VOLUME 32, NUMBER 6
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Zumper study: Multifamily rents keep rising in Minneapolis by Dan Rafter
Should multifamily developers, owners start to worry? by Dan Rafter
y now, you know the story: Apartment rents across the country, including in the Midwest, continue to rise. At the same time, the demand for
new apartments everywhere from Columbus to Indianapolis to downtown Omaha is soaring. The multifamily sectors remains the top performer of all commercial asset classes. But is there reason Multifamily to page 22
here's a reason why so many developers are building new apartment towers in downtown Minneapolis: The demand for multifamily space is high. And with that high demand comes something building owners love, higher monthly rents. Zumper recently released its latest data on apartment rents in Minneapolis neighborhoods. According to Zumper, Minneapolis in June ranked as the 15th most expensive city in which to rent in the United States, coming in just ahead of Denver and Baltimore. In June, the median rents of a one-bedroom apartment unit in the city rose 2.4 percent to $1,260. The median rent of two-bedroom units actually fell a bit, dropping 2.7 percent to a median rent of $1,460. Rents, though, are not equal throughout the city. The most expensive Minneapolis neighborhood in which to rent in June was Downtown East, with a median rent of $1,800 for a one-bedroom apartment. Downtown West, with a median rent of $1,610; Uptown, $1,600; and the Warehouse District, also $1,600, ranked as the next-priciest neighborhoods in which to rent. The most affordable neighborhood for renters in June was Near North, where the median monthly rent for a one-bedroom apartment stood at $600. The Hawthorne neighborhood, with a median rent of $630, and Willard Hay, $700, were the next most affordable Zumper to page 22
NorthMarq’s Blumberg: Skin in the game matters when it comes to commercial financing
innesota Real Estate Journal recently spoke to Susan Blumberg, senior vice president and managing director with the Chicago office of NorthMarq Capital, about how busy developers and investors are these days when it comes to requesting commercial financing for new developments and acquisitions. Blumberg’s answer? Very Minnesota Real Estate Journal: What are some of the latest trends when it comes to construction financing?
Susan Blumberg: The newest trend in the last year is that we are seeing more borrowers looking for 100 percent of their costs to be financed in a permanent loan. They’re not looking for 100 percent with construction loans. That is still usually limited to a maximum of 75 percent of costs. But Blumberg more borrowers outside of that are looking for 100 percent of their costs to be financed. We do have deals where this can happen because the value and rents are higher than the costs. Replacement
costs even on a new deal have reached that point depending on the value of the land and how you were able to secure that land. It all comes down to, though, skin in the game, equity and the strength of the borrower. That will determine everything. MREJ: When it comes to multifamily financing, are you concerned at all about a possible oversupply of new multifamily units in some markets? Blumberg: The apartment market is still so active. The monthly rents with the new properties are giganBlumberg to page 23
Topics Include: Brainerd Lakes Area State of the Market/Way of Life Residential Real Estate Market Update Commercial Real Estate Market Update Business Park & Industrial Park Development & Opportunities
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JUNE 2016 • VOLUME 32, NUMBER 6
SHOULD MULTIFAMILY DEVELOPERS, OWNERS START TO WORRY? ZUMPER STUDY: MULTIFAMILY RENTS KEEP RISING IN MINNEAPOLIS NORTHMARQ’S BLUMBERG: SKIN IN THE GAME MATTERS WHEN IT COMES TO COMMERCIAL FINANCING
KESSLER: CROWDFUNDING CONTINUING TO EARN RESPECT FROM COMMERCIAL REAL ESTATE INVESTORS
THE CONDITION OF BUSINESS AND REAL ESTATE ASSET VALUES
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CBRE is expanding its leading global commercial real estate services offering in North Dakota by hiring Chance Lindsey, a Crosby, North Dakota, native, as First Vice President to lead Advisory & Transaction Services throughout the state. While CBRE professionals have worked throughout the state on behalf of clients, Mr. Lindsey will be dedicated to the area and be based in Fargo and Williston. “Many of our corporate and investor clients have needs in the state of North Dakota,” said CBRE’s Minneapolis Managing Director Blake Hastings. “We felt it was a good time to have true boots on the ground and Chance was a great fit for this focused approach.” Mr. Lindsey has completed more than $460 million in transactions in the Bakken area and represents both landlords and occupiers. Prior to joining CBRE, he was the President of Opulent Real Estate Investment Group, a division of KW Commercial. Mr. Lindsey has experience in virtually all product types including office, industrial, hotels, retail centers, multifamily, investment sales, farms and land. “This role will allow me to combine the world’s largest commercial real estate services firm and its global offering with my years of local market expertise and relationships throughout the state,” Mr. Lindsey said. Mr. Lindsey holds a bachelor’s degree in Exercise Science and Business from North Dakota State University. He is a member of the International Council of Shopping Centers (ICSC) and is an associate member of Certified Commercial Investment Member Institute (CCIM).
