2016 - Page 2 of 2

Real Estate Taxes: Calculation, Methodology and Trends

May 23, 2016/in Hot Topic /by Shenehon Company

By Wendy S. Cell and Robert J. Strachota, MAI, MCBA, CRE^®

Real estate taxes vary widely throughout the Twin Cities area for many reasons. The primary factors that determine property taxes are the tax levies of the district the property is in, the value of the property relative to the value of all other properties in the district, and the use of the property. Real estate taxes are calculated based upon the market value of the property. Market value is the probable price a property should sell for assuming the buyer and seller are well informed and neither is under duress. There is no direct relationship between estimated market value and property tax liability. Instead, the property’s taxable market value is used to determine how much property tax is due. If your property’s value increased or decreased, it may affect the amount of property taxes you owe.

Rising property values increase the proportion of your property’s value that is subject to tax and decreasing property values lower the taxable amount of your property. While property taxes are supposed to rise and fall with property values, it is common that even when the economy is down, property taxes may rise. If governmental spending is reduced, less money is needed from taxpayers, and property taxes might be reduced. Conversely, if spending is increased, taxes may increase. Other factors include voter-approved referenda, local government aid, value of other properties in the city, and value of properties within tax increment financing districts. Shown below is a summary of the taxable market value in Minneapolis from 2008 through 2016 and the effective tax rate for commercial properties from 2011 through 2016.

RE taxes chart 1

One could presume that values will continue to increase as new construction continues and new projects enter the market, and thus tax rates are likely to decline. However, the overall proposed Minneapolis property tax levy for 2016 will increase 3.4 percent over 2015. Property taxpayers in Hennepin County will see an increase of 4.48 percent in 2016 over 2015. These increases reflect demands for quality services provided to residents. Yet, not everyone’s property tax bill will increase by the same rate. As shown in the chart in the next column, prepared by the Minnesota Department of Revenue, the effective tax rate is usually between 3 percent and 4 percent for commercial property.

MN property taxes

Building owners often compare their real estate taxes to their competitors’ real estate taxes. They do this using a particular unit of comparison used by participants in the market, such as real estate taxes per unit, per door, or per square foot. While on the surface this practice seems reasonable, real estate
taxation is complicated, and as a result, this comparison should not be an owner’s primary benchmark. The assessor sets a market value on every property each year.

The assessor uses a mass appraisal process. As a result, assessors rely on general market data. Even though Minnesota statute requires the assessor to value each property on a fee simple basis (unencumbered with existing leases or assuming leases in place are at market levels), providing specific building information to the assessor may be useful in valuing a specific building. The actual performance of an income-producing property is typically more indicative of the property’s submarket. However, without the owner’s proprietary information, assessors have a diminished ability to account for differences within market sectors.

The Condition of Business and Real Estate Asset Values

May 20, 2016/in Economic Snapshot, Uncategorized /by Shenehon Company

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 two-tenths 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.

16 counties-outstate-US

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 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 marketplace.

Growth image

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.

IRS and Medtronic

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

residential sales

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.

homes prices

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%.

Building activity

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.

Top cities for building

projects under construction

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.

Twin Cities Apartments

Outstate Apartment market

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.

Student debt

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 1^st 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 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 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, 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 non-recourse 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 multi-nationals. 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 16-county 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

Industrial Market – 2015 Recap

March 28, 2016/0 Comments/in Economic Snapshot, Hot Topic, Uncategorized /by Shenehon Company

Demand

Posting positive demand for the 23^rd consecutive quarter in the fourth quarter of 2015, absorption in the national industrial market totaled nearly 220 million square feet during the year, with the pace of absorption increasing across most major markets. Several trends and factors are supporting strong demand in the industrial sector.

Most notably, e-commerce sale activity continues to increase at an impressive rate and companies are responding to consumer preferences by shortening the supply chain to deliver goods more quickly. Additionally, a number of coastal markets are also benefitting from the anticipated opening of the Panama Canal expansion. Given the changing landscape, demand in the industrial sector is projected to be healthy through at least the near and into the long term, and to a significant degree, a sizeable amount of absorption in the industrial sector will come at the expense of the retail sector.

