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Job growth seen
rebounding to 1.2% annually in 2004
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Twin Cities and
Minnesota per capita income highest among 12-state region
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Investment market
unusually vibrant given the decline in fundamentals in the office,
industrial and multifamily sectors
Recent
trends in the Twin Cities commercial real estate markets confirm that when
it comes to the economy, the region today is more mainstream than not. For
example, vacancy rates in the office and industrial real estate markets
have moved higher in the Twin Cities almost in lockstep with the rest of
the nation’s major metropolitan areas. Real estate experts in other
parts of the country, such as Boston, are noting the same difficulty today
in re-kindling demand for office and industrial space as in the Twin
Cities.
From the commercial real estate world’s perspective, there is good
reason to believe the coming year will be better for landlords than 2003.
Certainly better than the protracted stall in demand that characterizes
much of the region’s office and industrial markets today.
More Jobs On The Way As Economy Strengthens
Job growth -- essential to the recovery in the office, industrial and
multifamily markets -- may be slow to materialize but it is on its way.
Wells Fargo Chief Economist Dr. Sung Won Sohn foresees a slight increase
in non-farm payroll jobs through this year, albeit at a level below that
of 2001.1
However, his June 22 chart of economic indicators suggests growth of 1.2%
in non-farm payroll between July 2003 and July 2004. That’s in line with
the Minnesota Department of Economic Security’s projected average annual
employment growth in Minnesota of 1.2% per year for the 1998-2008 time
period.2
Assuming the hiring projections materialize, approximately 20,000
more people will be working in the Twin Cities region in July 2004 than
there are today. That’s healthy enough growth to allow companies to
begin reusing their excess “shadow” space and may result in a modest
increase in demand for office and industrial space. Employment growth will
also breathe new life into the demand for apartments.
Virtually no new office and industrial development is planned over the
next six months. Multifamily activity will continue to be strong, as
developers are completing projects funded when markets conditions were
more favorable to landlords.
Minnesota Per Capita Income 8% Above National Average
Retail continues to be a bright spot in the Twin Cities real estate
market, with rapid expansion occurring in the community and neighborhood
shopping center sectors. Several factors make the Twin Cities a good area
for expansion by national retailers, not the least of which is that
Minnesota’s average per capita income is 8% higher than the national
average.
Minnesota’s per capita income is also the highest of any state in the 12
state Great Lakes/Plains states region, including Illinois, Indiana,
Michigan, Ohio, Wisconsin, Iowa, Kansas, Missouri, Nebraska, North Dakota
and South Dakota. As the July issue of The Region, the Federal
Reserve Bank of Minnesota publication, notes Minnesotans’ per capita
income edge is achieved mostly through their paychecks, rather than
through other income sources such as investments.3
That helps explain why the Twin Cities ranks 11th nationally in
retail sales, even though it is the 13th largest metropolitan
area.
Continued low interest rates are helping give the real estate investment
market a surprising vibrancy, especially considering the overall
sluggishness in leasing demand for office, industrial and multifamily
properties. Demand for small to medium size buildings is especially brisk
among private investors who can leverage their purchases with low interest
financing. An increasing number of these transactions are 1031-exchange
driven deals and users that are purchasing buildings for their own
operations.
Larger institutional investors, such as pension fund advisors, are present
but not as active in making transactions. In spite of weakening
fundamentals in the office, industrial and multifamily markets, pricing of
many types of commercial properties remains high, although below the peaks
of a few years ago. Owners have been able to refinance their properties at
lower interest rates and reduce the impact of rising vacancies and the
consequent erosion in returns. There are signs that investors are becoming
more willing to lower their yield expectations, which could help bridge
what has been a stubborn pricing gap between buyers and sellers of larger
properties.
A significant rise in interest rates could negatively impact investment
demand for commercial real estate, particularly the leverage-driven side
of the equation. Cash-driven institutional investors may take a more
active role if rates increase. At this time, there seems little likelihood
of a significant rise in interest rates over the next six months.
Institutional investors are nonetheless locking in long-term credit today,
for both refinancing and new acquisitions, which may be an indicator that
the period of declining interest rates is coming to an end. Dr. Sohn, for
one, projects that 10-year Treasury yields will approach 5 % sometime next
year from 3.53% today.4
Educated
Workforce A Key To Region’s Competitiveness
Although
some progress has been made in reducing commercial property taxes at the
state level in the most recent legislative sessions, Minnesota remains one
of the highest cost states in terms of total business taxation. Where
Minnesota does rank well, in terms of relative attractiveness for business
locations, is in the high education levels of its workforce – a key
competitive attribute in today’s knowledge economy.
The
next few months will continue to test the staying power of landlords of
Twin Cities office, industrial and multifamily properties.
There will continue to be pressure on rates for property sectors
where available space is plentiful.
Real job growth is not expected to begin in earnest until next
year. We
still need three to six months of positive, profitable economic growth
before companies will begin to hire new employees. If the second half of
2003 matches the gains the stock market experienced in the second quarter
of 2003, next year could prove to be a big year in the recovery of the
Twin Cities office and industrial markets.
1
DrSohn.com
2 Minnesota Department of Economic Security, 2003
3 "Business Cycles and Long-Term Growth: Lessons from
Minnesota," Terry J Fitzgerald, The Region, Vol. 17,
No. 2, June 2003, Federal Reserve Bank of
Minneapolis
4 Sales and Marketing Management's "Survey of Buying
Power," Sept. 2002
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