Twin Cities office leasing market appears healthy despite numbers

By the numbers, the Twin Cities office leasing market appears headed into a slump.

Vacancy rates are going up in office towers for the first time since the economic recovery started. Absorption, or the rate at which rentable office space is leased, is predicted to remain relatively flat.

But at the same time, tenants have started to sign longer leases. And rising rental rates have led some building owners to revamp their spaces as they compete for tenants. To several local real estate experts, those are signs enough that the office leasing market is healthy and in a period of renewal.

"There is still growth, and there is still expansion in the number of transactions and the velocity," said Blake Hastings, managing director of CBRE Minneapolis. "Is it monumental? No, but it is consistent."

As of the last quarter of 2016, there were close to 84 million square feet of multitenant office space in the Twin Cities, according to a report released last month by the local office of Colliers International.

The office vacancy rate for multi­tenant buildings in the Twin Cities market rose to 14.5 percent in 2016 from 13.7 percent the year before, according to Colliers. That ended a streak of declining vacancies that began in 2010.

Also for the first time since 2010, the market experienced negative absorption. The dip of more than 421,000 square feet of multitenant space was largely because of Wells Fargo workers who relocated from Baker Center and Northstar Center in downtown Minneapolis to the new Wells Fargo Towers that the company had built near U.S. Bank Stadium.

And in likely the biggest leasing deal so far this year, pharmacy benefit manager Prime Therapeutics last month announced a lease with developer United Properties for a new headquarters in Eagan that will allow Prime to consolidate most of its offices.

Much local research either doesn't or just recently started to include single-tenant office space in tracking numbers. If smaller multitenant buildings as well as single-tenant office space were included, the market actually experienced positive absorption of more than 1 million square feet last year, according to Colliers.

"I think people are investing more into downtown than ever, even if you have negative [data] in the multitenant market," said Jim Damiani, a senior vice president at Colliers.

Another indicator of the health of the market is the rising rental rates. According to commercial real estate services firm CBRE, the average asking rent in the Twin Cities has climbed steadily in the past few years. It hovered around $14.50 per square foot last year.

According to Cushman & Wakefield/NorthMarq's biannual Compass report published in January, leasing activity is expected to remain quiet for the first half of the year.

One reason is that tenants have started to commit to longer leases. In the past, tenants would sign leases for three to five years, but recently the trend has been for tenants and landlords to agree to leases as long as 10 years, said Bill Rothstein, an executive director in office leasing at Cushman & Wakefield/Northmarq. "Now fewer are rolling, so the activity is down," he said.

Software company Code42 signed a 10-year lease last year to relocate about 400 workers to the re-imagined Washington Square. The firm moved in late January.

"For a tech company, a lot of times that's a long lease," said Joe Payne, Code42 CEO.

Even though the company is growing rapidly, Payne said, he was confident the office would remain a good fit in the long-term with so much open space that can be reconfigured and possible expansion opportunities on other floors.

In general, many companies are trying to be more efficient and fit more people into less space because they want offices that can be flexible and allow for growth and at the same time attract new employees.

Landlords have also started to agree to bigger tenant improvement allowances so companies can create their ideal spaces. Sometimes refurbishment funds are spread out over the lease term so tenants can keep updating their space.

One factor in Code42's move was that the allotment given to the company for tenant improvements was "aggressive."

"They wanted us here as much as we wanted to be here," said Jon Gambill, Code42's director of facilities.

With competition to attract tenants heating up, many office buildings across the Twin Cities have decided it is a critical time to revamp their space.

According to the last quarter report by CBRE, there are 16 buildings scheduled to be renovated or currently undergoing renovation in downtown Minneapolis. The former TCF Bank Building, Fifth Street Towers and Baker Center, which used to house some Wells Fargo workers, are all under renovation as they try to update and create the first-class amenities that many in the market have come to expect. The soon-to-close Macy's building on Nicollet Mall may turn into the biggest renovation project of them all.

In order for many older buildings to compete, they are updating their common areas such as conference spaces and fitness amenities.

There is also office renovation activity in downtown St. Paul. The former Macy's building is being converted into a new mixed-use building that is planned to include office space. The former Woolworth department store is being converted into a modern office space.

"It is going to be an arms race," said Mark Stevens, senior director at Cushman & Wakefield/Northmarq. "It's going to be who does it better and who offers the best value, not necessarily the cheapest rents."

While existing buildings are attempting to capitalize on tenants' demand for amenities, it has been tough to get some new office construction off the ground without tenant commitment beforehand.

Ryan Cos. is trying to find a lead tenant for an 11-story office building in St. Louis Park that it's developing with Excelsior Group. The firms haven't yet announced when they will break ground on 10 West End.

And for Block 1, an office tower Ryan Cos. wants to build on top of the parking ramp near the Vikings stadium, the company says it also needs some preleasing action before starting construction.

There have been some outliers in new office construction. The T3 office building in the North Loop of Minneapolis as well as the Offices at MOA were both started without preleasing. Both landed major tenants. Ryan also has recently completed its newest office build: the Millwright in the East Town part of downtown Minneapolis. Ryan Cos. itself will move into the building next month.

Nicole Norfleet • 612-673-4495

Twitter: @nicolenorfleet