One commercial real estate sector in the Twin Cities that isn’t losing value: industrial real estate

Industrial buildings are often not eye-catching from the outside, but for developers and investors they could just as easily be a desirable large home at the end of a cul-de-sac.

Demand for the unassuming, low-rise concrete warehouses, distribution centers and manufacturing buildings that are increasingly popping up in the Twin Cities suburbs remains unusually strong at a time when other key segments of the commercial real estate world are faltering. But construction hasn’t grown enough to satisfy the hunger.

The average vacancy rate for industrial buildings across the metro area has hovered around 4.5% for the past six months, up a percentage point from a year ago and slightly below historical averages, according to new data from commercial real estate brokerage Colliers.

It’s also a fraction of the double-digit office vacancy rate. Office demand has fallen, and rents have plummeted. Office development in the Twin Cities is stalling, and apartment construction is evaporating.

That means the Twin Cities, like many other major metropolises, should be in the midst of another industrial revolution. If the rise of e-commerce and online retail — with its reliance on massive warehouses and distribution centers with high ceilings and plenty of space to store goods awaiting delivery — hasn’t already swayed developers, the weakened office and multifamily markets should.

While demand for industrial space is strong, supply continues to shrink. Higher borrowing costs and rising construction costs mean fewer new projects and rapidly rising prices.

“Developers have had to put their pencils away because of debt costs and inflation,” said Joe Owen, executive vice president of Colliers Minneapolis-St. Paul. “It doesn’t make sense to build.”

Growing demand

There was only 2.8 million square feet of industrial under construction in the metro area at the end of June, down 73% from a year ago, according to Colliers. Meanwhile, industrial rents are rising, with the average rent sitting at $9.55 per square foot, up nearly $2 from a year ago. Rental yields are particularly strong in the metro area’s core submarkets, where supply is most constrained.

“It’s incredibly tight out there,” Owen said. “The industrial market is still incredibly healthy.”

Minneapolis-based Opus Group broke ground on an industrial project in Dayton this week: a 132,200-square-foot distribution and light manufacturing facility on a 10-acre site. The company said the Dayton Parkway Business Center will have 28-foot ceilings, 19 dock doors (expandable to 34) and four drive-in gates. It will have 136 vehicle parking spaces and 14 trailer parking spaces, as well as space for employees and delivery drivers.

“The Twin Cities Northwest Industrial submarket continues to lead and outperform the rest of the metro with active users and strong demand,” said Nick Murnane, vice president and general manager of real estate development for Opus. “This asset will allow us to provide a unique offering to users who require smaller spaces in a submarket that has historically been dominated by larger spaces.”

Murnane said TurbinePROs, a field services company for manufacturers of rotating equipment, has already signed a lease for more than 87,000 square feet, leaving about 44,000 square feet available.

Opus has several other industrial developments in various stages of development and construction, including the River Valley Business Park in Shakopee, which includes two adjacent industrial buildings totaling 450,000 square feet on 51 acres. It was a “speculative” development, meaning there is no specific tenant in mind, so the eventual tenant can customize the raw space to suit their needs. The buildings have ceilings of 28 and 32 feet, plenty of dock doors and hundreds of parking spaces for delivery vehicles.

The company is also nearing completion of a custom aluminum recycling facility for Spectro Alloys in Rosemount. The 90,000-square-foot facility will enable the aluminum recycler to increase production of recycled billets and ingots from post-consumer aluminum scrap, including aluminum cans.

In addition to these industrial users, there is another growing demand driver: office tenants. Even as the flight to higher-end offices drives demand for flashy, well-appointed high-rise buildings with hotel-style amenities, Owen said more companies are looking for office space in these no-frills industrial buildings that include what is known as “flex-tech” office space.

The advantage of these single-story structures, Owen says, is that they are much cheaper to build and equip than most mid-rise and high-rise office buildings.

“A lot of office tenants are looking for cheaper space,” Owen said. “And they’re consolidating their space—and costs—in single-story technology buildings.”

Insufficient supply

The shift is one of several factors driving the rise in office vacancies. The latest Twin Cities office data showed that the average vacancy rate for the entire metro area rose to 22%, according to a second-quarter report from JLL. That report found that potential office tenants are eyeing about 3 million square feet, or about a third of the space sought by industrial users, according to multiple sources.

Much higher demand for industrial space is driving rents in this asset class to grow at double-digit rates annually, but the cost of such space can be almost half the cost of renting some tall office buildings.

“It’s very situational and a little bit complicated,” Owen said. “And it depends on the user.”

It’s definitely the combination of office/warehouse users and wholesale distribution companies that are driving the Twin Cities’ industrial scene. Sweet Harvest is one such company, best known for its honey but also selling agave and molasses. Earlier this month, the company moved into a 360,000-square-foot “fulfillment center,” Twin Cities-based Oppidan, which is being built on a 23-acre site in Lakeville.

Jay Moore, Oppidan’s senior vice president of development, led the project, the company’s largest industrial building to date and the largest in the metro in recent memory. Moore said the growth in existing space that companies like Sweet Harvest are vacating is offsetting the slowdown in construction. Still, the amount of available space in the metro has remained steady this year, according to a Colliers report.

Since Oppidan began developing industrial facilities in 2015, the company has completed nearly 5.5 million square feet of development in several other states, including North Carolina, South Carolina and California.

“The reality is that the amount of new space that’s being built has slowed down,” Moore said. “There’s not as much product being built anymore.”