We’re Hiring – Business Valuation Analyst

Business Valuation Analyst

Company Description

Founded in 1929, Shenehon Company is a highly respected and established commercial real estate and business valuation company. Shenehon provides clients with specialized knowledge necessary to solve their valuation problems. Shenehon is one of the few valuation firms in the nation to successfully integrate the practices of business valuation and real estate appraisal. Shenehon also provides consultation and litigation support to clients. Our service area encompasses the Upper Midwest with continued expansion throughout the country. Shenehon Company is an Affirmative Action/EEO employer.

Position Summary

The Business Valuation Analyst will work closely with senior analysts to prepare valuation reports for business enterprises.  Assignments may include valuing professional practices, service, retail or manufacturing companies, minority interests, holding companies, intangible property rights and other unique valuation challenges. The analyst’s work may be used in the potential sale or purchase of a business, gift and estate matters, divorce matters, dissenting shareholder lawsuits, internal management decisions, and purchase price allocations.

Duties and Responsibilities

> Analyze financial statements, company governing documents, and other business information
> Perform detailed financial modeling, including income, market, and asset-based valuation approaches
> Research industry data
> Write narrative appraisal reports
> Collaborate with other appraisers on best practices and quality control
> Interface with clients and senior management during preparation and delivery of valuation assignments
> Additional duties as necessary

Knowledge, Skills and Abilities

> Knowledge of valuation concepts, financial theory, and general accounting
> Superior critical thinking and analytical math skills
> Strong utilization of Microsoft Excel to analyze financial data
> Ability to write clearly and concisely
> Aptitude in quantitative and qualitative analysis
> Must be able to give attention to detail while having the ability to step back and see the “big picture”
> Ability to comprehend, analyze, and interpret various business and real estate documents
> Research oriented
> Excellent communication skills, both verbal and written
> Desire to work both independently and in team environments
> Demonstrated ability to meet deadlines
> Positive and enthusiastic attitude
> MS Office with advanced Word and Excel
> Bachelor’s degree in business, finance, or accounting
> 2 years of applicable experience or coursework

Send resumes to mstrachota@shenehon.com

Minneapolis Mulls Renter Protections

by Brock Boatman

Housing is one of the largest challenges facing communities across the country, particularly providing housing for those in lower- and middle-income brackets. One of the ways in which these groups are being affected is by the common purchase and repositioning of Naturally Occurring Affordable Housing (“NOAH”). In an effort to preserve NOAH, communities are considering various vehicles for preservation, including variations of Washington, D.C.’s Tenant Opportunity to Purchase Act (“TOPA” or the “Act”). TOPA was enacted in 1980 to address the housing crisis at the time, and remains in place today. States and cities across the country are now considering some variation of the TOPA framework, including Minneapolis. In this article, we explore the process by which property owners would comply with these new proposed laws based on TOPA, and how the Act affects the multifamily real estate market in D.C.

The Act classifies D.C. rental housing into three tiers: single-family housing, 2- to 4-unit housing, and 5+ unit housing. Until recently, all three tiers were treated relatively equally. This proved onerous for several important reasons, including discouraging rentals of Accessory Dwelling Units (“ADUs”) on single-family properties. ADUs are quite common in D.C., taking the form of English basements, carriage houses, and “Granny Flats,” allowing single-unit rentals on existing single-family properties. However, the renters of single-family homes yielded extraordinary power to delay sales. As a result, landlords would commonly either keep potential rentals off the market, find ways to terminate leases, or refuse to renew rents at reasonable rates to avoid the often costly alternative, which would be to buy-out the tenant lease. These results ran counter to many of TOPA’s goals. Under the revised D.C. rules, the only single-family tenant protection that remains is the right to occupy a unit for 12 months after sale under the current terms. TOPA now applies to D.C.’s second and third classifications, the 2 to 4 unit and 5+ unit properties, with the primary difference being the timeframes in which the tenants have to act.

