The top CRE pros in the Minneapolis/St. Paul market headed to the Radisson Blu Mall of America hotel in Bloomington, Minnesota, earlier this month for Minnesota Real Estate Journals’ Commercial Real Estate Forecast Summit.
And, yes, this was an unusual summit. Some speakers and attendees viewed the event virtually. Others attended in person, wearing masks and social distancing from each other.
The summit itself focused on COVID-19 and its effect on the Minneapolis/St. Paul commercial real estate market. This isn’t surprising: The pandemic has upended what was a soaring CRE market heading into 2020.
But the takeaway from the conference was a positive one. Yes, Minnesota’s CRE market faces challenges today thanks to the pandemic and the resulting economic disruption. But there is also hope. The CRE market in St. Paul and Minneapolis was booming before the pandemic hit. Summit speakers said that the strength of the market will help it withstand the COVID-related challenges it will now face.
And while no one could predict when the market would return to normal — or to whatever will pass for normal — panelists did say that despite the challenges deals are still getting done in the Twin Cities.
An interesting discussion took place regarding the office market, one of the commercial sectors that is seeing a huge impact from the pandemic. Moderator Tom Hoffman, senior vice president with Colliers International, moderated the panel of office experts, covering everything from what office spaces will look like in the next several years to the state of this market right now.
Brent Erickson, senior managing director with Newmark Knight Frank, said that from a historic standpoint the office market in the Twin Cities remains a fairly healthy one. The vacancy rate, for instance, remains in the low teens, which isn’t much of an outlier from recent years.
What has stood out, though, is absorption. Since the start of the pandemic, the absorption rate in the Minneapolis/St. Paul market has remained flat, Erickson said.
“There haven’t been any big changes up or down,” Erickson said. “There is no submarket that has stood out in terms of high absorption or really low absorption.”
The number of office sales is down since the start of the pandemic, too, Erickson said. And this is where COVID-19 has made its greatest impact on the market.
“This is the one area that has really been hit by COVID,” Erickson said. “There are not a lot of office sales coming up in the future. The lack of sales is the biggest indicator of how COVID has impacted our office market.”
Scott Peterson, vice president with United Properties, agreed that office sales are down. This has been disappointing to those wanting to buy office properties today, as many buyers expected to see a significant drop in sales prices throughout the Twin Cities office market.
But Peterson said that that flood of discounted properties hitting the market hasn’t materialized. Owners don’t want to sell their office properties at a big discount if they can instead hold onto these buildings and wait for the market to improve.
“What is the motivation for a seller to sell right now?” Peterson asked. “There really isn’t much of one. You haven’t seen the fire sales that buyers wanted. We will see sales in the future, but probably not until the first quarter or second quarter of next year. There is not a lot of sales activity in the office space right now.”
That’s a snapshot of the current office market in the Minneapolis/St. Paul area. But what about the future? How will the office market evolve as the state continues to deal with COVID-19? And what will the market look like once the pandemic finally fades?
Corey Whitbeck, principal with TaTonka Real Estate Advisors, said that companies might need less office space in the future. Many have discovered that their employees are still efficient and productive when working from home.
This means that flexibility will be key as office tenants and landlords try to work out what companies’ office space needs will be in the next six to 12 months, Whitbeck said.
“It’s critical that landlords and tenants figure out a way to work together for the next six to 12 months,” Whitbeck said. “We are a tenant rep. That’s all we do. We know that the relationship between tenants and owners is like a marriage. Our clients don’t know if they’ll need 40 percent of their office space in the near future. They don’t know how many of their employees will keep working from home. Those landlords that can remain flexible during tis time will build stronger relationships with their tenants.”
Mark Evenson, managing principal with Avison Young, said that office owners should expect significant long-term changes in the office market because of COVID-19.
Companies are learning that they don’t need all their employees in the office at any one time. Flexible work schedules and work-from-home arrangements aren’t new. But the pandemic, which sent so many workers to their home offices at the same time, will accelerate the shift to more flexible working arrangements, Evenson said.
“Working from home works. We have to acknowledge that,” Evenson said. “But many of us are also going to want to come back to the office. Working from home doesn’t work for everyone. We will see an increase in flexible work schedules in the future.”
Evenson cited a a survey by Fortune of the chief executive officers of Fortune 500 companies during the last two weeks of April. Only 27 percent of these company leaders said that they expect their workers to fully return to their usual workplaces in 2020. Only 38.1 percent expected this to happen by June of 2021 and 26.2 percent said they expect their employees to work from home indefinitely.
“We are going to see a change in the office market,” Evenson said. “It just remains to be seen whether the extra space we’ll need for social distancing will offset the lower amount of space companies might need because of the smaller population in offices.”
Evenson predicted that the amount of office space companies need will drop by about 10 percent to 15 percent on average during the next several years. He also predicted that many employees will want to come back to the office but on a more limited basis, perhaps choosing to come in just two to three days a week.
Erin Fitzgerald, principal with Transwestern, said that the majority of office lease transactions today are short-term lease renewals. Companies are hesitant to make bigger long-term decisions, she said.
This isn’t surprising. COVID-19 has brought so much uncertainty that most companies are holding off on long-term planning. Many are not ready to invest in new office space until they see how long employees will be working from home and how many will want to return to the office on a full-time basis in the next year.
The pandemic might impact, too, the flow of new companies leasing office space in downtown areas, Fitzgerald said. Many that might have moved from the suburbs to downtown St. Paul or Minneapolis might hold off.
“The majority of deals are short-term right now,” Fitzgerald said. “Companies are trying to figure out what their workplace strategies are going to be throughout this pandemic. Some of the companies in the suburbs will decide to stay put. They’ll stay with the building that has wide-open surface parking lots where their workers don’t have to worry about public transportation.”
Like others, Fitzgerald emphasized that owners will have to be flexible to maintain good relationships with their tenants. Owners might have been able to secure longer-term leases of five to six years before the pandemic hit. Today, though, many might have to settle for shorter terms of two to three years.
The pandemic, of course, won’t last forever. The office market it leaves behind, though, might look different from the one before COVID-19, panelists said.
Evenson said that the office might not be the daily destination for a growing number of employees but instead might be reserved more for work that can’t be done from home.
“The office will be a place for people to come together to collaborate or to meet a client,” he said. “You might see more meeting spaces and more team spaces but less space for alone work, for the heads-down type of work.”
Whitbeck said that creative companies will redesign their office spaces to meet whatever new reality emerges after COVID-19. This long work-from-home experience has taught companies that workers can do many of their tasks from home offices. But it’s also shown that some tasks are still better suited to the office space.
“Employees are realizing that taking conference calls in their cars because their kids are running around the house doesn’t work,” Whitbeck said. “It will become, then, about making sure the workplace environment matches the functions we need to accomplish. Some employees might be able to accomplish those functions at home more often. That works. But they might need to come into the office to accomplish other functions. It needs to be about allowing employees to be happier and healthier.”
Fitzgerald said that while there will be some changes to the office environment, office work won’t disappear entirely. She pointed to the months and years after 9/11. Back then, people predicted that no one would want to work in high-rise office buildings. They’d instead flock to three-story buildings in the suburbs.
That didn’t happen, of course. Yes, Fitzgerald said, there will be some changes to the office sector because of COVID-19. But people will one day resume commuting to work. And they’ll one day return to high-rise buildings in downtown areas.
“Ultimately, human beings have very short memories,” Fitzgerald said. “We might see some changes in the short-term. Some companies might go to the suburbs. But people will return to the office.”