Investor Demand Grows for Twin Cities Commercial Real Estate Investment Properties

• Ceiling on industrial rental rates giving way, bolstering property valuations
• Leveraged real estate investors feeling pinch from rising interest rates
• Big office deals simmering in Minneapolis, St. Paul CBDs

Rising Interest Rates Benefiting Institutional Investors

The Twin Cities continues to benefit from strong regional and national investor interest in owning commercial real estate assets in the office, industrial, retail and multi-family areas. First-half transaction levels, while steady, may not adequately reflect the continuing level of investor interest in this market. While demand remains strong for most property types, the number of available properties has receded somewhat—especially for retail and industrial assets.

On the buyer side for larger projects, institutional investors are both more active and more successful in winning deals over leveraged private investors. In a rising interest rate environment, the relative competitive advantage can shift to the well-capitalized equity investors such as pension funds, insurance companies and other large, low leverage institutional investors.

Treasury note yields increased more than 50 basis points over the first half, fueling interest on the part of leveraged investors to pre-pay existing higher-rate loans and lock in new financing. With 10-year Treasuries yielding approximately 5%, mortgage interest rates are 6.0% to 6.5% for borrowers with good credit—still relatively low by historical standards. 

Yields on institutional quality properties remain low, reflecting continued strong demand for real estate by large pension funds, insurance companies and other low leverage investors. Yields on more interest-rate sensitive properties are edging higher in some cases to reflect the higher cost of debt.

Retail Market: Investors Still Shopping for Twin Cities Retail

Investor demand for multi-tenant retail properties continues to outpace supply by a significant margin. Grocery-anchored retail centers remain the most desirable from an investor standpoint. However, there are multiple bidders for virtually every type of “core” retail property that comes on the market. Regional malls, with their ongoing operational and marketing challenges, remain something of a question mark to potential investors, however.   Read more

Industrial Market: Breaking Through the Ceiling on Rental Rates

Rising rental rates for industrial properties, driven by increasing land and construction costs, put a charge into the first-half investment market. Although still early, the evidence suggests that the market is beginning to accept rental rate increases over and above the sedentary norm for the previous 20 years. Investors are banking on higher rates, as valuations for industrial properties continued to increase during the first half.     Read more

Office Market: CBDs Seize the Spotlight

National institutional investors are taking a closer look at the Twin Cities office market, with an emphasis on expanded investment opportunities in the Minneapolis and St. Paul Central Business Districts (CBDs). While the quantity of investment transactions is likely to be down in 2006, the overall dollar volume is likely to be significant based on first-half indications.     Read more

The Outlook

Investment interest in Twin Cities commercial real estate is likely to remain strong throughout the balance of the year, regardless of where interest rates go. Even assuming continued upward pressure on interest rates, they will likely remain within the low end of the historical average. Higher rates may spur increased interest in owning real estate if there is a corresponding upward move in cap rates—although sellers may be more reluctant to sell properties at a price discounted to reflect the higher cost of capital.

Institutional investors will continue to seek to diversify their holdings into commercial real estate, with the Twin Cities drawing increased interest as a stable market with a growing, diversified economy and strong demographic base. Interest in retail properties will continue to expand as these national investors seek to further diversify their commercial real estate holdings away from over-weighted positions in office product. Demand for all types of industrial properties will remain strong, particularly bulk and office-flex product that is competitive with the pure office building market. Interest in office properties will likely increase during the next six months, driven by further evidence of improvement in the leasing market. New development will continue to be constrained by the high cost of new construction.

Investor demand for multi-family properties is expected to grow substantially, fueled by rapid improvement in market fundamentals.