For purposes of our discussion, we focus on the 5+ unit properties as they typify multifamily properties as we generally think of them. This discussion assumes typical market rate rentals and tenants; additional legislation in

D.C. applies to special situations, particularly involving seniors and persons with disabilities, but those minutiae are beyond the scope of this discussion.

The key factor affecting a seller is the timing of all the required notices and the tenants’ response periods. When the owner of a multifamily property enters into a sale agreement, they must notify the tenants. The following chart visualizes the various steps required to complete a sale.

After receiving notification of the sale, the tenants may request information regarding the property: floor plans, rent rolls, and income statements – the same information any buyer or investor would typically request. After review, the tenants may form an association (comprised of 50% or more of the tenants of the occupied units) to exercise their tenants’ rights. At this stage, they have four options. The tenants’ association may:

Attempt to purchase the property with terms roughly equivalent to the proposed third-party deal. In these cases the ownership has a responsibility to negotiate in good faith with the tenants’ association, and not attempt to re-trade the deal with terms different than with the third-party buyer. If the purchase goes through, ownership is then typically controlled by the tenants as a cooperative or limited equity cooperative, with tenants holding the right to purchase their units.

Transfer their rights to purchase to a new investor/developer, in which case the tenants have the right to negotiate how the property will be managed by the new owner. This option can also stipulate renovations and rental increases for existing and future tenants, keeping the property cost-controlled, and may involve public assistance, non-profit involvement, or the creation of a public-private partnership.

Offer to release their rights to purchase the property to the existing owner for some consideration, effectively being bought out in exchange for not slowing the sale process. A key component in this arrangement is that some form of consideration must be given by the current ownership, which can become costly for the seller or new buyer when cash consideration is involved.

Opt to do nothing, and the sale proceeds just as we would see today. This option is most often seen with high-end and luxury developments in which new ownership intends to keep the property “as-is,” with no significant plans to renovate or reposition the property.

Under the D.C. law, a tenants’ association can easily tie up a deal for 285 days, or longer. The owner has 360 days in order to enter a sale contract; if not, the TOPA process starts over. This protracted period is necessary for the tenants’ association: they need time for research, analysis, and organization in order to decide what their course of action will be. However, this also creates major challenges for the seller. First, there is the financing issue; most lenders will not commit to a term sheet that they might have to hold for over nine months. Changes in market rates can cause a deal to fall apart while a property owner is negotiating with the tenants’ association. Second, it makes using a multifamily property as the upleg of a 1031 exchange nearly impossible, given that there needs to be compliance with the 180-day rule. As a result, tenants can leverage extraordinary power and money over property owners looking to sell.

So what effects do these laws have on the apartment market? Anecdotally, market participants will say that these laws drive down values. However, we found the two largest outcomes were that 1) deal volume reduced dramatically and 2) properties remained on the market for an extended period of time.

In order to isolate the effects of TOPA legislation, we aggregated the last five years of apartment sales in D.C. and compared that activity to the nearby Alexandria and Arlington, Virginia markets, which are not affected by TOPA laws. After controlling for market size, we found that transactions of apartment buildings and complexes (50+ units) were 25% to 30% lower in D.C. than in the Virginia markets, and properties in D.C. typically spent 50% to 55% more time on the market. Both of these factors lead to downward pressure on values. This makes multifamily buildings a less attractive investment type in a TOPA market, and lowers the real property tax base for municipalities.

TOPA rules exempt new construction as properties under construction do not have tenants. This creates a strange quirk in the market as new construction properties often sell 100% vacant before tenants are able to occupy units and trigger the TOPA process. These laws affect both pure merchant developers as well as groups that intend to retain ownership positions in their projects.

TOPA rules also prompt the question of what constitutes a sale. Up until the mid-2000s, owners could sell 95% – and some argued up to 99.99% – of their ownership and still avoid triggering the TOPA process based on the courts’ interpretations of what constituted a sale. Clearly, this went against the spirit of the Act, and has since been nixed by subsequent court decisions. However, the definition of a sale continues to be debated. A court case this summer asked whether a reallocation of ownership interests constituted a sale. The court ruled that a third party was necessary to define a sale and trigger the TOPA process. More importantly, the case demonstrates that TOPA legislation still provokes questions and challenges almost 40 years after its passage.