Mike Wilhelm returns to CBRE as senior vice president in Minneapolis CBRE announced that Mike Wilhelm has joined the firm as a senior vice president focused on office leasing in downtown Minneapolis and St. Paul. A 25-year commercial real estate industry veteran, Wilhelm spent the last 15 years with Zeller Realty Group, most recently as senior vice president where
he led the Minneapolis office leasing team. He has completed more than 1,000 transactions totaling more than 8 million square feet, primarily in the downtowns of Minneapolis and St. Paul, throughout his career. He joins the CBRE team of Brian Wasserman, Jim Freytag and Teresa Borgen to expand and strengthen landlord representation in both downtowns. Wilhelm is returning to CBRE after more than 15 years away—he first joined the firm as a senior associate on the office leasing team in 1997. Prior to that, he spent five years in office leasing, sales and property management at the Shelard Group. His key clients have included Invesco, Unilev Corp., PIMCO and Carlson Real Estate. Wilhelm holds a bachelor’s degree in economics and business from Macalester College and earned an MBA from the University of Minnesota.
Veteran real estate finance professional Murray Kornberg joins Dougherty Funding as Executive Vice President Dougherty Funding LLC (DF) has announced that it has hired Murray Kornberg as Executive Vice President. In this role Kornberg will further develop Dougherty Funding’s institutional capital markets services by expanding product offerings and leading this new mortgage banking platform, which will complement and collaborate with the other Dougherty real estate investment platforms already operating, including: Dougherty Funding – community bank loan syndication; Dougherty Mortgage – multifamily, student, senior and affordable housing lending; Dougherty & Company – municipal debt-based structures and products; and Dougherty Real Estate Equity Advisors – real estate investment and advisory Murray’s expertise will allow DF to better serve its clients by providing access to a broader range of capital sources, including life insurance companies and other balance sheet lenders; regional, money center and national banks; Wall Street lenders; debt funds; mortgage REITS; and mezzanine and preferred equity lenders.
Kornberg has over 30 years of experience in the real estate industry, including over 25 years in real estate finance. He was the vice president of finance at Minneapolis based CSM Corporation where he oversaw the sourcing of CSM’s secured real estate borrowings, and for the past 13 years was senior Vice President at CBRE Capital Markets in its Debt & Structured Finance Group which last year completed over $38 billion in loan activity. Kornberg has originated in excess of $3 billion in real estate financing transactions, and is a frequent speaker on real estate finance topics at industry conferences and meetings. David Juran, President of Dougherty Funding, says about Kornberg’s hiring, “This is a major statement in our commitment to provide our clients best in class advice and experience across the entire real estate capital stack. Murray joins other recent hires Andy Deckas and Lori Larson, as well as longstanding Dougherty executives, to offer top level experience, knowledge and execution capability for any and all real estate investment or financing needs.” Murray’s professional affiliations include Licensed Minnesota Real Estate Broker; Member, Mortgage Bankers Association of America (MBA); Member, Minnesota Mortgage Bankers Association; Member, National Association of Industrial and Office Properties (NAIOP).
Mark Jensen named CEO of Steven Scott Management Steven Scott Management, Inc. named Mark Jensen CEO and President of the firm. Jensen succeeds Barbara Halverson who is retiring after 44 years; she will consult with company management for a two-year period. Jensen, who joined Steven Scott 28 years ago, is currently chief operating officer (COO) and chief financial officer (CFO). In these roles, he oversees the operations of more than 9,000 rental units, and the financial functions of the company.
News North Loop makes Cushman & Wakefield’s Top 15 “Cool Streets” in North America Inaugural Report of U.S. and Canada’s Hottest Urban Retail Markets Puts Minneapolis Side-By-Side with San Francisco, Toronto, Chicago and more A new breed of urban, experiential, and independent mid-market retailers catering to millennial consumers has led to the rise of 100 “Cool Streets” across the U.S. and Canada, according to an inaugural report released today by global real estate services firm Cushman & Wakefield. The firm’s first-ever Cool Streets of North America report (click here to download) explores the phenomena behind the rise of dozens of new, edgy retail districts across the U.S. and Canada. While some of these areas featured in the report are longstanding bohemian enclaves and focal points for local arts, music, or LGBT communities, the renaissance in nearly all of the Cool Streets has been driven by an explosion of unconventional new retail concepts.