Absorption in the industrial sector during the year was led by the logistics segments, though positive demand was also noted in the light industrial segments. Demand remains robust throughout all regions. The strongest absorption figures continue to be noted for logistics space in primary industrial markets, including the Atlanta, Chicago, Dallas-Ft. Worth, and Inland Empire markets. Absorption in the Midwest region is led by the Chicago market, followed by the Indianapolis, Detroit, and Twin Cities markets.

Led by demand for warehouse and distribution space, absorption in the Twin Cities industrial market totaled approximately 3.55 million square feet in 2015. The light industrial segment in the local market also was consistently healthy during the year.

New Construction

Led by growth in the logistics segment, new construction activity in the industrial sector increased at a rapid pace in 2015, with the amount of new distribution space added during the year particularly impressive. New construction deliveries involving logistics space, including both distribution and warehouse properties, increased by 2.5% over the year ended December 2015, while new construction in the light industrial segment increased by 0.2% during this period. Accounting for a significant portion of the sectors pipeline, speculative construction activity in the industrial sector has surpassed pre-recession levels, with sources indicating as much as 40.0% to 60.0% of new logistics properties under construction are being built as speculative projects.

Among regions, new construction activity is strongest in the West and South regions, but construction levels were also strong in the Midwest and Northeast regions. Over 20 million square feet of new inventory was delivered in the Inland Empire market during the year, while new construction added over 15 million square feet of space in both the and Chicago and Dallas-Ft. Worth markets. Despite widespread industrial construction activity in the Inland Empire market, the market’s vacancy rate decreased into the low-3.0% range at the close of 2015, down 80 basis points compared to the fourth quarter of 2014. In the Northeast region, developers continue to remain active in the Lehigh Valley market, with Liberty Property Trust construction a 1.7 million-square-foot distribution building for Uline and Duke Realty scheduled to deliver a 1.1 million-square-foot speculative building in 2016.

Development activity in the Midwest region was led by the Chicago market, but supported by widespread new construction in the Indianapolis, Kansas City, and Twin Cities markets. Although the pace of new construction activity in the Indianapolis market appears to be slowing, developers added nearly 6.5 million square feet of speculative space to the market over the last 18 months, adversely affecting occupancy levels in the face of healthy absorption figures. Developers added roughly 1.77 million square feet to the existing Twin Cities inventory in 2015. Development activity in the Twin Cities was strongest in the Southwest submarket, but developers are active throughout much of the area.

Vacancy

In the face of robust new construction activity, vacancies in the national industrial sector decreased by 40 basis points in 2015, declining into the mid-7.0% range at the close of the year. Vacancy rates in over 20 major markets have fallen below 6.0%, and on the national level, vacancy rates have declined by approximately 3.5% in the last five years. Occupancy levels in the light industrial segment noted the most significant improvement in 2015, but vacancy rates continue to remain tighter in the logistics segment, in spite of new development activity.

Occupancy levels further increased within most major markets. Vacancy rates remain tightest in the West region, but softer occupancy levels were noted within some markets in the region compared to the year prior. Occupancy levels in industrial markets throughout the Midwest largely remain strong, but a surge in speculative development is testing demand in several Midwestern markets. Vacancy rates in the Twin Cities market declined by a sizeable amount in 2015, and though excess capacity exists, noticeable improvements in occupancy levels were recorded in the Southwest submarket.

Asking Rent

Over 50.0% of major markets recorded year-over-year asking rent growth of greater than 3.0% in 2015, as rents increased at a robust pace in both the logistics and light industrial segments. Strong rent growth was noted across several Midwestern markets, and asking rents advanced across all submarkets in the Twin Cities industrial market, but the strongest growth was observed in the Southwest submarket.

Investment Activity

The industrial sector has emerged as a preferred asset type for institutional and foreign investors. Favorable investment returns and minimal capital expenditures compared to other asset types as well as the emergence of e-commerce have attracted investors to enter and expand their reach into the industrial market. Sales activity in the national industrial market increased by 44.0% year-over-year in 2015, with sales volume totaling nearly $72 billion for the year. Sales activity in the industrial market began the year at a robust pace, before reaching a lull in the second and third quarters of 2015, and then finished strong in the final three months of the year. Sales volume in the light industrial segment increased by approximately 30.0% year-over-year in 2015, but activity in the light industrial segment remains overshadowed by investment in logistics space.