So why pursue such legislation? Again, the goal of the legislation is to give renters, particularly those that occupy NOAH, seniors, and disabled people, tools to maintain rents and remain in their homes. Generally, these populations are renters “by circumstance” as opposed to those who rent in the newer luxury developments “by choice.” People renting at top of the luxury market, say $3,000 for a two-bedroom unit in newer projects here in the Twin Cities, are generally not at risk of being displaced by new ownership. Additionally, TOPA legislation creates opportunities for those with more moderate means to purchase their apartment through the creation of a co-op. However, as much as the legislation can help empower renters, it can create substantial challenges in capital markets. As the data shows in the closest “apples to apples” comparison, available deal velocity and timing will be affected, particularly for larger investors. If TOPA legislation passes in Minneapolis, it will take years to fully measure its effects on housing and the real estate market.

Spotlight on South Loop

By H. Ellis Beck

Throughout its history, the northeastern portion of Bloomington, Minnesota has been home to plenty of notable developments.  This corner of a second-ring suburb, sandwiched between the Minnesota River and major highways, has hosted farms, a wildlife refuge, a professional football and baseball stadium, a professional hockey and basketball arena, huge surface parking lots, hotels, and a dedicated space for landing approach lights for Minneapolis-St. Paul International Airport.

Today, the area still has the wildlife refuge, the airport lights, and hotels, but the professional sports venues and their parking lots have been replaced by the Mall of America and IKEA.  Since the 2004 opening of the Blue Line, which connects the Mall of America to the airport and Downtown Minneapolis,  office buildings and multi-family developments have sprung up around the district’s stations.

Still, the area now known as the South Loop sees potential for more growth in its future and announced that potential to the world when the site finished as a finalist to host the 2023 World’s Fair, before eventually losing the bid to Argentina.  It announced it again by entering a bid to host the 2027 World’s Fair, the winner of which has not yet been announced.

Most of this excitement for potential growth centers around the South Loop District Plan, adopted by the Bloomington City Council in August of 2013.  The plan focuses on leveraging the area’s existing assets to foster responsible growth.  These unique assets include the country’s largest mall, which serves 40 million visitors annually, and the district’s close proximity to Minneapolis-St Paul International Airport, a major hub for Delta Air Lines.  The area is home to four light rail stops, increasing opportunity for Transit-Oriented Development and improving walkability throughout the area.  A map by the City of Bloomington highlighting the existing assets is below.

So, what does the city think “built out” looks like for the South Loop?  Below are the published projections for the area.

The South Loop’s population, households, and housing units are projected to more than triple from 2010 through 2050.  The annual population growth rate of 3.1% would roughly quadruple growth rates anticipated in Hennepin County over the same period, and Bloomington expects that over two-thirds of its population growth will occur in the South Loop.  Households and housing units are anticipated to follow a similar trend.  While employment growth is anticipated to lag population, household, and housing unit growth, the South Loop already serves as an employment hub due to the Mall of America’s presence.

Residential units are projected to grow at roughly the same rate as population and households, with office and technical space lagging only slightly behind.  Growth in retail and hotel space is anticipated to trail the housing sector, but the South Loop clearly has an established retail base and is already a hotel hub due to its mall and proximity to the airport.

To encourage growth at the projected rates, the city updated its land use plan to emphasize density, walkability, transit, and public green space, as seen in the map below.

The South Loop exemplifies the growing trend of suburbs transitioning portions of their land from the open, auto-centric, and decidedly “sub-urban” style of planning to a far more dense, transit-oriented, walkable, and “urban” style.  We’ve seen this trend play out in mid-size metropolitan areas; Seattle and Denver area suburbs have recently attempted to build around new or planned transit corridors.  However, Bloomington’s situation is unique in the Minneapolis-St. Paul area.

