Few commercial real estate professionals – few people at all, in fact – will look back fondly on 2021. That’s thanks to the COVID-19 pandemic, which continued to upend life throughout the country.
Add in the supply chain shortages that have come with the pandemic, and bringing commercial buildings to life in 2021 has not come without challenges.
But not even the pandemic could bring commercial real estate development to a halt in the Twin Cities area. Despite the struggles brought on by COVID-19, developers throughout Minneapolis, St. Paul and their suburbs continued to bring multifamily towers, distribution centers, warehouses and mixed-use developments to the Twin Cities.
And 2022? It looks to be even busier as several new projects come online throughout the market.
We recently spoke to three commercial real estate professionals about a busy, if challenging, 2021 and their hope for the new year, Anne Behrendt, chief executive officer and principal with Bloomington, Minnesota-based Doran Companies; Tony Kuechle, president of development with Doran Companies; and Paul Hyde, co-founder of Hyde Development in Minneapolis.
Here’s some of what they had to say.
Throughout the pandemic, multifamily has remained one of the strongest commercial sectors. What do you think is behind this strength?
Anne Behrendt: I think that many of the renters who are choosing to live at the projects we are developing are choosing a lifestyle. They want quality and they want walkability. That desire didn’t change during the pandemic. People still want a connection to the community and the ability to live in a way that provides a lot of freedom. Those wants were driving renters by choice before the pandemic and they remained strong throughout it. We are continuing to see those choices being made by the populations that have driven the rent-by-choice trend during the last decade.
Tony Kuechle: Renters by choice are exactly who are driving the demand for multifamily. We are seeing more empty nesters who have sold their larger homes and are moving to a maintenance-free lifestyle community closer to their children and grandchildren. That is part of the reason why we are seeing multifamily flourishing in the suburbs.
What are some of the new projects Doran Companies is working on?
Kuechle: We broke ground a couple months on a project in Minnetonka on Shady Oaks Drive that be 375 units. It will be the largest market-rate multifamily development in Minnetonka. We also have a multifamily development in Tonka Bay on Lake Minnetonka that will be 86 units. That will be added to a community of 1,050 people. The population could increase by 10 percent with that project. It’s not a massive development, but it will be a change for that community.
Before the pandemic hit, we had written a lot about how strong multifamily demand was in the center of cities. That seems to have changed now. Are you seeing increased demand for multifamily projects in suburban areas now?
Behrendt: We are, and we think that demand will continue. There are a number of renters by choice who are looking to change their lifestyles but not their networks and circles. They want to go to the same grocery store, the same place of worship and the same walking trail, but they want to sell their larger homes. They are choosing suburban projects that provide a bit more of an urban lifestyle but in an area that they call home.
Do you think demand for urban multifamily properties will return as the pandemic fades?
Kuechle: I sure hope so. I think it will, but there are other concerns that renters have in addition to the pandemic. People have safety and security concerns in downtown Minneapolis, too. Those do have to be addressed.
Behrendt: There are a number of high-profile large multifamily projects that will be delivered in the urban areas in 2022. I think that how those projects perform will be telling. I am hopeful that these new projects will spur continued growth in the commercial market in downtown.
When it comes to new apartment buildings, what type of amenities are renters looking for today?
Kuechle: The number-one desired amenity that we have seen hasn’t changed much lately: It’s the ability to work from home, and not necessarily in the apartment unit itself. People want to pick up and move throughout different portions of the building as they work. They want to change their environment as they work during the day. When people were required to stay home, they didn’t necessarily work from their apartment units. Instead, they worked in the community areas. That is still the case. Many people are looking for the social interaction that they have missed from the office.
In addition to that, we are still seeing renters interested in pools, workout facilities, entertainment suites and outdoor amenities.
Behrendt: Renters want different options in their buildings for working from home. We will continue to design that in our projects. That is what our tenants want. The work-from-home spaces add to the overall flow and community feel of the buildings.
Kuechle: It’s important to remember, too, that as we talk about empty nesters, the amenities in the buildings aren’t necessarily for them. They are for the grandkids who want to go swimming or play in a game room. It’s fun to see grandma and grandpa and experience all those amenities.
It’s not easy to predict the future, but do you think 2022 will be another strong year for multifamily development in the Twin Cities area?
Behrendt: I think that we will continue to wrestle with supply chain issues and significant price fluctuations with construction materials and labor. That is a challenge during this stage of the pandemic. But in real estate development, there are always some headwinds. The market fundamentals are strong. There is demand still not being met. The pace and strength that we have seen in the last year or so will continue in 2022.
Kuechle: I think the other factor to watch is interest rates. Demand for apartment units will be there. The ability to perform and deliver developments, though, will be challenged by supply chain issues.
Behrendt: The challenge with supply chain issues is that it feels a bit like whack-a-mole. When one thing improves, another becomes constrained. The uncertainty is going to be a challenge for everyone in real estate development and construction.
