Reclaiming the urban office – Finance and Commerce

By: Paul Nolan April 20, 2021 4:04 pm

Find the original article from Finance and Commerce here.

Pardon commercial real estate professionals if they feel a bit like the old man slung over John Cleese’s shoulder in the “I’m not dead yet” scene of “Monty Python and the Holy Grail.”

It’s true that most Twin Cities office buildings continue to operate at 20% occupancy or less in terms of employees coming to the office. And an announcement by Target earlier this year that it is abandoning 985,000 square feet of leased office space in City Center in downtown Minneapolis (with a significant amount of time left on that lease) generated dramatic headlines by the local media about the pandemic’s permanent impact on commercial property. Similar stories have been written by a number of national publications.

Those who own, lease or monitor urban office space in Minneapolis and St. Paul want the business press to know that reports of the death of downtown offices are definitely exaggerated. They are exasperated by the gloom-and-doom headlines regarding their industry. A portion of their job has become lobbying for their own profession and the importance of traditional work environments.

“I’ve probably read 100 different articles like that, and the only thing that’s going to be certain is people are wrong,” said Tom Tracy, a specialist on downtown Minneapolis commercial office property who works for Cushman & Wakefield, a global commercial real estate services firm. “We have to let this thing play out.”

“I quit reading all the people talking about what the workplace is going to be like in the future,” added Paul Donovan, a colleague of Tracy’s at Cushman & Wakefield who represents businesses that lease downtown office space. “If there is a common theme in what they’ve said, it’s that they don’t know.”

We’ve been here before

Commercial real estate professionals and downtown business advocates agree that rebounding from a global pandemic is not something that anyone alive has lived through. Yet they argue that past events such as 9/11 and the recession of 2007-2009 rocked the commercial real estate environment in a similar fashion, but did not knock it out.

They take heart that the current disruption is not tied to an economic downturn for many industries. “Unlike the Great Financial Crisis, when global sales volume and values plunged and remained at low levels for two straight years, in this cycle the capital markets have already begun to rebound. Sales volumes have generally been improving since May of 2020, and pricing for high-quality assets is generally holding firm,” a report from Cushman & Wakefield states.

The overriding sentiment from commercial real estate corners is that companies continue to figure out what their workplace culture and office policies will be long term, but few foresee an officeless world in their future. “By no stretch of the imagination has there been a psychological abandonment of downtown,” said Steve Cramer, president and CEO of the Minneapolis Downtown Council.

Office property managers have armed themselves with studies that tout the critical role office space plays in recruiting and retaining top talent, reinforcing a corporate culture, fostering collaboration, improving productivity, and increasing engagement and job satisfaction.

Early indications are that businesses buy into that message for the most part. Though Target will not have 3,500 employees return to the City Center space they occupied pre-pandemic, company leaders emphasize that its downtown Minneapolis footprint will still be more than 2 million square-feet, and its northern campus in Brooklyn Park adds another 1,173,000 square-feet.

According to a Target spokesperson who responded to an inquiry via email, the retailer pushed the timing of its workers’ gradual return to offices to at least next fall. Approximately 12,000 team members are based in Target’s Twin Cities office locations, including the corporate-owned Brooklyn Park facility. Approximately 8,500 are based in downtown Minneapolis.

“As we look beyond 2021, our longer-term headquarters environment will include a hybrid model of remote and on-site work to allow for flexibility and collaboration,” the corporate statement said.

When Target does bring workers back to the office, it will do so alongside hybrid work-from-home and office arrangement it calls “Flex for Your Day.” In an email sent in March to its office employees and shared with the media, Executive Vice President and Chief Human Resources Officer Melissa Kremer stated, “Our headquarters will always play a central role in who we are and how we work at Target. We believe in the culture, collaboration and competitive advantages of working together at our vibrant headquarters in the Twin Cities and around the world.”

Wells Fargo Place

Heide Kempf-Schwarze, senior property manager of the 37-story Wells Fargo Place in downtown St. Paul, said the building renewed a number of long-term tenants in 2020 for standard 10- to 15-year contracts without dropping its price per square foot. (Submitted photo: CoStar)

What the numbers reveal

Positivity from commercial real estate representatives comes in spite of the fact that 461,000 square-feet of vacant office space was absorbed in the Twin Cities in the second half of 2020, according to a Cushman & Wakefield report. (Absorption is a measurement of the increase or decrease in occupied office space that occurs during a given period of time.) That pushed the market’s direct vacancy rate to 18.5%, an increase of 150 basis points compared to year-end 2019, the report stated.