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The report captures the top 15 Cool Streets including the North Loop in Minneapolis and: Sunset Park in Brooklyn; Logan Square in Chicago; Overthe-Rhine in Cincinnati; RiNo in Denver; Silver Lake in Los Angeles; Wynwood in Miami; Roosevelt Row in Phoenix; Carytown in Richmond, Va.; East Village in San Diego; Jackson Square in San Francisco; West Queen West in Toronto; Mount Pleasant/Main in Vancouver; and Shaw in Washington, D.C. About the North Loop, According to the Cool Streets Report: Millennials make up 39.4 percent of the population The average household income is $61,767 Rental rates for retail locations are in the basic range of $18 to $42 per square foot. “Our inaugural Cool Streets guide is yet another example of how Cushman & Wakefield provides our clients with industry-leading research and gives them the best, most useful information first,” said Gene P. Spiegelman, Vice Chairman and the firm’s head of North
America Retail Services. “Today’s marketplace is moving forward at an unprecedented pace, offering immense opportunity and presenting real challenges. The data-driven, analytical approach we use to design and employ creative strategies for retail occupiers is second to none.” In an age of increasing retail uncertainty, Cool Streets serve as an incubator of sorts for what will likely be the hottest new retail concepts of the future, according to Garrick Brown, Vice President of Retail Research at Cushman & Wakefield. “If retailers live and die by cool, the same also holds true of retail properties, shopping centers and entire neighborhoods,” Brown said. “And in an age of frugality, e-commerce encroachment and vast gaps in shopping center performance, cool matters now more than ever.” Preferences for urban over suburban living and for experiences over material goods are at the heart of the Cool Streets trend. And in roughly half of the Cool Streets markets the firm surveyed, restaurant concepts outnumbered actual
retail businesses (excluding service retailers) by a ratio of 2:1. In areas like San Diego’s North Park and Cincinnati’s Over-the-Rhine, for example, craft brewing is the definitive driver behind the Cool Street’s resurgence, while fine dining has been central to the rejuvenation of New Orleans’ Warehouse District. Cool Streets retailers are often a mix of the new and the old, according to the report, which cites clicks-to-bricks players like Warby Parker, Bonobos and Marine Layer as examples. Similarly, brands like Kit and Ace and Shinola have flourished, Brown said, by putting Cool Street locations at the forefront of their real estate strategies. “Independent retailers remain the heart and soul of the Cool Street phenomenon,” Brown said. “Small chains, start-ups and little guys are those most thriving in those locations, and this is largely driven by rents, which stand at roughly 55% of the average asking rate of the nearest Class A mall or high street shopping district.” So what’s next for the Cool Streets? Many of them are in transition, the
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report notes, and their rising popularity very well could bring a new wave of tenants that weakens the areas’ roles as incubators. The report predicts that in the months and years to come, more mainstream retailers – particularly beleaguered mall apparel concepts facing Wall Street pressure to “rightsize”—will begin searching for shop space in these up-and-coming districts. “The mandate is and has been to reduce portfolios to only the Class A or trophy locations with the highest sales,” Brown said. “However, Class A landlords know this, and many are aggressively raising rents. This situation may force many traditional mall tenants to rethink their real estate strategies and begin looking for creative alternatives. Cool Streets will be one of them.”
Cushman & Wakefield/NorthMarq Completes Sale of Prime Redevelopment Site in Minneapolis-St. Paul Midway The Cushman & Wakefield/NorthMarq team of Senior Director David Stokes, SIOR, and Senior Associate
Boston Weir has arranged the sale of a 13.3-acre prime redevelopment site in the Minneapolis-St. Paul Midway. The sale closed June 24. Stokes and Weir represented the seller in the disposition of the building and site at 700 Emerald St. SE in St. Paul, on the northwest quadrant of Interstate 94 and Highway 280. The site is just two blocks from the Westgate Light Rail Station, a short walk from the Mississippi River and is just east of the University of Minnesota. “This sale includes a huge redevelopment site with lots of potential in the heart of a changing area,” Stokes said. “We enjoyed a competitive sales process for the site and are excited to see it utilized to its highest and best use in the near future. The future site use will benefit from proximity to both Minneapolis and St. Paul.” The buyer, Dominium, plans to raze the structures on the site and construct a multi-phase housing project with approximately 600 rental units over the next several years. “The redevelopment will complement our physically adjacent apartment com-
plex, the 808 Berry Street Apartments, which has shown us the exceptional strength of the housing market in the area,” said Neal Route, Development Associate at Dominium. “The new development will allow our residents easy access to the light rail and short commutes to both Minneapolis and Saint Paul. Dominium appreciates the assistance received from Cushman & Wakefield/NorthMarq throughout the acquisition of the site.” Among other notable developments nearby, the site is adjacent to a new office building by Sunrise Bank (under construction), and is just east of a new mixed-use apartment project including a Fresh Thyme Farmers Market and a mixed-use hotel project slated to include a Hampton Inn.
Knutson Celebrates the Grand Opening of the Hennepin County Library in Brooklyn Park Together, with the Brooklyn Park community, Knutson celebrates the completion of the new $23.5 million Hennepin County Library in Brooklyn
Park. The best value project began in April 2015 and has been a collaborative effort with HGA Architects and Engineers and Hennepin County. The new library replaces the original 1976, 15,000-square-foot library on Zane Avenue. Located on the northeast corner of 85th Avenue and West Broadway, the new facility is approximately 40,000 square feet and focuses on flexible space that maximizes library staff’s ability to create new areas for engagement and learning. The facility utilizes a raised access floor throughout a majority of the building, a new innovation designed for maximized flexibility. The access floor allows mechanical, electrical, and plumbing pipes to be placed beneath it avoiding the need to have ductwork and conduit overhead. There are also over 300 air diffusers in the floor that create an upward air flow to minimize sound and improve air quality. Though the library is a single story facility, it features three large vaulted ceilings and a massive vaulted “butterfly” ceiling in the entryway and south east portion of the building. The three
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areas create intimate settings separated from the main portion of the library. Spaces are defined by custom patterned carpet and furniture, and include the adult area – home to computer stations and a majority of the books and magazines; teen area – featuring technology stations, an eight foot tall glass magnetic marker board, and a sound proof production studio; and children’s area – showcasing a myriad of playbased spaces for children and families to engage in active learning. Pieces in the children’s area include the “Amazing Airways” (clear plastic tubing which blows air in various directions and creates a floating array of ribbons and foam balls), a giant light bright, a wooden play house, an insect microscope, and various toys. The library has seven private study rooms that are named after types of raw materials such as zinc, iron, slate. The rooms have custom patterned wall coverings that were inspired by various cultures around the world. The exterior of the building is just as unique utilizing an array of building materials, including hand chipped Vir-
ginia slate, custom metal panels, and stained cedar siding. The design also incorporates two pieces of public art, including: a hand welded steel bike rack representing an Ojibwa canoe and a large mural, which spans across two interior walls. The outdoor space features a community butterfly garden, donated by Knutson Construction and built by Autumn Ridge landscaping. "We see this new library as becoming a center piece for the Brooklyn Park community. The spaces, designed by HGA Architects and Engineers, are very unique and offer flexibility to ensure it’s an exciting place to continue to visit for years to come. We are extremely proud of the way it has turned out and what it will offer the community.” stated Lance Hornaday, Knutson Construction’s general manager. In addition to Knutson Construction and HGA Architects and Engineers, the Hennepin County Library project team included: Hennepin County, the City of Brooklyn Park, Muska Plumbing, Architect Mechanical, Preferred Electric, Superior Painting, Stern Drywall,
Sowles Steel erectors, Twin City Acoustics, Becker Brothers Flooring, Autumn Ridge Landscaping, Bartley Sales (access flooring), Woodside Industries, Life Saver Fire Protection, and Landscape Architect Damon Farber Associates.