Industrial assets have become a favored property type among foreign and institutional buyers, resulting in stronger pricing and capitalization rate compression. The average sale price on a per square foot basis in the national industrial market increased by 9.5% year-over-year in 2015, while average capitalization rates in the sector decreased by 40 basis points during the year. Prices increased in both segments of the industrial market, with the average price per square foot in logistics approaching $70 per square foot and surpassing the $80 per square foot in the light industrial segment. Capitalization rates in both the logistics and light industrial segments compressed at a similar rate during the year, and private investors in the industrial sector remain aggressive in underwriting rents and vacancy.

Some concern in the national industrial market, and in the broader commercial real estate market, is the greater amount of portfolio and entity-level transactions. Three massive sales accounted for over 20.0% of all industrial sales volume in 2015. Exeter Property Group sold a 57.9 million-square-foot industrial portfolio for $3.15 billion in December of 2015. Earlier in the year, Global Logistic Properties and Singapore’s sovereign wealth fund completed an $8.1 billion purchase of IndCor Properties industrial assets and operating company from Blackstone, while Prologis and Norges Bank Investment Management purchased a portfolio from KTR for $5.9 billion. The KTR portfolio contained 60 million square feet of operating space, 3.6 million square feet of space under construction, and a land bank with a build-out potential of 6.7 million square feet.

A number of large single-property sales also occurred during the year, with a significant amount of activity noted in the Midwest region. Two of the largest single-property transactions at the national level in 2015 involved Duke Realty selling a mission-critical building leased by Amazon in Delaware for $91 million, equating to approximately $89.50 per square foot, and the sale of a newly-built Home Depot Fulfillment Center in Ohio for $97 million or $59.20 per square foot.

Mirroring trends at the national and regional levels, industrial investment activity in the Twin Cities was strong in 2015. Several large portfolios in the Twin Cities market were sold during the year, but sales velocity drove sales volume in the local market and investment activity in the local market was consistent throughout the year, with healthy activity noted across all segments and submarkets. One of the largest transactions in the Twin Cities market during the year included the sale of the BAE building for $46.8 million to Gramercy Property Trust in July.

Retail Market – 2015 Recap

March 21, 2016/0 Comments/in Economic Snapshot, Hot Topic /by Shenehon Company

Demand

Bolstered by a relatively modest rate of new construction activity, increasing personal income levels, and lower fuel prices, demand in the national retail market outpaced new supply in all four quarters of 2015, as positive absorption across all property subtypes facilitated improving market fundamentals. Demand for available retail space in the neighborhood/community segment was particularly encouraging during the year. As evidenced by healthy retail sales figures in spite of declining foot traffic and shrinking footprints among big-box retailers, the emergence of e-commerce continues to impact absorption levels in the retail market.

Absorption in the retail market also remained positive across all regions in 2015. From a year-over-year perspective, absorption in the national retail market was strongest in the South region, with the Dallas-Fort Worth, Atlanta, Raleigh, South Florida, Austin, and Orlando markets absorbing excess capacity at the most robust rates. Absorption was also strong in the West region, particularly in the Bay Area markets, with the Phoenix and Las Vegas markets also recording significant improvements in demand for retail space. Although remaining positive for the year, the pace of absorption in the Northeast region appears to be slowing.

Absorption in the Midwest region continued to gather momentum during the year, but absorption figures in the Midwest region remained more modest from a national perspective. Bolstered by competition in the grocery space for market share, the pace of absorption in the Twin Cities retail market increased during the year. Absorption in the Twin Cities market was strongest within neighborhood centers in 2015, with the Northeast submarket logging the most robust demand.

New Construcation

Although new development in the retail sector remains modest relative to historical norms and other property types, construction activity accelerated slightly in 2015 compared to recent years, though a noticeable divergence in activity among retail segments exists. New construction levels of power centers are considerably lower than in previous cycles, while construction activity for grocery-anchored community/neighborhood centers has regained momentum, indicating an improving outlook among smaller retailers.

