State of the Real Estate Market

by Robert Strachota and Ellis Beck

Over the past year, we have seen continued growth in real estate. Here is a breakdown by market type.

Single Family Residential

Determining what is normal in these abnormal times is a challenging proposition. Pending sales contracts of single-family homes were up 0.8% from November 2020 and up 15.9% from November 2019. Over the last decade, home prices might have increased in the range of 3% to 5% per year. Year over year increases over the past 12 months show an increase of 8% to 9%. The median sale price of a home that sold in the 16-county Twin Cities region from November 2020 through November 2021 was $340,000. The average home sat on the market for just 27 days, and there is no indication that the spring 2022 market will bring relief for buyers.

Apartments

The apartment market seems to be returning to its pre-pandemic trend of growth at a slower pace. Rent increases this past summer were flat but now are edging up again. However, suburban rent hikes largely exceeded those of the urban submarkets. At the end of 2021, trailing 12-month net deliveries are near an all-time high, with approximately 12,000 units currently under construction. Metro-wide occupancy is near 95%, which for most of us reflects a balanced rate for a long-term investor. The slowdown in renter demand in the Minneapolis city core, and St. Paul, will most likely continue moderate rent growth for the foreseeable future. Concessions and other incentives should remain common through early spring 2022. Twin Cities rental growth is currently 3.6%, exceeding the area’s five-year average yet trailing national markets.

Hotels

Unfortunately, business travelers are not back; the leisure traveler has the travel bug. Explore Minnesota has found that people are ready and willing to engage in leisure travel this winter. Roughly 82% of surveyed Minnesota travelers planned domestic U.S. trips this winter. Approximately 50% plan to visit destinations more than 500 miles from home, and approximately 48% of those surveyed are planning trips that include time in Minnesota. Generally, travelers expect pre-pandemic levels of customer service, product quality, and pricing. For those who will not be traveling, COVID-19 is the top reason for not planning to travel in the next six months. Obviously, new variants of COVID-19 and restrictions surrounding them are the wild card in any projection of the future of the local hospitality market. The downtown hotel market is struggling as reflected by recent sales of the Marquette and Westin hotels. The Marquette traded at a loss of $14 million from the 2016 acquisition price of $74.5 million, a 19% loss. And the Westin, which sold for $66.4 million in 2015, sold for just $47.2 million in October, a 29% loss.

Manufacturing

Minnesota has over 8,300 manufacturers making a wide range of products. Manufacturing is growing in Minnesota with employment in this sector rising over 11% since 2020. Real estate used for manufacturing is not constructed on a speculative basis. Usually, a manufacturing facility is built for a specific user. When that user grows and needs a new building, they leave behind a second-generation manufacturing building that is available for a startup. The opportunities to build new manufacturing space and the availability of second-generation space are balanced in terms of supply and demand. Numerous government incentives supplement all manufacturing startups. In summary, Minnesota manufacturing has strength in a broad range of industries. It has momentum to grow, but there is an acute shortage of workers that will keep the lid on expansion for the near term.

Warehouses

There appears to be no end in sight for the industrial warehouse boom. Despite clogged supply, demand for major distribution facilities and warehouses seems to be “off the charts” in the Twin Cities. Other regional hubs like Dallas, Atlanta, Chicago, and Denver are experiencing the same shortages of space.

The pandemic has accelerated the already growing trend of e-commerce. Some call this the Amazon Effect. To manage growth, businesses of all types are leasing space to store more inventory and reduce reliance on material supply flows. Despite rampant new development, record-setting demand has kept the Twin Cities vacancy rate below 4% for 22 consecutive quarters. The strongest performing industrial market in the Twin Cities is the Northwest submarket.

Retail Malls

Considering the economic damage brought on by the one-two punch of the pandemic and civil unrest, the Twin Cities retail market has been somewhat resilient in the past two quarters. The retail sector is made up of several submarkets, such as malls and big box stores. In the Twin Cities, these markets make up 29,700,000 square feet. There is virtually no new construction, and there won’t be for many years. These sectors are plagued by big box store closures and bankruptcies of numerous tenants. Most landlords have sued dozens of tenants for overdue rent in 2021. All malls continue to see foot traffic down compared to pre-pandemic levels. Even the metro’s “best in class” malls are suffering from the pandemic’s impact. Older malls and areas with below-average demographics are having the most difficulties backfilling large scale vacancies. Reported vacancy rates for market power centers are in the 11% to 12% range. It is likely that the vacancy rates reflect the occupancy level but not the amount of rent being paid; we at Shenehon believe that landlords may only be collecting 80% of all rent due. Rental rates in these sectors have been flat at $20 to $30 per square foot plus operating expenses, and they will not show any meaningful increase for the next one to two years. For malls in particular, creativity is the theme as landlords and developers will reconfigure and redevelop obsolete or underperforming retail spaces. The goal of the creativity is to explore unique venues that will draw traffic and again engage the consumer’s interest. Despite the e-commerce expansion, most retailers are confirming their commitment to brick-and-mortar retail.

Community Strip Centers

Community Strip Centers have not received the same amount of negative pressure from COVID-19. While the pandemic nearly gave the malls and power centers the “knock-out punch,” certain retail segments (i.e. grocers, pet supplies, coffee, sporting goods, alcohol, discount clothing, and home improvement supplies) were propelled by the pandemic. How many of you wait in drive-through lines for your Starbucks or Caribou coffee? Most of us, even at the height of the pandemic, were visiting our community/neighborhood strip centers with more regularity than in pre-pandemic times because we were not traveling out of town. As with anything, there are exceptions to this rule, with restaurants being the biggest example. It is anticipated that restaurants will likely be the area of this sector to recover.

TC Office Market

The Metropolitan Twin Cities downtown office market, which is composed of 46,100,000 square feet, reached an all-time high vacancy rate in the third quarter of 2021. This 46.1 million square foot market includes all Class A, B, and C buildings. Think of the total office space as the equivalent of 30 IDS buildings in a row. The current vacancy rate as of January 1, 2022, is 14.3% of all space, or 6,700,000 square feet. This is as if we had four and a half empty IDS buildings. While we have not returned to pre-pandemic levels of downtown office vacancy, we are seeing improvement.