• Signs of stability give birth to a ‘hopeful bottom’ perspective

• Flattening out the curve on rising vacancies, sublease space in decline

• Golden opportunity for tenants to take advantage of weak but stabilizing market

TWIN CITIES MARKET OVERVIEW FIRST HALF 2003  Light is glimmering at the end of the tunnel for Twin Cities commercial office building landlords, based on the first half data. After a two and one-half year descent, the market seems to be at what landlords might call a “hopeful bottom,” with rising vacancy rates beginning to flatten out and negative absorption decreasing fairly dramatically.

Available sublease space on the market is declining as well, an indication that the wave of corporate downsizing and consolidation, which rattled the market these past few years, is ebbing. New construction is all but non-existent, with 124,315 square feet of new space added to the market over the first half.

Suburban Submarkets Showing Signs Of Returning Demand

Demand, if not robust, is at least anecdotally recovering some forward momentum, especially in some suburban submarkets where small- to medium-sized businesses are beginning to see signs of growth. The pace of recovery is less certain in the Central Business Districts of Minneapolis and St. Paul and in the Golden Triangle area of the Southwest submarket, where the bulk of the corporate consolidation activity is still being felt.

The one big negative, again from the landlord’s point of view, is that rental rates continue to decline. Net quoted rates are down to $11.89 per square foot for all types of office properties in the metro area, versus $12.56 per square foot at year-end 2002.  Net effective rates – the rental rate minus marketing incentives paid for by landlords such as tenant improvements, broker fees, free rent and the like – are significantly lower than the quoted rates.

Rush To Renew Leases Benefits Tenants Who Took Space At Peak Of Development Phase

More than 5 million square feet of new office space was added to the Twin Cities market in 1999 and 2000, at the peak of the last development phase. Many of the companies that leased space during that time period would normally have their leases coming to term over the couple of years, since most office leases in the Twin Cities are for an average of five years.

Normally landlords would expect to see a surge of new leasing activity under such conditions. However, many of these tenant companies are responding to landlord incentives and renewing their leases early. Even so, the market may well receive a boost over the next few years as the remaining balance of tenant leases expire.

Landlords seeking to maintain vacancy levels in their buildings have increased their incentive packages significantly in order to retain existing tenants. One free month’s worth of rent per lease year is being offered by some buildings. Landlords are also willing to offer increased compensation to brokers and they have in many cases increased their dollar allotment for tenant improvements.

The overall result has been a dramatic lowering of the net effective rental rates. For example in the Twin Cities’ suburban Class A office market, the average net effective rental rate after discounting for tenant improvements, broker fees and free rent is now $4.32 per square foot. Compare that to the $11.53 per square foot – including marketing incentives –-- commanded by Suburban Class A office space in 1999.

THE OUTLOOK

Some further weakening in rental rates is anticipated over the next six months, making this an excellent time for tenants to plan and execute their next moves. In the absence of new construction, new job growth expected to begin next year will begin to absorb some of the excess space on the market. Based on current indications, it seems most likely that the Twin Cities office market is at or near bottom and will begin to see some recovery in the first half of 2004.