New medical office building planned for Brooklyn Park The new multi-tenant, two-story MOB will expand access to healthcare for the community of Brooklyn Park and help provide a superior patient experience. Construction is scheduled to begin in early fall 2016 and be completed in spring 2017. PrairieCare, LLC, a leading provider of specialized psychiatric services for all ages, will occupy the full second floor of the building and serve as the anchor tenant. An announcement of a second national healthcare provider tenant is expected to be announced in the coming days, with an additional 11,300 square feet of space still available for lease.
Located in one of the Twin Cities’ fastest growing areas, the location has high visibility and easy access from the key crossroads of Highway 610 and Zane Avenue. Ryan and the City of Brooklyn Park have a long-standing partnership that has resulted in numerous successful developments, including Target Northern Campus, Hy-Vee, Olympus Surgical Technologies America, and others. Ryan is delighted to offer this premier Brooklyn Park location to medical service providers seeking space in this dynamic, growing suburb. Ryan is providing development, capital markets, civil engineering, construction, and management services; HGA Architects is providing design services; and the Welsh and Colliers International | Minneapolis-St. Paul team of Louis Suarez and Brian Bruggeman are providing leasing services.
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Kessler: Crowdfunding continuing to earn respect from commercial real estate investors by Dan Rafter
avid Kessler, national director for commercial real estate at accounting, tax and advisory firm CohnReznick, has studied the relationship between commercial real estate and crowdfunding carefully. He points to the old formula of supply and demand as one of the main reasons why crowdfunding has become such a viable option so quickly for commercial real estate investors. And he doesn’t see the growth of commercial real estate crowdfunding slowing anytime soon: The benefits of this way of investing in office, multifamily and other commercial buildings are just too strong. “On the supply side, you have a lot of sponsors who are looking to buy into commercial real estate,” he said. “They want to rehab these properties, create some value in them or develop a real estate project. They need the capital to do this. Maybe they don’t have enough access to capital from friends or family members. Maybe their deals are not
David Kessler large enough for the institutional investor or the private equity funds. But they can get this capital from crowdfunding campaigns.” That is fueling the supply side. And on the demand side? There are plenty of smaller investors who are eager to participate in the commercial real estate market, Kessler said. “People are seeing that they now
have access to invest in these real estate transactions that were out of their reach before,” he said. “A lot of the crowdfunding platforms have 10,000-plus potential investors, people who have logged onto their sites and looked at their deals and have been cleared as accredited investors. We are always hearing in the media about how great the returns are with real estate, while at the same time we’re hearing about how the stock market isn’t doing so well.” As Kessler puts it, why would you invest money in a CD and earn 1 percent when you can earn from 7 percent to 15 percent on a fairly safe real estate investment? Kessler said that crowdfunding works with all commercial property types, but that it works best with properties that are income-producing. “You always have risk when investing in commercial real estate,” Kessler said. “There’s the risk that you invest in properties and the tenant moves out. There’s the risk that a new building will open up across the street and everyone will move to that property
and leave yours behind. But the risks are definitely higher with development properties than they are with an income-producing property.” Kessler said that commercial real estate crowdfunding has come a long way toward earning respect from investors and sponsors in a short time. “When crowdfunding came out, no one thought it would work for commercial real estate,” he said. “They thought that commercial real estate was too sophisticated for crowdfunding. But not only is crowdfunding working, it is a viable solution for investors and sponsors.” The biggest trend now in real estate crowdfunding? Kessler said that institutional-quality investors, those who can access capital through private equity companies, life insurance firms and other traditional means, are now participating in crowdfunding, too. These investors aren’t turning to crowdfunding because they need to. They’re doing so because they recognize that crowdfunding is an efficient way to source capital to real estate projects, Kessler said
Minnesota Real Estate Journal
The Best Defense Is A Good Offense by Kristin Rowell, Esq. “On this team we fight for that inch. On this team we tear ourselves and everyone else around us to pieces for that inch. We claw with our fingernails for that inch. Because we know when add up all those inches, that’s gonna make the f***ing difference between winning and losing.” – Tony D’Amato in Any Given Sunday (1999) I think I love that quote because I love Al Pacino. And the movie Any Given Sunday. And the year 1999. On the other hand, I might really love that quote because it relates directly to my real estate practice. My partners and I are successful in the courtroom because we are constantly fighting for every inch. Those inches really do make the difference between winning and losing. And I love winning . . . I recently reviewed some of my personal real estate case successes and realized that in several instances, I successfully solved my client’s problem by taking my client out of the defense position and putting my client in the offense position, inch by inch, to achieve the win. Here are three examples. 1. The Carlyle: Don’t Slander My Title The Carlyle condominium building has maintained its status as one of the primary luxury condominium buildings in downtown Minneapolis for more than a decade. What many people do not know, however, is that a mechanic’s lien could have prevented the entire project. During the Carlyle’s development, a local man who fancies himself a real estate developer slapped a $1.3 million mechanic’s lien on the project claiming that it was his idea. We represented the developer of the Carlyle, and the client came to us because the lien halted development and the client needed a way to get out from under it. The client couldn’t wait for the mechanic’s lien process to play out, as that process is lengthy and would have taken at least a year or more to play out. Rather than allow our client to sit in the defense position and merely defend against the mechanic’s lien, we put our client in the offensive position – i.e. plaintiff – and sued the self-proclaimed developer under a unique and not-often used legal claim called “slander of title.” Not only did we win the case, but we also recovered all of our client’s attorney’s fees. The development moved forward as a result.
