Class A offices see uptick in vacancy, report says

Office vacancy rates continue to differ wildly depending on submarket, according to a second-quarter report on the Twin Cities office market released by Colliers. Minneapolis and St. Paul’s downtowns sit at a combined vacancy rate of 22.3% while the suburban vacancy rate sits at a combined 11.1%.

The report, released Tuesday, also heralds a “pronounced” rise in vacancy among Class A buildings, which increased 17.7% year-over-year. Rent for Class A buildings has consequently fallen from a peak of $36.34 per square foot in the third quarter of last year to $34.64. Rents are down 8% year-over-year.

Class A asking rates for the Minneapolis CBD and St. Paul CBD are $31.32 and $26.39, respectively.

The overall second-quarter vacancy of the Twin Cities metro sits at 14.8%, compared with 13.3% this time last year, the report said. The net absorption was negative 443,000 square feet. There are 35,700 square feet under construction.

Michael Gelfman, an executive vice president for Colliers, said companies have continued the downsizing process and landlords have continued to compete against one another to try and win over tenants. Even well-occupied buildings are struggling, he said, which reflects how the buildings were underwritten during the pandemic.

“Many of these buildings, Class A buildings have been taken to the market over the last 12 months and to the best of my knowledge, none of them have traded,” Gelfman said. “And that just goes to show you that the numbers are not penciling out for buyers.”

Peter Loehrer, a senior associate for the Colliers Capital Markets team said buildings returning to lenders is certainly a possibility and that it is likely to happen to some buildings. However, Loehrer said that both parties in the deal lenders and building owners have incentives to figure out something “before the bank takes back the keys.”

But buildings returning to lenders and being sold for less could have a potential good outcome for Minneapolis, Loehrer said.

“As painful it is in the moment when values get written down and a new owner or new equity group or new lender takes control or all three that’s a huge net positive for the city of Minneapolis and the tenants of Minneapolis,” he said. “The new owner can start to renovate and otherwise put more money into the building.”

Gelfman said he is worried about Class B buildings, however, saying the submarket is facing an existential crisis. According to the report, the second quarter saw around 13 million vacant square feet, more than the vacant square feet for Class A and Class C buildings combined.

“We have far too much and there’s only so much that can be repurposed for other uses,” Gelfman said.

Because there’s not much that can be repurposed, Gelfman said, some of the properties will be only worth the land value, but high interest rates have slowed the razing and building process.

“We’ve seen a huge slowdown, even within the multifamily world, where functionally obsolete office buildings have been knocked down for something else,” Gelfman said. “I think that will heat up again once interest rates decline.”

On the other hand, the capital markets saw $67.8 million of office product trade hands during the second quarter. This was led by the $60.7 million purchase of the Blue Cross Blue Shield building in Eagan by Colorado-based Real Capital Solutions. According to the report, this property was “sold with plans for partial industrial redevelopment.”

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