Development activity also remains bifurcated by location. In contrast to recent cycles, in which developers were chasing rooftops into outer ring suburban and exurban locations, a greater amount of new retail development is occurring in the nation’s urban core, with developers targeting infill sites in walkable and transit-oriented locations.

Among regions, new retail construction activity is strongest in the South region, followed closely by the Northeast and West regions. The amount of new inventory added in the Orlando retail market doubled in 2015 compared to the year prior, with the pace of new construction expected to further increase in 2016.

New retail development remains relatively muted in the Midwest region, but was supported by healthy activity across a number of markets in 2015, including the Kansas City, Detroit, and Indianapolis markets. Retail construction levels remain consistent in the Twin Cities market, and mirroring trends observed at the national and regional levels, a majority of new construction in the local market consists of grocery and grocery-anchored neighborhood space. In contrast to trends observed at the broader levels, however, retail development activity in the Twin Cities market remains healthy in outer ring suburbs, including Woodbury and Plymouth.

Vacancy

Aided by modest new construction activity, the average vacancy rate in the national retail market trended downward by another 20 basis points in 2015, declining into the low-10.0% range at the close of the year. Occupancy levels within the retail sector continue to be highly bifurcated by location, with properties in strong locations within good trade areas thriving and properties in weaker trade areas struggling to regain momentum.

Retail occupancy levels are highest within the West and Northeast regions, though several markets in the South region demonstrated the most substantial improvements in occupancy levels compared to the prior year. In spite of an aggressive pace of new construction and the downturn in the energy industry, retail vacancies decreased in the four largest markets in the state of Texas. Developers delivered nearly 4 million square feet of retail space in the Dallas-Ft. Worth market in 2015, yet occupancy in the market reached the highest levels recorded over the last 10 years.

Vacancies in the Midwest are strongest in the Columbus market, yet the biggest improvement in occupancy levels within the region was recorded in the Detroit market. Retail vacancies declined in the Twin Cities market during the year, and despite healthy demand for neighborhood centers, occupancy levels remain strongest at regional and super regional centers. Among submarkets in the Twin Cities area, retail vacancies are tightest in the Southwest submarket, but encouraging demand, led to the most impressive gains in occupancy levels within the Northeast submarket.

Asking Rent

After advancing by 1.0% in 2013 and 1.7% in 2014, asking rents in the national retail market increased by 2.0% over the year ended December 2015. Led by rent growth in excess of 5.0% within the San Francisco, Orange County, Los Angeles markets, the strongest rent growth within the retail sector was noted in the West region during the year, followed closely by the South region. Rent growth within the Northeast region was relatively tame in 2015, decelerating slightly during the course of the year, while rent growth remained generally subdued in the Midwest region. Rent growth in the Midwest region was led by the Indianapolis, Kansas City, and Milwaukee markets, with asking rents also advancing in the Twin Cities market.

Investment Activity

On a per square foot basis, property prices in the national retail sector increased by approximately 2.5% year-over-year in 2015, as capitalization rates trended downward by 30 basis points during the year, yet overall sales volume in the national retail market decreased to $82.5 billion in 2015, down 5.0% compared to the year prior. Accounting for approximately 19.0% of all sales activity among the four major property types in 2015, sales activity in the retail sector was strong in the first quarter of 2015 and then tapered off in the remaining three quarters of the year.

Investor interest in the retail sector remains strong for single-tenant net lease assets, with particularly strong competition among buyers for available drugstore and quick-service restaurant assets. Transactions involving net lease drugstores selling for more than $10 million totaled at least 14 in 2015. Five of the 14 sales transactions over $10 million involved net lease drugstores that also sold for more than $1,000 per square foot. The largest net lease drugstore sale transaction during the year involved a 16,000-square-foot Walgreens located along The Strip in Las Vegas. Built in 2000, the property is located along Las Vegas Boulevard, just north of the Wynn and Encore and across the street from the planned World Resorts Casino. Equating to over $2,300 per square foot, the property sold for $37 million in October 2015.