Kristin Rowell 2.Winning The Fight Over Bakken Oil Despite recent drops in oil prices, Western North Dakota has been experiencing an oil boom for more than a decade. One of my clients ran an oil transloading facility in the Bakken at the height of the boom. A dispute arose between my client and the property owner having to do with the number and volume of spills that took place on the property, and suddenly my client was forced to defend against a nearly $3 million claim. We took two offensive steps for this client: (1) we asserted a claim against the property owner for hundreds of thousands of dollars that were owed to my client under its contract; and (2) we brought in more than a dozen third-party defendants, nearly each of whom ultimately ended up contributing money toward settlement with the other side. The ultimate settlement of the lawsuit was a significant win for my client. My client got out from under a $3 million claim because we put the client in the offensive, rather than defensive, position. In fact, despite that my client was the one faced with the multi-million dollar claim, I was able to get my client paid the majority of what my client was owed. 3. Convincing The Jury That The City Was Wrong My client was a homeowner in the City of Minneapolis who was incorrectly cited by the City for an ordinance violation. The City refused to leave my client alone and threatened her with tax assessments and levies if she did not remedy the violation. Incredibly, the alleged “violation” was a broken, cracked, run-down retaining wall that was adjacent to the sidewalk along 48th Street in southwest Minneapolis. My client and I maintained from the very beginning that the retaining wall was the City’s responsibility, not my client’s.
Rather than sit around and wait for the City to start assessing her property and fining her significant sums of money, we stepped into the offensive position of plaintiff and sued the City. We were able to try the case to a jury – which was no insignificant feat considering that as a general rule my client’s claim (declaratory judgment) would not be one that would entitle the party to a jury. I knew my client would have the best chances of winning in front of a jury, so I came up with a creative argument for why my client should be allowed to try her claims to a jury, and it worked. The jury returned a verdict in my client’s favor, deciding that the City of Minneapolis was indeed wrong and that the retaining wall was the City’s responsibility.
Kristin Rowell is a trial lawyer and shareholder of the business litigation boutique law firm of Anthony Ostlund Baer & Louwagie P.A. in Minneapolis. Kristin represents companies and individuals in complex real estate disputes, closely-held company shareholder disputes, contract, and employment matters. Kristin regularly appears on behalf of her clients in state and federal courts in Minnesota and North Dakota, as well as other states. When she is not helping her clients solve their legal problems, you can usually find her running, strength training, spending time with family and friends, or volunteering for the University of Minnesota Masonic Children’s Hospital.
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The Condition of Business and Real Estate Asset Values By Robert J. Strachota, MAI, MCBA, CRE® Note: The following article is a presentation given by Shenehon President Robert Strachota at the Minneapolis Business Law Institute on May 2, 2016. I am Bob Strachota, president of Shenehon Company, which appraises businesses and commercial real estate throughout Minnesota and more than 40 other states. We know the pulse of the Minnesota business climate and are in tune with market expectations of the near future. Today, we will discuss the condition of the Minnesota business climate for commercial and residential real estate, and the general level of profitability for small and large businesses in our state. The Minnesota business climate has two major tiers: the 16-county Twin Cities metropolitan area, and the outstate Minnesota market. Rochester is an exception: an outstate city that behaves differently than all other outstate cities because of the effect of the Mayo Clinic. Nonetheless, we will keep Rochester in the outstate category because it is not nearly as strong as the 16-county metro area.
The general health of the Twin Cities market is positive, and the prognosis is for a continued upward trend. The healthy growth curve has not reached the crest of the wave or the high point of a business cycle. The same applies for the outstate market, but the size of the wave is much smaller. How do we know this? We typically focus on 6 critical community characteristics when sizing up the economic health of a market. They are: • Unemployment rate • Average wage level • Average age of population • Population growth • Employer and labor force data (new jobs) • Education level of workforce Characteristics gauging economic health in Twin Cities 16-county area: • Unemployment rate: 3.9% • Average wage level: $20.75/hour • Average age of population: 36.0 • Population growth: 4.3% from 2010 to 2015 • Employer and labor force data (new jobs): 1.8% • Education level of workforce: 24.2% with Bachelor’s degree Characteristics gauging economic health in outstate Minnesota:
• Unemployment: 6.1% (up twotenths over last year) • Average wage level: $17.35/hour • Average age of population: 41.8 • Population growth: 0.7% from 2010 to 2015 • Employer and labor force data (new jobs): 0.4% • Education level of workforce: 14.5% with Bachelor’s degree Comparing the 16-county metro area and the outstate statistics with statistics for the United States at large underscores the strength of the Minnesota market.
