The Minneapolis-St Paul office market suffered a "significant" pandemic-related contraction during the first quarter, losing nearly 1 million square feet of tenancy across the market, according to a new report by commercial real estate services firm Colliers International.

"Physical occupancy has been bleak both in the Minneapolis-St. Paul market and across the nation," wrote Colliers Managing Director and Twin Cities Market Leader Jeremy Jacobs. "Many companies are now faced with the question of when, how and whether to fully return to work as they gradually have been bringing workers back to the office."

The pandemic stoked fears about the fate of the commercial real estate sector as office employees fled office spaces for the safer option of working from home. More than a year later with vaccinations on the rise, many workers have told employers they want to keep working from home.

That trend prompted a few firms to cease office leasing. Others with expiring leases opted for smaller space.

While Twin Cities office space grew 1% to 185.1 million square feet from a year ago, vacancy rates jumped to 9.3%, up from 7.8% during the first quarter of 2020, the report said.

In contrast, local demand rose for warehouses, logistical and fulfillment center leases, creating industrial vacancy rates of just 4% for the quarter.

Offices weren't that lucky. Downtown Minneapolis and St. Paul

had the highest office vacancy rates in the region - 11.7%, and 11.6% respectively.

Office buildings along the west metro's I-394 and I-494 corridors followed with troubling vacancy rates 10.9% and 9.4%. Lastly, 10% of the 13 million square feet of offices in the east metro's Apple Valley, Burnsville and Eagan area also sat vacant.

On the bright side, Colliers found Twin Cities office tenants with expiring leases were signing short-term lease extensions and at slightly elevated rates.

It also reported that few Twin Cities companies followed through on threats to leave the core cities for the suburbs because of safety concerns stoked by last year's riot and spikes in crime.

A year later "relatively few deals have come to fruition," even as some firms who "never considered the suburbs before" say they are "testing the waters" and still exploring suburban options, Jacobs said in the report.

Despite the uncertainty, the first quarter delivered some significant transactions for the region's office sector.

The city of Minneapolis moved into its newly completed 380,000-square-foot building at 505 4th Av. S. That massive move offset first-quarter occupancy losses for the entire city.

Across the river, the historic Great Northern Building in downtown St. Paul successfully leased 153,000 square feet of space. The state's Department of Employment and Economic Development will move its headquarters into the 11th, 12th and 13th floors.

The Merit of Midway building, also in downtown St. Paul leased 52,000 square feet and the Normandale Office Park along Interstate 494 leased 43,000 square feet.

The Colliers report noted other bright spots, such as the recent news that Ernst & Young became the first tenant to lease space in the newly redeveloped Dayton's Project building on Nicollet Mall in Minneapolis. That follows last year's decision by Deluxe Corp. to sign a lease to move to 801 Marquette Av. in Minneapolis from Shoreview.

Those successes, however, are not enough to ease concerns about the future of the office sector. Colliers officials said it remains unknown how the sector will ultimately fare once the pandemic subsides and if more Twin Cities workers fully return to brick-and-mortar offices.

Prime Therapeutics announced in March that as part of a new hybrid "work from home" and/or "work in office" model, it will vacate seven floors inside the Normandale Lake Office Park location in Bloomington next year and move 700 workers into its existing Eagan headquarters.

Target Corp. announced in March plans to vacate nearly 1 million square of Minneapolis office space in City Center on Nicollet Mall. It will blend 3,500 "remote work" employees into three other existing offices downtown. Target still has 10 years left on its lease.

While the Target news was a blow to the Minneapolis Downtown Council and other city boosters, Jacobs at Colliers noted that the retailer "has not listed the City Center space for sublease yet, indicating that it might not be willing to the pull the trigger until it tests its flex working model postpandemic. It may hold onto the relatively inexpensive space until well after bringing employees back to the office."

Colliers report comes as several large law firms, accounting firms and others announced moves into much smaller Minneapolis offices. Fredrikson & Byron, Henson & Efron, EY (formerly Ernst & Young) signed leases for smaller spaces because of the pandemic, technology upgrades and other trends.

In a national conference Monday, Dodge Data Analytics Chief Economist Richard Branch said he is seeing similar changes to the office market nationwide. While Apple, Amazon and Google are investing in new office spaces, many other firms are waiting for their workers to return to the office before committing to more real estate space, he said.

It's why office construction and occupancy rates "continue to underwhelm," Branch said. That could change once workers dramatically return to their offices spaces in the fall, after children return to school.