In addition to strong interest for single-tenant net lease assets, investment activity in regional and super regional malls accelerated during the course of 2015, as investors demonstrated renewed interest in obtaining large retail assets in some of the markets hit hardest by the subprime crisis. More specifically, investment interest in larger retail assets increased within the Atlanta, Las Vegas, Phoenix, and South Florida markets. Kimco Realty Corporation purchased the 850,000-square-foot Christown Spectrum Mall for $115.25 million in November 2015. Additionally, a joint venture purchased the Tempe Marketplace in October 2015 for $367 million. Located along the 202 corridor in the city of Tempe, Arizona, the Tempe Marketplace is an expansive open-air super regional mall that is situated in close proximity to the main campus of Arizona State University and Marina Heights.

Further demonstrating improvements in the regional and super regional mall segments, Taubman Centers and Macerich announced an agreement to purchase Country Club Plaza just after the close of 2015. Located approximately four miles south of downtown Kansas City, Country Club Plaza is a 15-block, mixed-use development containing 1.3 million square feet of retail and office space. A sale transaction closed on the property later in the first quarter of 2015 for $660 million. Additionally, MGM Resorts International has reportedly reached an agreement to sell the Shops at Crystals mall to group led by Simon Property Group for $1.13 billion.

Sales volume in the Twin Cities retail market increased by 20.0% in 2015 compared to the year prior. One notable transaction during the year included Heitman purchasing the former Knollwood Mall in St. Louis Park for $106.7 million. Situated along Highway 7, just east of Highway 169, the property has undergone the transformation to a grocery-anchored community shopping center.

Economy Market View – 2015 Recap

March 17, 2016/0 Comments/in Economic Snapshot, Hot Topic, Uncategorized /by Shenehon Company

According to the latest Beige Book, seven of twelve Federal Reserve Districts, including the Minneapolis District, reported increasing economic activity. Economic activity in four of the remaining five districts was noted as mixed or flat, with economic activity declining in the Kansas City district, due to weakness in the energy and manufacturing sectors.

Construction, business investment, and consumer spending continue to take on leadership roles in driving the domestic economy, while global economic concerns as well as conditions in the oil and gas industry and manufacturing sector continue to serve as drags on more robust growth. Fostering growth in the construction sector, the pace of homebuilding has begun to accelerate and commercial construction activity remains strong across numerous major markets. Business investment and consumer spending levels also remain encouraging; with conditions in the labor market continuing to tighten.

The energy industry continues to be hamstrung by a glut of supply and tepid demand, resulting in lower commodity prices. In the state of North Dakota, the number of active drilling rigs has fallen to the lowest levels observed since 2009. Spot prices for West Texas Intermediate and Brent crude both declined by over 30.0% in 2015, putting significant pressure on producers, with retail gasoline prices falling by roughly 26.8% providing considerable relief to consumers and supporting healthy retail sales.

Although the overall economy expanded for the 81^st consecutive month in February 2016, activity in the manufacturing sector contracted for the 5^th consecutive month in this period, yet nine of 18 manufacturing industries continued to report growth. According to the latest ISM Report on Business, the manufacturing sector showed some improvement in February of 2016 compared to year-end 2015, but the Purchasing Manager’s Index (PMI) remained below the pivotal 50.0% mark. The PMI registered 49.5% in February 2016, up from 48.0% in December of 2015, but down from 52.9% recorded in February 2015.
A strong dollar and the downturn in the oil and gas industry are also adversely affecting conditions in the manufacturing sector, with choppy and uneven results recorded across the manufacturing sector during the year. Manufacturers that rely on oil as an input cost have fared relatively well, while companies that provide goods to oil and gas companies have suffered. All segments in the manufacturing sector, however, have been impacted to varying degrees by the strength of the dollar, as international export levels at several major ports have sagged.

Several other economic indicators remain mixed. Activity in the non-manufacturing sector increased for the 73^rd consecutive month in February 2016, with the Non-Manufacturing Index (NMI) standing at 53.4%, yet the most recent NMI readings have fallen below the rolling 12-month average of 56.6%. After falling by 0.3% in December 2015, the Conference Board Leading Economic Index also slipped another 0.2% to 123.7 in January 2016. In spite of rising concerns, most economic indicators continue to signal modest economic expansion in the months ahead.

