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METRO
MARKET OVERVIEW SECOND HALF 2002
Investor interest in Twin Cities commercial real estate – particularly apartment and retail properties – rallied over the first half of 2002, pushing the total number of transactions completed in the year to approximately 30, or about the same level as in 2001. Few observers would have predicted even that many deals to occur after watching the investment market slumber through the first quarter of the year.
Investor interest in commercial real estate rekindled partly in response to the stock market’s continuing struggles through the second half – a trend that is expected to continue into the future. With real estate returns still largely positive, investors turned increasingly to commercial real estate as a presumed safe haven. Low interest rates also helped fuel the investment market by giving private investors access to less-expensive capital and enabling them to more effectively compete with public capital.
While capital is in plentiful supply, underwriting standards are significantly tighter today than in the recent past, creating a gap in bid and ask pricing. For the completed transactions, this gap was eliminated by either sellers with special motivations or buyers willing to accept lower returns. The historically low interest rates allowed investors to push values and property owners to strengthen their financial position by refinancing.
Greatest demand was for stable properties with good credit and longer lease terms. These properties are still able to command aggressive pricing. It’s the buildings with higher vacancies and less predictable income streams that are being sharply discounted by investors. Demand still exists for these types of properties, but at a price that reflects a higher perception of risk.
Well-positioned grocery-anchored retail centers receive the highest degree of interest from investors searching for properties in the Twin Cities. Bulk warehouse properties are in favor on the industrial side. In spite of softening in the multifamily market, investment interest in apartment projects also remains high. Investors appear to be willing to underwrite what they perceive to be a near-term recovery in the apartment market.
Investor interest in the Twin Cities office market was underscored with the December sale of Southdale Office Centre, a four-building, Class B office complex in Edina. This was the largest office transaction completed in the market during 2002. The largest apartment transaction was RREEF’s sale of Chasewood Gates Apartments in Minnetonka to CAPREIT. A majority of the other deals completed in 2002 were in the lower-profile, $5 million to $10 million range.
THE OUTLOOK Until companies generate sustainable profits and begin to hire new workers, vacancy rates in the office, industrial and apartment markets are likely to remain high. For some investors with debt maturing in the coming year, that scenario may pressure them into making some difficult choices. Some investors may not be able to meet the demands of lenders for higher equity participation, forcing them to put their properties on the market. Any rise in interest rates would also negatively affect owners holding floating rate debt.
Investors have turned increasingly to the commercial real estate markets as a safe haven, helping sustain pricing for several different types of properties – even those in markets in which vacancies have climbed. Twin Cities apartment properties are commanding record high prices, and retail properties are increasingly sought by investors. Pricing for well-leased office and industrial properties is stable.
Pricing has declined most significantly for poorly located office buildings with high vacancy or poor credit risks among their tenant mix. Investors underwrite future operations with caution, factoring in higher tenant improvement costs and longer lease-up periods.
Owners of buildings with no compelling need to sell may choose to hold their properties until the real estate markets recover, resulting in another slow year for transaction volume in the Twin Cities. However, recovery in the real estate market will likely be accompanied by a rise in interest rates as well – which may negatively impact the pricing for buildings in the future.
Buyers will continue to pay substantially more for well-leased, good credit office and industrial properties versus lower-quality buildings. Values will be enhanced if interest rates remain near their current levels.
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