The Twin Cities’ office market in the first quarter of 2023 continued to struggle thanks to rising interest rates, concerns about public safety and worries over possible bank failures. Most concerning? The Minneapolis-St. Paul office market’s slump doesn’t appear ready to end any time soon.
According to a first-quarter report by Avison Young, office leasing volume fell 18.5% in the Twin Cities area, with just 938,826 square feet of office space signed in the first quarter of the year.
The slowdown in leasing activity has been seen across the commercial real estate industry, with properties outside of the central business districts showing more resilience. The Avison Young report does show that the North Loop Green mixed-use development in Minneapolis has continued to attract tenants a year before its delivery. That project, though, is increasingly looking like an exception. Consider that available office sublease space continues to climb, increasing by 7.2% from the fourth quarter of last year, as companies including Blue Cross and Blue Shield of Minnesota and UnitedHealth Group decide to give up large blocks of office space.
Some of the companies that have signed office deals in the Twin Cities market have increased their space, but the majority are downsizing, with many choosing higher-quality space in an effort to persuade employees back to the office, at least on a part-time basis.
Avison Young’s report also indicates that the return-to-office push from executives has been relatively muted. This has resulted in many employees continuing to work from home, either on a full-time or part-time basis. Office tenants continue to embrace the hybrid-work model, cutting their office space by up to 50% and using hot desks for when their employees do visit the office. This trend might be beneficial for workers and their employers, but it has resulted in a rising number of office vacancies across the Twin Cities region.
In general, law and financial firms have shown the greatest interest in boosting their physical occupancy, while tech companies are often still working remotely. Net effective rental rates are declining, providing some good news for tenants. Landlords are offering concessions to attract tenants and fill spaces. This trend is likely to continue, with many landlords needing an influx of cash to avoid more properties going back to their lenders.
The total square footage of all leases signed each quarter has been steadily declining since the first quarter of 2021. The 938,826 square feet signed in the first quarter of 2023 was 18.5% lower than the 2021-22 quarterly average and only 2.4% higher than the quarterly average during the Great Recession of 2007 through 2009. The number of deals also declined, signaling that tenants are not only reducing their footprints but are increasingly hesitant to commit to new spaces.
Available sublet space increased 7.2% from the fourth quarter of 2022, with most of the sublet availability concentrated in the highest-quality buildings. The 3.3 million square feet of Class-A space currently up for sublease (81.4% of the total) makes up 5.7% of all Class-A inventory. While the recent consensus in the market has been that tenants are flocking to quality office space, this shows that landlords may need to get even more aggressive with concessions.
Triple-net direct asking rents barely declined in the first quarter from $17.33 a square foot to $17.27, sitting 1.8% below what they were in the first quarter of 2022. Increased concessions from landlords have driven down net effective rents. This is a welcome development for tenants that will hopefully bring a surge in the number of new deals signed through the rest of the year.
The Avison Young report shows that the Twin Cities office market is still experiencing the effects of the pandemic, along with other economic factors. Avison Young makes it clear: The local office market continues to require concessions and innovative solutions from landlords and city officials to attract tenants and fill spaces.