National Employment

While representing a slight deceleration from the 2.2% increase recorded in 2014, non-farm employment at the national level increased by 2.0% year-over-year in December 2015 on the net addition of over 2.7 million jobs. Employment growth in the service-producing sectors increased by 2.1% over the year ended in December, up from 1.9% posted 12 months prior. The goods-producing sectors also noted improvements, but the pace of growth decelerated from 2.9% in 2014 to 1.0% in 2015. Marking the second consecutive year of positive, albeit modest, improvements, headcounts in the public/government sector increased by 0.5% in 2015, on par with the growth recorded one-year ago. The following chart presents non-farm employment growth at the national level.

Facilitated by employment growth, the national non-seasonally adjusted unemployment rate decreased to 4.8% in December 2015, remaining unchanged compared to the month prior, but down 60 basis points from 5.4% recorded in December of 2014. Tight conditions in the construction sector are creating significant upward pressure on skilled labor wages, yet wage growth remains uneven across employment sectors.

Conditions in the labor market are healthy in the majority of major markets. Non-farm employment increased by over 3.0% annually in 18 of the largest 84 metropolitan areas during year, with 16 of the 18 markets also boasting unemployment rates below 5.0%. The pace of job growth remains strong across a number of markets in the West region, but hiring activity continues to gain momentum in several Midwestern markets.

The following tables present the nation’s top 10 leaders and laggards in unemployment rates and employment growth.

Leading non-farm employment growth in the Midwest region were the Sioux Falls and Grand Rapids metropolitan areas, which witnessed year-over-year employment growth of 4.1% and 3.8%, respectively. Non-farm employment in the Twin Cities metropolitan area increased by 1.8% year-over-year in 2015 on the net addition of approximately 34,000 jobs. Job growth within several of the Twin Cities largest employment sectors, including education/health services, professional/business services, and financial activities, remained particularly encouraging, though the strongest growth was within the leisure/hospitality sector during the year.

Unemployment rates within 68 of the largest 84 metropolitan areas were below 5.0% at the close of 2015. Labor markets are tightest in the Midwest region, with seven of the largest metropolitan areas enjoying unemployment rates at or below 3.5%. The non-seasonally adjusted unemployment rate in the state of Minnesota stood at 3.6% in December 2015, unchanged compared to the year prior, but up 60 basis points compared to 3.0% posted in November of 2015. Labor markets in most Minnesota metropolitan areas remain relatively tight. Unemployment remains lowest in the Mankato area (2.5%), followed by the Rochester (2.9%) and Twin Cities (3.1%) areas, while unemployment stands above the statewide rate in the St. Cloud (3.7%) and Duluth (5.5%) areas.

For-Sale Residential

Sales activity and prices increased by sizeable margins in the national for-sale residential market during the year. Existing home sales activity increased by 6.3% in 2015, compared to a decline in 2014, while the pace of new single-unit home sales advanced at a more rapid rate, increasing by 14.6% in 2015. Activity within both the single-unit and multi-unit segments also showed improvement, as renewed demand continues to build for townhome and condominium product. In turn, the national median home sale price increased by 6.9% in 2015, rising from $208,400 to $222,700 during this period.

Among regions, pricing increases in the for-sale residential sector were led by the West region, which witnessed the region’s median home sale price increase to $323,600 at the close of 2015, up 8.4% compared to the year prior. In the West region, the for-sale residential sector remains strong across most markets, with an aggressive pace of growth recorded in the Denver, Portland, and Seattle markets during the year. In the Denver market, the median home sale price has increased by over 20.0% within the last 24 months. Sale prices also are rising at a robust pace in markets hit hardest by the subprime crisis, with the median sale prices increasing by at least 9.0% in the Las Vegas, Orlando, and Phoenix markets in 2015. Although noting significant upward pressure in 2015, for-sale residential product remains a relative bargain in the Midwest region, with a median home sale price standing at $171,600 in the fourth quarter of 2015, nearly 20.0% below the national average.

Progress continues to be noted within the for-sale residential sector in the Twin Cities market. Increasing from approximately 49,600 in 2014 to 56,390 in 2015, the number of closed home sale transactions in the Twin Cities market increased by 13.7% over the year ended December 2015. Indicating healthy demand, the average days on market decreased by 2.6% and the percentage of original list price received increased by 1.0% during this same period. Due to stronger competition among buyers, the median home sale price in the Twin Cities metropolitan area increased by 7.0% over the year ended December 2015, increasing to $220,000 at the close of the year.