By analyzing data like this, we conclude that the Minnesota economy remains in an ongoing expansion, particularly in the 16-county metro area. As this recovery matures, inflation, high interest rates, and cost-push will tamp down the expansion. The risk of a Minnesota recession in the near term is low, and it does not appear that the recovery will be ending anytime soon. Why? Well, for one, the Minnesota economy is highly diversified. This is one of its strengths. Of the various market sectors, the energy industry was Values to page 16
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the only one that was a strong component of the recovery but has now sharply corrected. A handful of Minnesota companies took it on the chin when oil prices plummeted. The energy industry appears to be refreshing itself in recent weeks and may have already bottomed out. Currently, there are no storm clouds on the horizon for the Minnesota economy. These would appear if the economy showed evidence of “excesses” by consumers or businesses. On the consumer side, there is little evidence of excessive spending and, in fact, the household savings rate has risen to near record levels in Minnesota. Furthermore, household net worth is approaching record levels. As a result, household debt service ratios are near record lows. As for businesses, we do not see the kinds of excesses that typically reveal themselves ahead of a recession. Instead, we observe that most businesses are not overstaffed, and their capital spending has not been overdone. Average factory utilization rates have not exceeded 80%. The housing industry has not boomed out of control, and consumer confidence has been timid. And, lastly, excessive lending and overbuying is not evident in the mar-
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ketplace. Business has been good for most Minnesota companies. For 2015, the top 75 public companies operating in the state reported a combined increase of profit of over 5% from the previous year. This includes the energy-related companies that lost over $2 billion. The total revenue for these 75 companies was over $512 billion, which tops every year since 2004. Fifty of the companies on the list posted higher revenues than they did in 2014. These are impressive results, but there is one statistic that we need to be aware of. The list we could previously study was called the Top 100 Public Companies. A major reason for the list shrinking is that fewer companies are choosing to be headquartered in Minnesota. The trend is downward, but diagnosing the severity of the problem is difficult. At Shenehon, we also appraise many private companies. This gives us access to financial information that is not public. Right now, the patterns of success we have just reviewed for public companies are mirrored in the private sector. For small businesses specifically, we conduct valuations for federal government Small Business Administration (SBA) loans, and we can report that
small businesses are opening up at record levels, creating new jobs and becoming profitable on timely schedules. So how does the current state of the Minnesota economy affect real estate asset values? Let’s study this by submarkets, which are residential, retail, office and industrial. RESIDENTIAL The residential submarket has to be subdivided further into single-family homes and apartment rental housing. The single-family home market in the 16-county metro area has been strong and will continue to get stronger. Short sales and foreclosures no longer dominate the market and have fallen back to historical norms. The traditional home sale transaction dominates the market; both in the metro area as well as most outstate markets. Average home prices throughout Minneapolis rose 3.98% in February 2016, compared to a national average increase of 5.1%. New housing starts are steady and nearly fully restored to historical levels. The top cities in the metro area for new housing permits are shown in this next exhibit, with Lakeville leading in dollar value of permitted units, and Minneapolis leading in number of
housing units. The apartment market is expanding at a record pace, with apartment projects planned throughout the metro area. Outstate, we have over 1,000 new units planned in Rochester, coinciding with the Mayo expansion, and Duluth is way up as well – five developers have announced plans for a total of 577 new units planned for next year. RENTS AND VACANCIES Rents continue to rise, and vacancies have shrunk to abnormally low levels. Exhibit H shows average rents and vacancy levels in various areas in the 16-county metro area and certain outstate markets. There are two reasons why the rental market is so strong. First, many people lost money in the housing downturn and have chosen a different lifestyle while in recovery. Second, most young people are saddled with substantial educational debt that precludes them from buying homes, either single-family or condominiums. Many of us in the real estate industry believe the educational debt crisis will be the next financial debacle that the federal government will need to fix to return normality to the single-family home ownership market. Values to page 18
Page 18 Values from page 16
RETAIL Bolstered by a relatively modest rate of increasing personal income levels and lower fuel prices, demand in the national retail market outpaced supply during all of 2015. Demand for available retail space in the neighborhood community segment was particularly strong during the year. The average vacancy rate in the national retail market trended downward another 20 basis points in 2015, declining to the low 10% range. The national average net asking rates increased 2% during 2015. The first quarter of 2016 marked the fifth consecutive quarter of positive net absorption in the Twin Cities market. Across all Twin Cities submarkets the 1st quarter vacancy rate sits at a mere 6.0% and average net asking rental rates are $15.66/sf. The Minneapolis/St. Paul market experienced a moderate decline in asking rents during the first quarter of 2016. However, due to the number of new retailers and new restaurants entering the market, demand is expected to cause rents to increase in most submarkets. Market value of retail space has remained constant over the past year, but has now surpassed the
