Update on the Office Market: 2019 Gains Forecast

Even though there were some mixed signals earlier in 2019, the Minneapolis and St. Paul office forecast for the year is expected to remain strong, performing better than the national average. The summer Yardi-Matrix Report provides an in-depth glimpse at local market activity for the first six months of the year.

Key Points of Pride

Although the report notes that year-over-year sales activity was somewhat slower in June, overall the annual gain is expected to exceed 2018's $1.4 billion volume, an impressive achievement. And that's just the tip of the iceberg in terms of good news for the Twin Cities market.

The local market is seen to be strong, no matter what specific numbers are examined:

• Demand for office space remains high;
• Asking rents moved higher by 1.5 percent during the second quarter, earning a place among the highest in the nation;
• Absorption rates remained "healthy," with the local vacancy rate of 12.6% among the lowest nationally;
• Gains in office employment were only modest, but they were positive; 1,200 jobs were added in the office sector for the one-year period that ended in May. A gain of 2,000 in the business-professional sector was impacted negatively by a loss of 600 jobs in financial services and 200 jobs taken from the information sector.
• Construction remains steady, with approximately 550,000 square feet of space expected to be completed by the end of the year. As of the end of June, more than 2.1 million square feet of new space is under construction.
• Finally, pre-leasing activity was strong, especially with the larger projects. Prior to groundbreaking, commitments were reportedly in place for more than 85% of the planned 530,000 square feet of space at the CBC Gateway Project.

Employment

The Twin Cities area remains a tight employment market, according to the report. At the end of May, office-using jobs represented approximately 25.5% of the total area employment pool, compared with a national average of 21.5%. The growth was just 0.2%, said to on par with the national average. Additional job cuts are forecast in the financial services sector, which may be counterbalanced by expected growth in information technology jobs; for the time being, the business and professional services sector remains strong.

However, despite a focus on retention of educated younger employees in the fields of information and technology, growing numbers of younger workers are leaving the area to seek more lucrative or more exciting employment elsewhere, especially on the West Coast, according to the report. Whether additional targeted funding from public and private sources can stem this potential talent drain is currently uncertain. If the employment situation tightens further, future numbers might be impacted.

Construction and Development

Multi-family construction in the central business district, much of it in the form of renovation of older downtown Minneapolis commercial space, has superseded office development for several years. The residential sector is expected to dominate the market, but a combination of need, pricing and a growing trend for business to return to the city's core might boost new office development. However, changing business trends continue to redefine the kind of space that will be of interest to current and future employers. And, the recent announcement by WeWork, could also affect the development of co-working and alternative office space.

Overall office lease rate average was $26.44 a square foot as of the June report; the average asking rate for Class A space was $29.51, with an average of $22.61 per foot for Class B assets. South Central and West Minneapolis, along with St. Paul's CBD, are currently the areas that command the higher prices, with lower asking rates available in eastern Washington County and near the airport.

Based on current activity, the supply of new office space will grow by about two percent when completed, adding 2.1 million square feet to existing inventory. A staggering 4.5 million additional square feet of office space was in pre-development, planning or permitting stages as of the end of June.

The two largest projects currently underway include the continuing renovation of the former Dayton's Building in downtown Minneapolis, and the 37-story tower that is to be the RBC Gateway. Together, they will add nearly 5.5% to the city's office inventory by the end of 2021. United Properties is involved in both projects. The mixed-use development that includes the RBC Gateway will also feature retail and residential space as well as a new Four Seasons Hotel.

No matter how one views the commercial real estate picture in the Twin Cities, the forecast for the future remains bright, despite a few bumps in the road for the office sub-market. The six-month Yardi-Matrix review is positive on all counts. Based on reviews of other sectors, 2019 will close as a good year.