Cushman & Wakefield reports also provide these statistics:

New leasing volume fell by 42% year-over-year in the second half of 2020 as lingering uncertainty about future space needs largely slowed real estate decisions by occupiers.

The amount of vacant sublease space in the Twin Cities increased by 30% since first quarter 2020, reaching 1.4% of total market inventory in Q4. The national average for sublease vacancy, by comparison, was 2.1% of inventory.

Renewals accounted for 38% of total leasing volume in the second half of 2020, and occupiers largely opted for shorter-term lengths as economic and public health uncertainties persisted.

Average cost for Class A office space in the Minneapolis central business district in the fourth quarter of 2020 was $33.74 per square foot compared to $34.30 in fourth quarter of 2019. In St. Paul, the average cost for similar space was $26.55 per square foot in Q4 2020 compared to $25.57 in Q4 2019.

Heide Kempf-Schwarze, senior property manager of the 37-story Wells Fargo Place in downtown St. Paul, said not only are stories different between the two metros (St. Paul has fared slightly better than Minneapolis), but they can be different from one building to another. Kempf-Schwarze said Wells Fargo Place, which is managed by Unilev Capital Corp., renewed a number of long-term tenants in 2020 for standard 10- to 15-year contracts without dropping its price per square foot. One renewing tenant decreased the amount of space it occupies, but Kempf-Schwarze said that would have occurred without the pandemic.

“A lot of people want to find a one-size-fits-all statement that this is how the world is going to look, but that’s not what we’re finding. Real estate is very cyclical, and users’ space needs expand and contract,” she said.

Joe Spartz, president of the Greater St. Paul Building Owners and Managers Association (BOMA), which represents the interests of commercial real estate investors, said St. Paul has managed to avoid the loss of a Target-like tenant from its central business district. Spartz said the largest tenants east of the river include The Travelers Companies, Ecolab Inc., and state government offices. According to Greater St. Paul BOMA statistics, absorption in the St. Paul central business district’s competitive office space from 2019 to 2020 was 214,609 square feet.

While Spartz agreed there is bound to be some sort of permanent impact on St. Paul commercial office space use from the pandemic, he doesn’t expect it to be dramatic. Some companies will likely reconfigure how their office space is utilized, and larger tenants may decrease the amount of space they lease, but Spartz said he expects that will be filled by smaller companies.

“The mixture of who occupies what, how they do their work, and what office space looks like may be different than what we were used to pre-pandemic, but the need for office space won’t go away,” he said.

New space on top of existing empty space

BOMA International co-sponsored a survey of 3,010 office space decision-makers and influencers in the fourth quarter last year and found that 74% believe their in-person office space is vital to conducting a successful business/operation. (80% of Minnesota respondents agreed with that statement.) Asked if their employees are generally comfortable with or supportive of coming back to office space, 59% of respondents nationwide said they are.

It is concerning, however, that 48% of Minnesota respondents to the BOMA survey last October said they will likely reassess office space needs, and 46% said reducing the amount of square feet they lease on their next renewal is likely.

A recent New York Times report stated that a nationwide reassessment of office space needs is occurring at a time when many new office buildings are being completed. One of those in downtown Minneapolis is the Dayton’s Project, the remodeled former department store on Nicollet Mall. Developers of the 12-story building announced in March that professional services firm Ernst & Young LLP will lease 30,536 square feet of office space. Ernst & Young is moving its offices from the U.S. Bank Plaza downtown and decreasing the amount of square footage it leases in the process.

Brian Whiting, CEO of Chicago-based Telos Group, which is leading the effort to lease the 1.2 million square feet of space at the Dayton’s Project, said they were nearing agreement to lease several hundred thousand square feet of office space in early 2020, but it all “evaporated” when the pandemic hit. Many of those same businesses are in talks again to lease space, as well as additional potential tenants, Whiting said. He said tenants are expected to move into the Dayton’s Project by late July or August.

Whiting feels the business press is missing a dramatic shift in strategic planning by companies that has occurred in the past several months — a reversal of thinking that is more rapid than any he has seen in his 35 years in commercial real estate.

“We are having completely different conversations now than we had even as recently as last fall,” he said. “There is a lagging trend here that is totally opposite from what it was in the fall. It shocked me how quickly things have turned from discussions of downsizing and work from home to discussions of ‘I need to get people back in the office as quickly as possible.’ The vast majority of our conversations don’t include talk of downsizing.”

