MINNEAPOLIS-Although it is lagging the industrial market, the Twin Cities office market is showing signs of strength, according to a new report on the market. The office market finished 2004 with positive 522,000 sf of absorption, according to United Properties’ year-end 2004 Outlook market study.

Any level of positive absorption is a strong indicator of returning demand–particularly following a two-year period of negative 2.7 million sf of office absorption, according to the Bloomington-based commercial real estate firm. The office market posted its first declining vacancy rates since 1997 with year-end 2004 levels of 18.3% direct vacancy or 20.7% vacancy with subleased space included, compared to year-end 2003 vacancy rates of 18.9% or 21.6% with subleased space.

Four of seven Twin Cities office submarkets reported declines in direct and sublease vacancy numbers during the second half of 2004, further signaling a broad-based recovery in demand. Only the Minneapolis and St. Paul central business districts reported year-end 2004 vacancy rates above 20%. The Northeast office submarket reported the lowest vacancy rate at 14%.

“The amount of office sublease space declined more than 10% over the last year, and office users are beginning to fill excess space in their current locations,” says John McCarthy, vice president of office brokerage at United Properties. McCarthy anticipates companies will begin leasing new space for growth. “The increased activity level we began to experience this year could translate into nearly one million sf of absorption in 2005.”

Office developers delivered 225,000 sf of new multi-tenant construction to the Twin Cities this year, the lowest level since 1997. Speculative development will be limited next year with the majority of construction activity occurring in build-to-suit projects and new developments with significant pre-leasing commitments, according to the report.

Both office and industrial developers will continue to focus on securing land positions through 2005 and into 2006 as they prepare for the market to warrant future development. They face stiff competition from residential developers who are also vying for prime sites.

Office rental rates declined modestly from year-end 2003 to year-end 2004. Class A office rents at year-end 2004 averaged $13.43 per sf, while class B and class C rates were at $9.93 per sf and $8.16 per sf, respectively. Declines ranged from $0.04 per sf in class C properties to $0.26 per sf in class A properties. Tenants willing to sign long-term leases will continue to find good deals, but they’ll need to work harder to find them, especially in the suburbs, according to United officials.

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