Even as other sectors of the commercial real estate market have made full or at least partial recoveries from the financial crisis and subsequent recession, “Class B” office buildings — which comprise most of the office space in the Twin Cities — have remained stubbornly resistant.

While luxury Class A office properties bounced back quickly, for the better part of five years owners of more modest “A-minus” and “B” buildings have struggled with high vacancies, stagnant rents and lack of buyer interest in their properties as their core clientele of small-to-medium-sized businesses continued to downsize and aggressively cut real estate costs.

Now, however, local experts say the Twin Cities’ vibrant economy has firmly cemented its status as a hot “secondary market” for national and global capital seeking growth — so much so that some of the love is finally trickling down to its lower-tier building market. Judging from a spate of recent building sales, those investors believe rent growth and lower vacancies are in the offing.

That’s good news for building owners such as Target Corp., which announced last week it is moving 1,300 employees out of the 61-year-old former Prudential Insurance headquarters building along Interstate 394 in Minneapolis and putting it up for sale. At 400,000 square feet, it’s exactly the kind of Class B property that may once have sat vacant for a long time. Now, that’s not likely to be the case, says Mark Kolsrud, a senior vice president with Colliers International.

“The bar on what buyers were willing to pay for a Twin Cities office property was really raised last year when the 601 Tower at Carlson (a 15-story office tower in Minnetonka) sold for $75 million,” he said. “That made people say, ‘Holy moley!’ Now, with this Target property, there’s going to be all sorts of people who will be willing to buy that empty building. Because it’s in a great location, it’s got the possibility of being something really special for someone.”

As the leader of an investment sales team at Colliers, Kolsrud says he’s never been busier. He was also part of a big recent deal in which he represented the buyer of a six-building office portfolio in Mendota Heights for $40 million. The buyer, MSP Real Estate, was making its first foray into office properties.

Near the Target building in St. Louis Park, the 560,000-square-foot collection of Class B office buildings known as the Parkdales also sold for $40 million, with the new owners (Twin Cities-based Excelsior Group and New York’s Goldman Sachs) planning to spend $12.5 million to renovate them.

“Those buildings were in foreclosure just a few years ago,” Kolsrud said. “I have a lot of clients who are ‘value-add’ buyers, who see the potential in buying distressed buildings, fixing them up and selling them. It’s getting tougher for them because so many people are looking at the same buildings.”

Vacancy numbers for Class B office product are still anything but eye-popping — 17.2 percent compared with 12.5 percent for Class A in the second quarter, according to Colliers. But institutional investors have confidence in the future of the local Class B leasing market, said Steven Buss, executive vice president with CBRE.

“Part of the reason for that is that those ‘A’ buildings are filling up, and rents there are increasing, so there’s confidence the ‘B’ assets will be next,” Buss said. “In this market, the top area is along Interstate 394. If you look at the ‘A’ office buildings there, like the Colonnade and the 601 Tower at Carlson Park, they have recovered quickly and their rents have increased dramatically.

“So investors look at the rest of that market and say, ‘Hey, the next tier of asset can’t be that far behind’ in terms of quality, and they’ve been right. You’ve got Excelsior Group taking a position in the Parkdales, for instance. I think everybody has an expectation that ‘B’ assets there are going to be doing very well.”

 

Don Jacobson is a freelance writer in St. Paul. He is the former editor of the Minneapolis/St. Paul Real Estate Journal.