City Center in downtown Minneapolis

Target announced earlier this year that it is abandoning 985,000 square feet of leased office space in City Center in downtown Minneapolis. (Submitted file photo: Ryan Cos.)

The critical role of offices

Like many of his commercial property counterparts, Whiting is adamant about the critical role that offices play for companies, and he’s spreading that message more often these days. To support his view, he points to a recent survey of CEOs by global professional advisory firm KPMG that reported just 17% of chief executives plan to cut back on offices, down from 69% in a KPMG survey last August.

“Work from home has started to run its course and reversed its impact on productivity, as people have not been able to be mentored, people have not been able to grow, and cultures have suffered dramatically as a result,” Whiting said. “It’s these factors that make me confident the corporate heads who are making short-sighted decisions to force WFH are not in front of the curve, but behind it. They are counting on WFH to save a marginal amount of operating expenses without sacrificing productivity. In exchange they risk their culture, their ability to innovate and their ability to recruit and keep their future.”

Paul Donovan of Cushman & Wakefield agreed that companies that are shifting to remote work fail to see the forest through the trees. They may reap an immediate — and what he claims is a relatively small — savings by decreasing office space while placing their corporate culture and productivity at risk. Donovan feels corporate leadership would be wiser to stay the course while the post-pandemic world sorts itself out.

“Everyone looks at things and says, ‘I have to act.’ You can act today by not renewing a lease and have everyone work from home, and you’ll get immediate savings — it’s probably 2% to 3% of the payroll you sent home. That is the definite benefit, and there is no more benefit,” he said. “There is a risk with that — the productivity of your employees drops, your innovation drops, you lose valuable employees, and then you also have the component of the health and well-being of your employees. You get one gain and you have risks that you can’t quantify.

“By acting on the real estate, I can measure the cost, because it’s just cost. But what I can’t measure are all the other items that I spoke to. Is it worth that immediate savings for that potential risk of all the unknowns? Wouldn’t I be better served to quantify those first?”

Buildings with a brand and a purpose

Some of those who monitor the commercial property industry say the option to have employees work remotely has created a buyers’ market for office space. Dror Poleg, author of “Rethinking Real Estate” and the co-chair of the Urban Land Institute’s Technology and Innovation Council in New York, said tenants are discovering they can demand more services, more design and more flexibility. At the same time, Poleg added, they’re less willing to sign the seven- to 10-year leases that have been common for office space.

Poleg told podcaster Scott Galloway recently that office space used to be bland by design, but those companies that operate top-performing office properties going forward will create a brand image and “a point of view.” Say what you will about WeWork, the shared workspace provider that stumbled into, and ultimately postponed, an initial public offering in 2019. The company still has a brand message of community that resonates with a number of people, Poleg said.

“WeWork is a joke to some people and a great service to other people. The customers who love it, if they’re willing to pay for it, that’s all that matters.” Developing average office buildings will no longer work, said Poleg. The office property that will succeed will have a brand and its property managers will establish tenant relationships that mean something.

Pat Wolf, founder of St. Paul-based Commercial Real Estate Services, Inc., is on board with that concept. Wolf’s 30-year-old company provides property management and tenant representation for a handful of properties in downtown St. Paul and, more recently, in Minnetonka and Eden Prairie.

She is proud of all the buildings she represents, but talks most excitedly about The 428, a former Woolworth’s store in downtown St. Paul that was remodeled into a five-story commercial office property with 63,000 square feet of space. The building was refurbished in 2017 and 2018 with a focus on the emerging healthy buildings movement that promotes design and construction elements to support a more sustainable and healthy work environment.

Proponents of healthy buildings say studies have proven that creating workspaces that have improved ventilation, air quality, temperature control, lighting and other characteristics have a significant positive impact on the performance of those who work there. The movement is supported by WELL certification, a performance-based system established in 2013 for measuring, certifying and monitoring features of an environment that impact human health and well-being, through air, water, nourishment, light, fitness, comfort and mind. The 428 is a WELL-certified building.

Wolf said tenants of The 428 building are there because they are committed to the healthy building movement. She believes WELL certification will become more important to tenants, in large part because of the recruitment and retention advantages it provides.

“If you take into account the competition for talent these days, think about if someone is interviewing for a job and one company is invested in their building environment because they care about you,” she said. “Are you going to pick that company or one that does the same old thing?”


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