Twin Cities seeing office market ‘reset’

Listen to this article

By Dan Emerson

Finance & Commerce

The Twin Cities office market may be evolving into a bargain hunter’s market, according to some local commercial real estate stakeholders.

With occupancy rates still lower than normal in some sub-markets — such as downtown Minneapolis — and higher interest rates making deals more challenging, the market is in the early stages of a “reset,” with some under-performing properties being re-valued to reflect those lower occupancies, market participants say.

“We’re seeing office buildings trading at significant discounts to the values we saw three to five years ago,” said Brian McCool, chair of the real estate department and shareholder at Fredrikson & Byron.

One example is LaSalle Plaza, a 30-story office tower in downtown Minneapolis, which sold for about half its estimated tax value of $87 million. It sold for $46 million. In 2020, LaSalle Plaza’s value reached a high of slightly more than $103 million, according to Hennepin County property records.

Twin Cities-based Hempel Real Estate bought the 1991-vintage stone and glass tower at 800 LaSalle Ave., which has more than 620,000 square feet of space, plus 60,000 square feet of retail space. Hempel bought the debt on the property from Milwaukee-based Northwestern Mutual, which had repossessed it from the previous owner, Teachers’ Retirement System of the State of Illinois.

“It’s a really high-quality building,” Hempel CEO Josh Krsnak said, with stone and marble finishes and intricate design details.

Krsnak said higher interest rates made the LaSalle acquisition more complicated. “We almost couldn’t get financing; I flew all over looking for financing. If you want financing, the big banks are not interested.” He was finally able to make the purchase by enlisting four local community banks to take on the project. “No bank could lend on the whole [property], so we had to bifurcate the property into two pieces of collateral” with a land lease on one part and a lease-hold mortgage on another, he said.

Hempel plans to spend about $20 million on improvements with new elevators, upgraded HVAC and a lobby remodel, plus a number of tenant-appealing amenities like indoor pickleball courts, a rooftop golf simulator, sauna and cold tubs.

Hempel also bought the nearby Pence building, 800 Hennepin Ave. Also the firm was preparing to announce the acquisition of two more office buildings, and has made an offer on one located “within a block or two” of LaSalle plaza, Krsnak said.

Will taking a risk on under-performing office buildings pay off for Hempel? “Time will tell if we’re accurate with our underwriting and assumptions,” Krsnak said. “But we haven’t seen prices like this in a long time.”

“Most of the [revaluing] activity hasn’t happened yet, there is a lot more still to happen,” McCool said. “There are a large number of [under-performing] office buildings that have not yet had their reckoning.”

“Part of the reason why more hasn’t happened yet is that nobody really knows what office assets are worth right now,” McCool said. “What is the demand and how are employers going to embrace it? That is still sorting itself out.”

“It’s always easier to figure out the right outcome [for a transaction] when you know the value of what you’re dealing with, and value is elusive right now,” McCool said

John McCarthy, a senior vice president at Collier’s, has brokered some recent deals for local office buildings. He said Collier’s has contracted with a local buyer who is purchasing Waterford Office Park in Plymouth, with two Class A office buildings that were once owned separately being sold as a pair. “Every lender in the country had a chance to buy it.”

Colliers also recently contracted for an “off-market” sale of Olympic Place, a Class B office building at 7825 Washington Ave. S. in Bloomington, near the intersection of Interstate 494 and Highway 169. “They had a loan coming due and we were able to bring in a new investor — a local real estate fund — to recapitalize the assets,” McCarthy said. The property has some of the amenities employers are looking for to entice workers back to the office, like a fitness center, lounge and grab-n-go market.

“There’s a belief that things aren’t going to get worse. Maybe we have found a bottom, and we’re starting to have some discovery on price,” McCarthy said.

Deal makers are still waiting for capital markets to return to normal, said Krsnak. “It’s almost impossible to get debt right now. We just bought an office building in downtown Milwaukee that is 90% leased, with 12-year leases, and we could not get financing from almost anyone. We finally got a credit union to do it.” To make loans, banks are requiring larger deposits, at least 10%, he said. Also, “because of a lack of activity on the debt side, there is very little equity chasing these deals. But if you are a cash buyer you can pick up some pretty good deals.”

Krsnak also expects that the re-purposing of under-performing Class B and Class C office buildings will help “the supply and demand balance. As these buildings get converted or torn down, that softens the supply side. Market demand for existing buildings will start balancing itself out. We are starting to see that.”

In making acquisitions, “we used to underwrite [based on] 90% occupancy, now we’re underwriting to an occupancy of 80%,” Krsnak said. “The math has to work so your building performs” financially at that level of occupancy.

“There are still some very successful office buildings, but we are starting to see some office buildings being torn down; some converted to other uses,” McCarthy said. “There is not a lot of new supply and demand is slowly improving. A few more people are going back to work every day and we’re slowly getting back to normal.

“Meanwhile, folks who have a belief in their [building] management abilities are making new opportunities. There are some fantastic buys available for good managers who know what they are doing. They are buying real estate ‘by the pound.’”