Locally, suburbs have begun to either prepare to reshape downtown areas to accommodate incoming transit (such as along the Southwest Rail Line) or totally rebuild areas from the ground up (e.g. the Ford Site in St. Paul).  The South Loop is uniquely positioned in that the “hard part” is already accomplished:  trains are already running through the area, people are already coming to the Mall and nearby airport, the groundwork is already laid.  The South Loop’s continuing development from Bloomington’s rural “front door” to its fully built-out form should prove interesting to observe.

Waterfalls and Hurdle Rates in Real Estate Private Equity

By Madeline M. Strachota

What is better—tiered returns or pari passu? It’s up to you.

Private equity organizational structures have various merits and demerits.  As appraisers, we see a variety of entity structures—partnerships, limited liability companies (LLC), corporations—all organized in different ways, which makes understanding the governing documents of an entity essential to understanding the value of an interest in that entity.  Some of the most common reasons for the variety of organizational structures include optimizing wealth transfer in estate planning, tax planning, liability mitigation, incentive alignment, and role allocation based on what each partner brings to a deal.

As an asset class, private investment in real estate has grown substantially in the 21st century.  In fact, it was not until the 1990s that real estate private equity in the form of pooled funds for investment in real estate became popular.  These funds grew out of private investors pooling to take advantage of falling real estate prices in the early 1990s and have continued to grow in popularity, especially in the build up to the Great Recession.  In all economic cycles, investors choose real estate to add diversification to their portfolios, and because the assets are income producing, hedge against inflation, and are tangible.  Within real estate private equity, there is a common entity structure that seeks to align entrepreneurs and investors: the equity waterfall.

Each equity waterfall can be different; however, the main idea is to decide which partner(s) control the everyday operations of the deal and how distributions are made to the different equity classes.  Oftentimes these funds are structured as partnerships with one general partner and many limited partners.  Unlike entities that distribute capital on a pro rata (also known as pari passu) basis according to what portion of the initial investment each investor contributed, waterfalls distribute capital by splitting distributions unevenly among partners after certain performance milestones, known as hurdles, are met.

But why would investors agree to receive a distribution that is not proportionate to their initial investment? The rationale is that entrepreneurs bring ideas and investors bring capital.  As such, each partner needs to be compensated for what they bring to the table and the relative risk they bear.  When capital markets are flowing and good deals are sparse, organizational structures skew to provide a higher reward to the entrepreneur.  Alternatively, if capital markets are tight and deals are plentiful, organizational structures skew to favor the “money” investors.  Furthermore, a waterfall structure incentivizes the general partner to achieve higher rates of return because at each higher rate of return, the general partner receives a disproportionately higher percent of the distributions compared to the limited partners.  Lastly, oftentimes the entrepreneur bears most of the up-front costs associated with real estate development or investment; as such, they must be compensated for this higher level of risk.

Following is a comparison of a typical waterfall structure to a pari passu structure:

Most waterfall models follow the same general principals; however, organizational documents can specify different arrangements that materially impact management decisions and distributions.  Although entity management and distribution allocations are the key differentiators, an infinite number of provisions in the organizational documents can impact value.  For example, there may be a general partner or managing member that controls the entity and receives separate returns; other times there are equally divided interests, each with management voting rights.  In another arrangement, some equity partners are entitled to a “guaranteed” preferred return over other equity partners.  Furthermore, members, partners, or shareholders could be individuals, LLCs, partnerships, or corporations, and these subsidiary entities could have an equally complex structure.

Following are a few additional differentiators among waterfall agreements and why they might matter:

The provision.  Distributions based on individual investments versus aggregate investments.

→ The impact.  If a fund has one investment that performs extremely well, crossing the highest hurdle, but the other investments are a “bust,” the general partner may receive an excessive return on the successful investment, and there may be no returns to any partners on the other investments.

The provision.  A clawback provision.

→ The impact.  If a fund does not perform consistently over time, historical distributions made to a general partner can be clawed back and redistributed to limited partners.

