South suburbs, with most office vacancies after downtown Minneapolis, poised for turnaround

The office glut isn't just a downtown problem: Twin Cities' suburbs are swimming in empty offices, too.

That's especially true in the south metro, where the vacancy rate is second only to downtown Minneapolis. About a fifth of the office buildings that straddle a swath of Interstate 494 through Bloomington, Richfield and Edina are empty.

But unlike downtown Minneapolis, where office vacancies keep rising, vacancies along what's known as the "I-494 strip" have stabilized for the first time since the beginning of the pandemic, according to a third-quarter report from commercial brokerage firm Colliers.

"Things have definitely leveled off," said Michael Gelfman, executive vice president of Colliers.

Across the metro, office vacancies ticked up a full percentage point during the two previous quarters, while the vacancy rate along the I-494 strip dipped marginally to 20.1%.

Though the decline was slight, there were other positive signs. The amount of sublease space, which tenants, not landlords, offer before their leases expire, peaked a year ago but has fallen to a new post-pandemic low.

"That's a turning point," Gelfman said. "I think we've seen the worst in terms of sublease space."

With about 28 million square feet of office space, including Normandale Lake Office Park, the largest multitenant complex in Minnesota, the I-494 corridor has about a third less space than the central business district in downtown Minneapolis. That makes it the second-largest, and one of the most desirable, office locales in the metro.

Amenity-rich

The area has a variety of amenities appealing to employees and their clients, including parks, restaurants, hotels and major transportation routes. Minneapolis-St. Paul International Airport is just minutes from anywhere along the strip.

For some tenants, one of the biggest benefits is abundant free, covered parking.

"Most workers live in the suburbs," Gelfman said. "So they've got shorter commute times, and more parking ... that's spurring some of this growth."

Because few new companies are on the hunt for space, brokers are struggling to fill offices as leases expire and companies downsize. Most, brokers say, are looking for better-quality space that would make being in the office more appealing to workers.

That includes adding amenities — think provided lunches, golf simulators and cozy lounges — and other enticements, such as allowing employees to bring their pets to work.

"They're trying to create a place where employees have some of the creature comforts they enjoy in their own home," Gelfman said. "And it's easier to have an employee come back to the office when they don't have to pay for parking or public transportation."

That's why openings in Class A buildings, which are the newest and in prime locations, are leasing at a higher rate than lower property classes. The vacancy rate for those Class A buildings in the I-494 submarket is just 19%, 3 percentage points lower than Class B buildings, according to Colliers.

Moving pieces

Brokers are celebrating several big leases in the area. Last month, Burns & McDonnell — a Kansas City, Mo.-based construction, engineering and architecture firm — said it will move from its 40,000- square-foot offices in Bloomington into much larger accommodations at the nearby Norman Pointe II building.

And in August, manufacturer Stratasys said it was consolidating some of its operations by moving its U.S. headquarters 10 minutes away to more than 164,000 square feet of UnitedHealth Group's Minnetonka campus. UnitedHealth is one of several companies in the area that has been shedding office space.

Gelfman, who along with Nathan Karrick, is working on behalf of Norman Pointe's owners, said the Burns & McDonnell deal is typical of what's happening in the area: Companies want higher-quality space with better amenities. Norman Pointe is a newer building than the one Burns & McDonnell is leaving, and it's on a parklike campus that has on-site day care and preschool, a cafe and a fitness center with showers and locker rooms.

Gene Sieve, vice president and general manager of the Upper Midwest region for Burns & McDonnell, said the company had outgrown its current offices, with 260 employees and intention to expand.

"We've been on a very steady growth curve over last 10 years and don't see any signs of that slowing down," he said.

Downtown Minneapolis, where space is even more plentiful, wasn't even an option. That's partly because many of the company's employees already live in nearby southern suburbs and wouldn't enjoy the longer commute and expensive parking downtown. Also, many of its clients aren't local and fly to the Twin Cities for meetings, so being close to the airport was especially important.

"[The area] has more to offer," he said. "And there's good highway frontage so there's a branding opportunity."

The company is also an outlier. While many are letting employees work remotely at least a couple of days a week, reducing the amount of needed office space, Burns & McDonnell quickly brought employees back to the office full time.

"We offer a little bit more flexibility than we did [before the pandemic] in terms of remote, but it's been a company philosophy that we have a better opportunity to provide [the] right solutions to our customers and develop our people when we do it in person," Sieve said.

Because the company is employee-owned, Sieve said, there was little interest in some of the more lavish — and expensive — amenities many tenants now seek.

"Almost to a fault, we all act like owners. So when it comes to spending money even on our own office space, it's done with a scrutinizing eye," he said. "We forgo [some luxuries] because we see that as an unnecessary expense."

Options galore

Though there's a surplus of space in nearly every corner of the metro, building owners aren't yet slashing rents, especially for the most deluxe spaces.

Still, the southern suburbs are less expensive than downtown Minneapolis..

"There was not an abundance of space that tenants were trying to get out from under. We didn't see the fire sales that we thought we should," Sieve said. "If we were looking for 30,000 square feet, we could find lots of deals."

Doug Fulton, a principal at Avison Young who helped Burns & McDonnell shop for its new space, said with corporations shedding nearly 3 million square feet of space through the past years in the southwest metro alone, office shoppers have plenty of options. Burns, for example, had 10 potential landing spots.

Fulton said from 2020 to 2022, many tenants extended their leases. But now, many of those are coming up for renewal, putting more shoppers on the scene.

"It will take a while for that vacant space to be absorbed back into the market," Fulton said. "Today, it is a tenant's market, with lots of options."