Construction

Employment growth and progress in the for-sale residential sector have supported a more optimistic outlook from homebuilders, and confidence among homebuilders rose to the highest levels in more than a decade in 2015. The National Association of Home Builders/Wells Fargo Housing Market Index increased to 60 in June 2015 and remained at or above that level through the close of 2015.

Both commercial and residential construction activity remains strong in the Twin Cities market. In the city of Minneapolis alone, construction permits were issued for development projects valued at nearly $1.4 billion in 2015, marking the fourth consecutive year of over $1.0 billion in permitting activity. Construction is scheduled for completion on the new Vikings Stadium and massive Downtown East project in 2016, yet a number of significant development projects remain in various stages of the construction pipeline throughout the region that will support healthy activity into at least the intermediate term.

Apartment Market

Facilitated by healthy employment growth and favorable demographic trends, the apartment market continues to remain strong at the national, regional, and local levels, in spite of a wider new construction pipeline. Asking rents at the national level continued on an upward trend in 2015, marking the 6^th consecutive year of asking rent growth in excess of 2.5%, while vacancy rates in the national apartment market remained essentially unchanged. Conditions in the Midwest regional and Twin Cities apartment markets closely mirrored trends observed at the national level, as underlying fundamentals and investment activity remain strong.

Sales volume in for 50+ unit apartment properties in the Twin Cities market increased by approximately 6.4% over the year ended in December 2015, reaching nearly $900 million during the year. Apartment pricing in the Twin Cities market also continued on an upward trend during the year, and the average price per unit in the Twin Cities market increased by 32.0%, rising from $112,850 in 2014 to nearly $150,000 in 2015. Upward pressure on pricing in the Twin Cities market has been supported by a greater composition of sales activity involving newly built Class ‘A’ properties in the region’s core.

Notable transactions in the Twin Cities market during the year involved several Class A buildings in the core of Minneapolis, including 222 Hennepin, The Paxon, and The Walkway. These three transactions combined to account for approximately 22.0% of sales volume involving 50+ unit properties in the Twin Cities market in 2015. Several large suburban apartment assets also traded in 2015. Valley Creek Apartments, a 402-unit apartment property in Woodbury, sold as a value-add property for $54.25 million in May of 2015, after selling for $33 million five year prior. Sales activity involving small- and mid-size properties also remained healthy through 2015.

CRE Market

Fundamentals across the industrial, office, and retail sectors also continue to demonstrate improvement, with the most robust growth recorded within the industrial sector. Led by demand for logistics space, market conditions in the industrial sector at the national, regional, and local levels continued to improve in 2015, with strong absorption figures driving vacancy rates lower and putting upward pressure on asking rents. Absorption in the office sector has been supported by a more intense pace of employment growth within the traditional office-using employment sectors. Vacancy rates in office sector continue to trend downward, putting upward pressure on asking rents. In spite of the rise in e-commerce and the pursuit of smaller footprints by retailers, the retail sector also noted positive absorption in 2015. Combined with a more restrained pace of new development activity, demand for retail space facilitated improvements in occupancy levels and asking rents.

Fueled by improving to strong underlying fundamentals, the availability of low interest rate financing, and attractive yields relative to alternative investments, investment activity in the commercial real estate market remained strong in 2015. Sales volume for property and portfolio sales of more than $2.5 million increased for the 6^th consecutive year in 2015, with sales volume increasing on a year-over-year basis in three of the four major property types. The strongest year-over-year growth in sales volume was recorded within the industrial sector, yet overall sales volume continued to be led by the apartment and office sectors. The following chart presents national sales volume in the four major property types for property and portfolio sales of greater than $2.5 million.

For additional details on the performance of the national, regional, and local commercial real estate markets, please see our 2015 property sectors recaps at www.shenehon.com

Data referenced in this report was current as of March 7, 2016, and includes preliminary employment numbers as reported by the Bureau of Labor Statistics, which are subject to revision.