Sixteen floors of upscale office space in RBC Gateway — a downtown Minneapolis tower that's just a year old and nearly fully occupied — have sold for $225 million in one of the biggest office sales in the nation this year, a win in an otherwise challenging commercial real estate market.

San Francisco investment firm Spear Street Capital bought the space from United Properties in a deal that closed at the end of last week, according to public records. Spear Street Capital also owns an office building in the Warehouse District.

The deal, which has been in the works for months, includes parking, a lobby and offices in the 37-story tower, which is also home to a Four Seasons hotel, a trio of restaurants and nearly three dozen of the city's most expensive condominiums.

For trophy office buildings, it's been neither a buyer's nor a seller's market. And in the Twin Cities, there's been only one major office tower sale since the beginning of the pandemic.

"Now is not the best time to sell," said Erin Fitzgerald, senior director of capital markets for JLL. "Investors are few and far between, and unfortunately, there are even fewer lenders, which is the issue right now."

The Gateway acquisition comes after the recent sale of LaSalle Plaza, which sold for a steep discount. Brokers said the dearth of luxury tower sales is unusual and a reflection of the uncertainty about the downtown office market, which has seen a 20% to 25% decline in building values as vacancy rates hover near historic highs and building owners plot their next move.

"The mood is still controlled by uncertainty in the market. ... We're in a discovery mode," said John McCarthy, senior vice president of investment sales/capital markets for Colliers. "There's a lot of conversations happening off-market with a lot of investors and a lot of lenders."

Gateway to downtown

RBC Gateway opened in February 2022 and is the tallest mixed-use tower built in the city in nearly 20 years. The sale included underground parking and 525,000 square feet of Class A — the category for top quality and location — office space on 16 floors of the building, which had an estimated cost of $330 million to develop in 2018. After several changes and increases in construction costs, the entire project — including the offices, hotel and condominiums — ended up costing nearly $500 million.

The office vacancy rate in the Central Business District has been hovering around 30%, according to the most recent data from Cushman and Wakefield.

But the offices at RBC Gateway fetched a premium price, brokers said, because of its high occupancy as well as its quality and location. Unlike most downtown offices, the tower is 99.9% leased. It's home to several major firms, including RBC Wealth Management, which occupies more than 300,000 square feet. The Pohlad Cos. — the parent company of the tower's developer, United Properties — takes up nearly 100,000 square feet.

"Our team set out to create a development that would add to and invest in the future of the city that we call home," said Chris Pohlad, chief of staff for United Properties. "We are proud to have added new energy to downtown Minneapolis by creating a connection point between the Central Business District and the North Loop."

The slender tower — built on a parking lot that had been vacant for decades after the demolition of the Nicollet Hotel — is the product of years of planning and several iterations at the the north end of Nicollet Mall. The area has long acted as the "gateway" to downtown Minneapolis and also has helped fill a gap between several neighborhoods, like the Mill District and the areas Pohlad mentioned.

Ryan Watts, executive vice president of CBRE's Institutional Properties Group, which brokered the deal, said as tenants are choosing the best-quality space to entice workers back to the office, investors are also engaged in what's known as a "flight to quality."

"It's becoming pretty clear through the data that tenants are coming back to work, but generally, they're using less space but higher-quality space," he said. "As investors are coming back and trying to figure out how to invest in commercial real estate and in offices in particular, that's where investors want to be: higher-quality assets."

Watts noted the challenges facing the commercial sector aren't unique to the Twin Cities. Many commercial loans are coming in the next 24 to 36 months, and with interest rates high and liquidity low, there's growing concern that many will default if they're not able to refinance at more favorable rates. He said for those who can't refinance, a sale might be the only option.

"What we're not seeing a ton of is people getting into trouble paying their loans," he said, noting many are focused on how they'll refinance their mortgages.

Loans on more than 14 million square feet of office space across the metro will mature this year and next, with more than half of that in the Central Business District, according to a new report from JLL.

That report also showed office leasing activity across the region picked up slightly during the second quarter, with overall leasing exceeding 1 million square feet in large part because of new deals in the west metro and the Central Business District. That's in contrast to a quarterly average of 850,000 square feet in the past three years.

Investment sales, however, have been exceedingly rare. The last major tower sale since 2019 was LaSalle Plaza, a 30-story office tower in downtown Minneapolis that sold recently for about half its estimated tax value. Twin Cities-based Hempel Real Estate bought it and plans to invest millions in upgrades and new amenities for building tenants.

In 2020, the tower's value peaked at a bit more than $103 million, according to Hennepin County property records, but it sold for $46 million, well below its current estimated market value of $87 million.

The next sale?

Capella Tower, the second-most expensive office tower in the city, could be next. Eastdil Secured — a New York-based firm that Capella's owner, Shorenstein Properties, has retained — has quietly marketed the 58-story tower to potential buyers, according to downtown sources.

Bryan Rosenberg, director at Eastdil's Chicago office, said this week he was unable to comment on plans for the tower, which Shorenstein bought for $255 million in February 2018, a time when trophy buildings were selling at a rapid clip.

Like many downtown buildings, Capella is now worth far less than its most recent purchase price. This year, Capella valued at $254 million, according to the city assessor's office, down from $294 million in 2020.

Shorenstein also owns the 1.1-million square-foot Washington Square campus, which includes three architecturally distinct buildings along Washington Avenue in downtown Minneapolis.

The company bought those buildings in 2014 and invested tens of millions in renovations. Shorenstein's website now only lists two of those three buildings among its holdings. A source said one of the buildings is said to have found a buyer and could be a candidate for residential conversion.

Beyond the most recent office tower sales, several smaller office buildings have traded hands since the start of the pandemic. The most notable was in early 2021, when Thrivent Financial sold its new corporate campus — an eight-story, 264,000-square-foot building — for $130 million.

Owners of such high-profile office buildings are often discreet when trying to sell their buildings, especially during such uncertain times and while they're also trying to attract new tenants and retain existing ones.

McCarthy, the Colliers broker, said while there are no other office towers publicly on the market, many building owners are considering their options, testing the market and quietly shopping their holdings to a small pool of qualified investors.

"It takes a lot of energy and effort and recourse to bring a building to market," he said. "If the feedback isn't positive, then what do they do? People are just in a wait-and-see mode for the short term."