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The
Paradox of Plenty in Today's Real Estate Investment Market
By: Boyd B. Stofer
Chief Executive Officer/President-United Properties
With
market fundamentals at their weakest point in more than a decade, history
suggests that the Twin Cities office and industrial investment real estate
markets should be at crisis stage by now. Instead, we have the apparent
paradox of a vibrant investor market in which property values of
well-leased investment property are actually holding up surprisingly well,
in the face of troubling market vacancies.
“OVERALL INVESTOR INTEREST IN REAL
ESTATE REMAINS VERY HIGH, ESPECIALLY FOR HIGHER QUALITY MULTITENANT
PROPERTIES OF ALL TYPES…”
Credit the low interest rate
environment for helping support the foundation of the real estate market
through unsteady times. Even
though their rental income levels may have fallen and vacancy may be high,
many property owners are still able to achieve single digit returns on
their holdings after servicing debt at historically low rates. Overall
investor interest in real estate remains very high, especially for higher
quality multitenant properties of all types, while individual and
institutional investors are equally active.
Low interest rates are also
fueling an increase in leverage-driven investment activity, which is one
reason why prices have remained relatively high. Capitalization rates are
falling, leading some investors to pay prices that are very close to
replacement cost for some properties. If interest rates turn up, as some
suggest will happen over the next year, some of the more highly leveraged
buyers with floating loan rates could be headed for trouble.
Many investors with qualifying property and a longer-term perspective are
locking in long-term debt today, recognizing that there’s really very
little room left for rates to go much lower.
A
RECOVERY IN THE MAKING. BUT…
We hesitate to call it a
real recovery yet, but there are signs that the commercial real estate
markets have reached their low point in the current cycle. Sublease space
is declining, especially in the office market, and leasing activity is
slowly increasing in some Twin Cities submarkets.
Rental concessions are prevalent.
The
Twin Cities industrial real estate market is still struggling to recover
from the economic downturn. We remain extraordinarily concerned over the
status of the manufacturing sector in Minnesota. The Minnesota Department
of Economic Security reported a 9% decline in Twin Cities’ manufacturing
jobs between the first quarters of 2000 and 2002. Minnesota employers
further reduced their manufacturing workforce by an additional 5,000 jobs
through the first half of 2003, according to the respected June
Mid-American Business Conditions Survey conducted by Creighton University.
It’s not all bad news for
manufacturers, of course. Productivity increases mean that many companies
are getting more output from their existing workforce, which makes these
companies more competitive in the domestic and global marketplace. But the
loss of so many jobs – about the same number of manufacturing jobs
created in the state in the decade of the 1990s – is an undeniable
concern.
“WE REMAIN EXTRAORDINARILY
CONCERNED OVER THE STATUS OF THE MANUFACTURING SECTOR IN MINNESOTA.”
Some
signs show manufacturing positioned for improvement over the second half
of the year. Exports are one
encouraging factor, with growth in Minnesota manufacturing exports by 3.9%
to $2.5 billion over the first three months of the year (compared to the
same period in 2002). Medical and transportation products lead the way but
even with those positive signs, the road to full recovery in manufacturing
looks uncertain.
Minnesota’s manufacturers’ troubles are compounded not only as they
have to deal with global competition, but also Minnesota’s high business
costs – especially its commercial/industrial property tax. The real
estate community will need to be creative to identify effective,
innovative reuses for some industrial property that quite possibly will
never be used for manufacturing again.
The Glass is Half Full
Despite
the gloomy manufacturing outlook, the diverse service economy in Minnesota
has its many bright spots. Minnesota’s exceptional entrepreneurship
combined with continued good prospects in medical technology and financial
services will eventually tip the scales in favor of a recovery in the
commercial real estate markets. We
look for declining overall vacancy and a return to positive space
absorption in the market during 2004.
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