Office markets throughout the country face uncertainty as they wait for companies to bring their workers back into the office. And Jon Dahl, managing director in the Minneapolis office agency leasing group of JLL, said that the Minneapolis/St. Paul market is no different.
It’s still uncertain when or how many employees will return to the office buildings in downtown Minneapolis and its suburbs on a full- or part-time basis. Many companies are planning a hybrid work arrangement in which employees work part of the time from the office and the rest from home. How this impacts the office market throughout the Minneapolis area remains to be seen.
“Companies are downsizing,” Dahl said. “They are taking less square footage. That is creating some negative absorption and increasing the vacancy rate. I think that will shake out fairly quickly. I see the end of 2022 and 2023 as being rebound years. It will be a little bit of slow going between now and then.”
The COVID-19 pandemic has hit some commercial real estate sectors harder than others. The office sector, though, faces a particularly uncertain future. Many companies scuttled their plans to bring workers back to the office in September because of the rise of the Delta variant.
Dahl said that the sluggish office market, though, does present opportunity for some building owners.
Those owners who have a highly-amenitized Class-A office building with new vacancies now have an opportunity to attract new tenants, Dahl said. The office renewal rate in the Twin Cities market has historically been about 75 percent. It has now dropped to 50 percent or lower, Dahl said.
Many office tenants are looking at their space and, in the wake of the COVID-19 pandemic, are now saying that it no longer works for their company. These tenants, though, will need new office space if they leave their current locations. And that, Dahl said, is good news for the owners of quality Class-A buildings who do have vacancies. These tenants are more likely to move to these higher-quality buildings once they do determine their office space needs.
“Some companies will be reducing their footprint,” Dahl said. “That leaves a scenario where those companies are saving money on rent because their footprint will be smaller. They can now afford to move to a more expensive building and upgrade their office quality. These employers are trying to figure out how to get their employees into the office at least three or four days a week. Having an office space with more amenities can get people in.”
Dahl said that those office buildings that are seeing the most leasing activity in the Twin Cities market today are the those that are of the highest quality and charging some of the highest rents.
“We have had an amenities arms race for a few years,” Dahl said. “This is even a bigger opportunity for landlords to upgrade their buildings. It’s not just amenities such as tenant lounges or fitness centers. Air quality is a big one because of COVID. What kind of air filters do you have? What is the air exchange rate? What other COVID mitigation things are landlords doing? People might move their companies because of those features.”
According to JLL’s third-quarter Minneapolis office report, two big new occupiers that moved into the Minneapolis CBD helped move the market into positive absorption during the third quarter.
Deluxe Corporation relocated from the suburbs to 801 Marquette, taking 95,000 square feet off the market. And Life Time Work moved into Thirty, the converted YMCA building on the west end of the Minneapolis CBD, filling 53,000 square feet. These two moves accounted for the bulk of the positive office absorption during the third quarter.
In another big move, three of the four buildings in the Metropoint office campus in St. Louis Park, Minnesota, sold in July for $63.5 million to ABS Management. Other than Thrivent’s $130 million sale-leaseback of its headquarters in February, the Metropoint sale was the largest office trade in 2021 so far.
Overall, the total vacancy rate for the Minneapolis office market stood at 18 percent for the third quarter, according to JLL. At the same time, 531,419 square feet of new office space was under construction.
The average direct asking rent for office space in this market fell a bit to $28.65 a square foot, while the average sublease asking rent was $25.86 a square foot.
For the year of 2021 so far, net absorption in the Minneapolis office market was negative 819,134 square feet.
What does the future hold? No one knows for sure, but big office deals are on the horizon. JLL pointed to Target as an example.
In the first quarter of 2021, Target announced plans to sublease its City Center site in the Minneapolis CBD. That will make Target the biggest sublessor in the country when its 890,000 square feet of office space is officially listed, something that is likely to happen in the fourth quarter of this year.
The next major office delivery will be RBC Gateway in early 2022. This Minneapolis CBD development anchoring the east end of Nicollet Avenue will also include a Four Seasons hotel and condominiums. This in addition to the 531,000 square feet of office space. Fortunately, the majority of this office space is already pre-leased.
The big question, of course, is when will companies in the Twin Cities bring their workers back to the office?
Dahl said that no one has the answer to this question. But different types of companies, such as law firms and professional services firms, are already seeing higher occupancy rates than others.
“If you talk to senior level people at large organizations, they’ll tell you that they still don’t know when their employees will be back,” Dahl said. “Some are testing permanent work-from-home. Others are testing hybrid work environments. Others are saying they expect their employees to be back in the office five days a week. Everyone is still feeling it out.”
Dahl said that work-from-home does come with certain negatives. Maybe a company has hired interns. Who, Dahl asks, is mentoring these interns if they can’t speak to anyone face-to-face?
Office occupancy rates might be a bit higher in the suburbs than they are in the downtown Twin Cities market, Dahl said.
“When COVID hit and after the George Floyd incident and the resulting civil unrest, all activity dropped off in downtown,” Dahl said. “That lasted for a while. We saw more activity in the suburbs. There was a lot of talk of downtown companies moving out to the suburbs. There were a few and there are still a few kicking around that idea. But downtown, coming into the summer months, it was like a cork came off the bottle. There was tons of activity. Our office showing activity in the summer months was higher than it was in 2017, 2018 or 2019. People can only delay their office leasing decisions for so long.”
When will companies finally start making longer-term office decisions? Dahl said that some office end users are already at this point.
Some companies are asking for one-year extensions of their office leases, Dahl said. But most landlords and owners aren’t accommodating these requests.
“Normally, we don’t do those one-year extensions. But because of what was going on at the time, owners were more accommodating to those tenants,” Dahl said. “Now, owners are pushing back against anyone asking for a one-year extension. They are requiring a three- to five-year minimum. We have seen lots of long-term leasing in the last six months. I am feeling much better about this market today. I was wondering if 2021 was going to be a total wash. Instead, it’s turning out to be a better year than we expected.”