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all-time highs from before the real estate recession. Let’s move onto the office market. OFFICE Overall the office market has been affected by somewhat slower job growth, increased financial market volatility, and a marked slowdown in the tech sector. These influences contributed to a deceleration in the demand for office space in the first quarter of 2016. During that time, the average rent in 87 metro markets in the US was $28.50/sf. That was up 4.3% from the prior year. Overall, vacancy throughout the United States is 13.5% in the office sector. Current vacancy in the Twin Cities market is slightly higher at 15.1%, however that is down 1% overall from last year at the same time. It is important to note that the vacancy for office space in the new, north warehouse loop is 6.4%, that is less than half of the national vacancy percentage and it is the tightest office market in our metro area. In the Twin Cities, the average rent is $21.82/sf in the first quarter of 2016, which is up from $20.63/sf for a 5.8% increase from the prior year. Office values in the Central Business District, or CBD, are the strongest and have experienced an increase over the past
year. The suburban office market in the Twin Cities as well as other cities has remained rather static throughout the past year. INDUSTRIAL Our fourth submarket is Industrial. The manufacturing sector has improved in the first quarter of 2016. US factory activity expanded in March for the first time since last August. This is a sign that the nation’s economy is shaking off the effects of a strong dollar, depressed oil prices, and weak global growth. Current production has picked up, with factory orders rising to their highest level since November of 2014. All signs suggest there is a pickup in industrial production, yet businesses continue to work through the elevated stockpiles accumulated over the first half of 2015, when record inventories outpaced demand. There has been progress because inventories have declined in four of the past five months, with one exception being a flat reading in December. But despite these back-to-back inventory declines, the inventory-to-sales ratio remains elevated at 1.4 percent. This suggests that businesses will need to continue to work through the inventory overhang – which is hampering manufacturing and will curb GDP growth through the first half of 2016.
The average asking rent on a national basis in the first quarter of 2016 was $5.44/sf, which is 3.8% higher than the first quarter of 2015. The United States national average of vacancy for industrial space is 6.1%, which is down from the historical average rate of 6.8% in the first quarter of 2015. In the Twin Cities market, the overall vacancy for industrial space at the end of the first quarter of 2016 was 9.4% compared to 10.6% one year ago. The weighted average rent per square foot for industrial space in the Twin Cities market at the end of the first quarter of 2016 was $6.72/sf, which was up 6% from 2015 when it was $6.32/sf. At the end of the first quarter of 2016, approximately 900,000 square feet of positive absorption occurred in our industrial market. Over the last five quarters, the industrial market has absorbed 4.4 million square feet of space. This is a lot of data to crunch… suffice it to say that in my professional opinion, we can conclude from these numbers that, in the Twin Cities area, the industrial market is healthy and will likely only get stronger. During 2016, we expect to see an increase in market values or pricing of industrial space that will set new high Values to page 20
Page 20 Values from page 18
water marks for industrial property. Another proof point for this expectation is that the average price per square foot on a national basis increased 9.5% in 2015, which reaffirms the strength of the industrial market. LIST OF REAL ESTATE DEVELOPMENT and BORROWING OPPORTUNITIES FOR 2016 I would like to wind down by sharing a brief listing of real estate and development opportunities for 2016. Investment opportunities in gateway markets like the Bakken fields have come and gone. However, opportunities now exist in: • Technology Centers. Companies are collaborating on larger facilities with enhanced security to safeguard data and confidential records. • Neighborhood development. There is some small neighborhood development available for retail, such as coffee shops, small stores, and specialty services. Anything that starts with an “R” is a safe bet – renovation, rehabilitation, re-position, re-lease, refinance. • Residential condominium development. Opportunities exist in spot markets, such as downtown Minneapolis,
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where there is an acute shortage of “for sale” condominiums. But a 10-year clawback by homeowners is a deterrent. • Most Mixed-use urban infill development and redevelopment will be strong, if strategically located. • Prime retirement land. Development opportunities will be back as demand for retirement homes in warm places like Florida and Arizona reignites. BORROWING OPPORTUNITIES FOR 2016 • Last opportunities to lock down favorable long-term, fixed rate debt. Commercial mortgage-backed securities (CMBS) are back, the competition in the lending market is strong and interest rates are below long-term norms. Some owners are refinancing and leveraging up with cheap debt – in a sense, selling to themselves without paying income taxes by using nonrecourse debt. But the interest rates are rising and the time is limited to lock down favorable long-term debt. • Bargains in Downtown Minneapolis leasing. As Wells Fargo moves to new offices, look for bargain pricing on Class B office lease and subleases in the core of downtown Minneapolis.
