foreclosures in the coming year.

Susan Feyder • 612-673-1723