The provision.  General partner in both the voting and nonvoting equity pools.

→ The impact.  Whether the entrepreneur is in the deal as a common equity investor and/or a controlling investor entitled to the promote will determine how the equity splits flow.

The provision.  The waterfall difference between operating cash flow and reversion cash flow.

→ The impact.  If the waterfall specific to operating cash flow favors the general partner as compared to the waterfall specific to reversion cash flow, this incentivizes the manager to hold investments instead of selling.

It is important to understand the governance of an organization with an equity waterfall distribution to fully understand the potential upside and downside of investments.  Additionally, to better understand what cash flows to the entrepreneur, investors should consider the additional fees to entrepreneurs that hit the income statement and are not considered equity distributions.

Real estate private equity has championed the use of waterfall structures for operating and reversion distributions.  Although the intent of the waterfall organizational structure is good, the complexity of the structure begs the question—is it necessary? For those who do not run the numbers daily on these types of funds or do not have years of experience with this asset class, the structure of these pooled investment funds can seem overly complex.  Some critics argue that this structure falls into the category of the exact opaque financial practices that gave way to the Great Recession.  Of course, with any partnership structure, the fiduciary is trusted to make value creating decisions for all partners, and it is possible to exploit investors that do not have specialized knowledge of real estate finance.  However, the waterfall structure alone is not problematic—sure, it may create additional work for accountants and appraisers—yet many argue that this structure efficiently allocates risk and demonstrates an evolving sophistication in the industry.  Time will tell if investors demand simplified organizational structures for the sake of transparency.

The Condition of Business and Real Estate Asset Values

By Robert J. Strachota, MAI, MCBA, CRE®

Note:  The following article is a presentation given by Shenehon President Robert Strachota at the Minneapolis Business Law Institute on May 2, 2016.

I am Bob Strachota, president of Shenehon Company, which appraises businesses and commercial real estate throughout Minnesota and more than 40 other states.  We know the pulse of the Minnesota business climate and are in tune with market expectations of the near future.

Today, we will discuss the condition of the Minnesota business climate for commercial and residential real estate, and the general level of profitability for small and large businesses in our state.

The Minnesota business climate has two major tiers:  the 16-county Twin Cities metropolitan area, and the outstate Minnesota market. Rochester is an exception:  an outstate city that behaves differently than all other outstate cities because of the effect of the Mayo Clinic. Nonetheless, we will keep Rochester in the outstate category because it is not nearly as strong as the 16-county metro area.

The general health of the Twin Cities market is positive, and the prognosis is for a continued upward trend.  The healthy growth curve has not reached the crest of the wave or the high point of a business cycle.  The same applies for the outstate market, but the size of the wave is much smaller.

How do we know this? We typically focus on 6 critical community characteristics when sizing up the economic health of a market. They are:

  • Unemployment rate
  • Average wage level
  • Average age of population
  • Population growth
  • Employer and labor force data (new jobs)
  • Education level of workforce

Characteristics gauging economic health in Twin Cities 16-county area:

  • Unemployment rate: 3.9%
  • Average wage level: $20.75/hour
  • Average age of population: 36.0
  • Population growth: 4.3% from 2010 to 2015
  • Employer and labor force data (new jobs): 1.8%
  • Education level of workforce: 24.2% with Bachelor’s degree

Characteristics gauging economic health in outstate Minnesota:

  • Unemployment: 6.1% (up two-tenths over last year)
  • Average wage level: $17.35/hour
  • Average age of population: 41.8
  • Population growth: 0.7% from 2010 to 2015
  • Employer and labor force data (new jobs): 0.4%
  • Education level of workforce: 14.5% with Bachelor’s degree

Comparing the 16-county metro area and the outstate statistics with statistics for the United States at large underscores the strength of the Minnesota market.

16 counties-outstate-US

By analyzing data like this, we conclude that the Minnesota economy remains in an ongoing expansion, particularly in the 16-county metro area.  As this recovery matures, inflation, high interest rates, and cost-push will tamp down the expansion.  The risk of a Minnesota recession in the near term is low, and it does not appear that the recovery will be ending anytime soon.