MARKET PRICING FOR 2016 Before I close today’s presentation, I want to make a few cautionary comments about market pricing for 2016. Market pricing is strong across all submarkets; bargains can still be found in large, high-end luxury housing. There is a strong risk of overpricing in apartment buildings, while hotels are not far behind. The expectation of low capitalization rates, i.e. sub-6%, is not sustainable. Corporate balance sheets are strong and earnings are holding, but for foreign exchange issues for multinationals. Unemployment is tightening, but wage growth will be slow because the US competes in a world market of lower wage levels. MINNESOTA’S ECONOMY HIGHLIGHTS Closer to home, here are the takeaways for Minnesota’s economy: • Our state’s economy is growing ahead of national trends in the 16county metropolitan area, and ever so slowly in the outstate areas. • Minnesotans are back to work and consumer spending will continue to improve, due to increased “housing wealth,” a recovery stock market, and confidence from de-leveraging. • Minnesota businesses will postpone
spending and hiring decisions because of a lack of confidence in our current politicians and their strategies for government spending in the future. • The Minnesota economy will continue to recover, but it will not boom until the federal government restores confidence in the marketplace on key factors such as employment, inflation and bipartisan cooperation on balanced budgets and deficit reduction policies. And thanks to each of you for the opportunity to share my thoughts on Minnesota’s business climate for commercial and residential real estate, and the general level of profitability for small and large businesses in our state. Sources for this article: Standards & Poor/Case-Schiller, U.S. Census Bureau, Bureau of Labor Statistics, Jones Lang LaSalle, CBRE, Colliers International, Metropolitan Council, The Builders Association of the Twin Cities, Duluth News Tribune, City of Rochester Comprehensive Annual Financial Report, Northstar/MLS, NAI Everest, MPF Research, Zillow
Multifamily From page 1
for concern? This recent story by the Wall Street Journal suggests that there might be. The Journal story focuses on the spike in new apartment units in major cities across the country. This rising inventory is causing a slowdown in apartment rents in many of the biggest metropolitan areas in the United States, according to the story. The Journal reports that the annual rent growth for high-end urban apartments hit its peak of nearly 8 percent at the end of 2011. It has since slowed to just a bit more than 3 percent, according to numbers from MPF Research, a research firm that studies the nation's apartment market. The Journal writes that the slowdown in rent growth should only increase in the coming years. That's because in 25 of the largest U.S. cities, multifamily permits in urban areas had risen 39 percent in 2015 when compared with 2014, according to research by Zelman & Associates.
Minnesota Real Estate Journal
This increase in new supply might cause the owners of new buildings to offer increased concessions, such as a month or two of free rent to new tenants. At the same time, the owners of existing buildings might lower their monthly rents to compete. The developers working across the Midwest say that the apartment markets in their cities are still strong. And they're right: Urban areas in the Midwest are seeing a steady supply of new multifamily projects. The question that the Journal story raises, though, is a serious one, and it's one that CRE pros here have been debating: When do cities hit that point at which the supply of new apartments is too high for the demand for rentals? And when does an increase in supply begin hurting the owners of both existing and new apartment projects in the form of sluggish rent growth? No one knows when we'll hit that point. But the Journal story suggests that some caution is called for.
Zumper From page 1
areas. Check out the map above, provided by Zumper, for the median onebedroom apartment rents throughout the rest of the city. As the map makes clear, renting in Minneapolis is becoming a more costly proposition.
Blumberg From page 1
tic. And we are starting to see condos being built for sale that are exceeding even the rental values of new multifamily properties. That is exciting. That is a great strong market. The supply and demand right now is actually advantageous to more development and permanent financing. There has been a strengthening of the values when it comes to multifamily, and it is all about the values. I thought lenders might be concerned about possible overbuilding in this market. But the absorption in this sector has been incredible. There is trickle-down strength in multifamily even if you are not downtown. In Chicago, we see it all throughout the collar counties. There is a trickle-down of strength in the market. MREJ: What trends are you seeing in other commercial sectors? Blumberg: There arenâ&#x20AC;&#x2122;t that many new office buildings being built, but the ones that are being built are large projects. They are being built because they have already secured their big tenants. Even A-minus space will be priced differently now because of the new prices connected with A space. Consider a building like 111 S. Wacker in Chicago.
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That is a wonderful, modern building. But they are already redoing the common areas on the 10th and 11th floors. They have to upgrade to compete with what I think is an A building already. They have to do that to retain and regain tenants. MREJ: How about with industrial? How active is this sector when it comes to financing? Blumberg: Industrial right now is highly sought after by our lenders. Our lenders have a very big appetite for industrial. It has a lot to do, actually, with what is happening in the retail world and online shopping. The rise of online shopping increased the need for industrial properties. Companies need more industrial facilities located closer to more customers. When it comes to new development for industrial, the biggest trend now is an increase in properties that are purpose-built for certain users. That is the trend. MREJ: You briefly mentioned retail. How is that segment performing today? Blumberg: A lot of retailers are struggling. Everything is ordered online today. If you need to make an exchange, then you might go to the actual physical store. The need for physical locations is smaller today. Customer service has never been more important. There are
certain retail segments that are doing better. Health clubs are doing well. Many restaurants and lifestyle retailers are doing well. The discount centers are doing great. Home-improvement stores are still considered to be anchors. MREJ: NorthMarq Capital covers a large portion of the Midwest. When you look at financing requests, which Midwest markets, in addition to Chicago, are the busiest these days? Blumberg: There is strengthening in all of the Midwest markets in which NorthMarq has an office. We have offices in Chicago, Kansas City, St. Louis, Milwaukee, Minneapolis,
Cincinnati and Omaha. The downtowns of each of those cities have new development. One good sign is all the new hotels you are seeing in these markets. A lot of nice, affordable and boutique hotels are springing up. We are also seeing plenty of new restaurants and lifestyle retailers opening in the downtowns. I donâ&#x20AC;&#x2122;t have any negative cities in the Midwest right now. None of our offices are struggling. Itâ&#x20AC;&#x2122;s just a matter of how much new development there is.