While multifamily has remained strong throughout the pandemic, demand for industrial space has boomed. How busy has 2021 been for Hyde Development when it comes to industrial?
Paul Hyde: This year has been very active. We have even been active during the holiday week. This has been the busiest week of Christmas that I’ve seen in 24 years. Instead of attending Christmas parties and lunches, we are at our computers working.
You ended 2021 with an industrial acquisition, right?
Hyde: We purchased a 430,000-square-foot industrial building in Fridley, Minnesota, three weeks ago to the east of our Northern Stacks project. We are calling this Northern Stacks Nine. It is occupied now with a number of tenants that have some lease term left. We will be studying over the next nine months whether to reposition the building like we did with our Stacks 8, adding new utilities, a new roof, new paint and a new sprinkler system or if we should redevelop and build new buildings on the property once the leases expire.
We are fortunate to have a great team and a great community to work with in Fridley. We are at 100 percent occupancy with our Northern Stacks project. We are eager for more opportunities to expand the park. Buying this building was our way of doing that. We will either reposition the 430,000-square-foot building or build one to three new buildings. We have some homework to do in the first part of 2022.
What factors do you consider when making that choice to reposition a building or rebuild?
Hyde: The simple answer? It comes down to money. The more descriptive answer is that we look at the value of the land and property. We paid a good amount for the building and we are in a very good spot to reposition it. We can spend money on a roof, paint, parking lot, utilities and the sprinkler system and still be in a good cost basis to charge market rent. If you tear the building down, you have torn down a part of what you paid for. Then that purchase price has to get converted into your land basis. The question then is whether the land basis is competitive enough to support new construction and current market rents. That is what we are going to study. I think the answer will be ‘yes.’ Rental rates for industrial properties are rising. We have seen that from our first to our eighth buildings at the Stacks. The demand for infill construction is stronger than ever.
What are some of the reasons for industrial’s strong performance throughout the pandemic?
Hyde: The simple answer is that COVID accelerated a trend that we used to see only at holiday shopping time: people preferring to buy their goods online and delivered to their home. When COVID kept us in our homes, the goods that we wanted to buy and have delivered became much broader. It’s not just Gatorade and Minute Maid juice. It’s grills, snowblowers, lawnmowers, furniture, you name it. People expect to be able to buy it and have it sent to their homes rather than having to go into a store. There is not as much need for a large retail store, at least at the scale that we have been used to. There has been a dramatic increase in distribution centers to get these goods to consumers’ homes.
That was always going to grow as consumers’ preference for online shopping continued to increase. But COVID changed this to an everyday thing and not a season thing.
Then there are the supply chain shortages. These shortages highlight why just-in-time delivery doesn’t serve us well when there are disruptions. Companies need to store more stuff so that it is ready to be delivered quickly. This means that they need more warehouses here and not in China.
On the capital side, investors want to invest in industrial today. Industrial never used to be cool. Everyone wanted to invest in high-rise office buildings and fancy retail centers. Those have suffered, losing investment value during COVID. Investors want more of industrial.
Do you think those online shopping habits will continue even after the pandemic fades?
Hyde: That seems to be the indication. We are seeing our tenants planning for it. Companies are trying to get out in front and making sure they have their network of distribution centers ready to serve their customers. Companies sure seem to be planning on online shopping only become stronger.
You also work in the office space. Do you see any positive signs for the office market today?
Hyde: We play in the smaller, more creative office space, brick-and-timber. While we saw the need for rent relief for some of our tenants in early 2020, a lot of that has been recovered. In the last three months, our office building in the Northeast submarket of Minneapolis that was at 50 percent occupancy reached 90 percent with three deals that got done in the last eight to 10 weeks. I think the strength of the office market is neighborhood-specific today. In the North Loop and Northeast submarkets, we are seeing more success than perhaps the office market is seeing in the downtown core. We just need people to come back to work in the office for that to start to recover.
Are you seeing more people returning to the office throughout the Minneapolis-St. Paul market?
Hyde: It is slow, but yes, every week we see more people in the Skyway. The parking lots and garages are getting fuller. The next step is the big companies coming back. When they decide to start sending people back to the office, that will change the whole feel of the downtown office market.
How busy do you think 2022 will be for your company?
Hyde: It will be busier than this year. I think the constraining factors to watch for are interest rates and the supply chain issues. We have seen all-time-high pricing for industrial buildings this year. Because interest rates are still so low, there is more money that wants to own industrial buildings than there are buildings for sale.
The supply chain issues are a challenge, too. We are building a project in Fargo. Normally, we would get the materials for our roof delivered in one day, the membrane and the insulation. That is now being delivered in four weeks in spots. That slows your work down. The roofing people are having a hard time committing to any date. The supply chain problems we are now facing are unprecedented. More industrial buildings are being built. Companies like Amazon bought all the bar joists to make sure their buildings will be built. The rest of us are asking, where is mine?