Why?  Well, for one, the Minnesota economy is highly diversified. This is one of its strengths.  Of the various market sectors, the energy industry was the only one that was a strong component of the recovery but has now sharply corrected. A handful of Minnesota companies took it on the chin when oil prices plummeted.  The energy industry appears to be refreshing itself in recent weeks and may have already bottomed out.

Currently, there are no storm clouds on the horizon for the Minnesota economy. These would appear if the economy showed evidence of “excesses” by consumers or businesses. On the consumer side, there is little evidence of excessive spending and, in fact, the household savings rate has risen to near record levels in Minnesota.  Furthermore, household net worth is approaching record levels.  As a result, household debt service ratios are near record lows.

As for businesses, we do not see the kinds of excesses that typically reveal themselves ahead of a recession. Instead, we observe that most businesses are not overstaffed, and their capital spending has not been overdone.  Average factory utilization rates have not exceeded 80%.  The housing industry has not boomed out of control, and consumer confidence has been timid.  And, lastly, excessive lending and overbuying is not evident in the marketplace.

Growth image

Business has been good for most Minnesota companies. For 2015, the top 75 public companies operating in the state reported a combined increase of profit of over 5% from the previous year. This includes the energy-related companies that lost over $2 billion.  The total revenue for these 75 companies was over $512 billion, which tops every year since 2004.  Fifty of the companies on the list posted higher revenues than they did in 2014.

IRS and Medtronic

These are impressive results, but there is one statistic that we need to be aware of. The list we could previously study was called the Top 100 Public Companies.  A major reason for the list shrinking is that fewer companies are choosing to be headquartered in Minnesota. The trend is downward, but diagnosing the severity of the problem is difficult.

At Shenehon, we also appraise many private companies. This gives us access to financial information that is not public.  Right now, the patterns of success we have just reviewed for public companies are mirrored in the private sector.

For small businesses specifically, we conduct valuations for federal government Small Business Administration (SBA) loans, and we can report that small businesses are opening up at record levels, creating new jobs and becoming profitable on timely schedules.

So how does the current state of the Minnesota economy affect real estate asset values? Let’s study this by submarkets, which are residential, retail, office and industrial.


residential sales

The residential submarket has to be subdivided further into single-family homes and apartment rental housing.  The single-family home market in the 16-county metro area has been strong and will continue to get stronger.  Short sales and foreclosures no longer dominate the market and have fallen back to historical norms.

homes prices

The traditional home sale transaction dominates the market; both in the metro area as well as most outstate markets.  Average home prices throughout Minneapolis rose 3.98% in February 2016, compared to a national average increase of 5.1%.

Building activity

New housing starts are steady and nearly fully restored to historical levels.  The top cities in the metro area for new housing permits are shown in this next exhibit, with Lakeville leading in dollar value of permitted units, and Minneapolis leading in number of housing units.

Top cities for building

projects under construction

The apartment market is expanding at a record pace, with apartment projects planned throughout the metro area.  Outstate, we have over 1,000 new units planned in Rochester, coinciding with the Mayo expansion, and Duluth is way up as well – five developers have announced plans for a total of 577 new units planned for next year.


Rents continue to rise, and vacancies have shrunk to abnormally low levels.  Exhibit H shows average rents and vacancy levels in various areas in the 16-county metro area and certain outstate markets.

Twin Cities Apartments

Outstate Apartment market

There are two reasons why the rental market is so strong. First, many people lost money in the housing downturn and have chosen a different lifestyle while in recovery.  Second, most young people are saddled with substantial educational debt that precludes them from buying homes, either single-family or condominiums.  Many of us in the real estate industry believe the educational debt crisis will be the next financial debacle that the federal government will need to fix to return normality to the single-family home ownership market.

Student debt


Bolstered by a relatively modest rate of increasing personal income levels and lower fuel prices, demand in the national retail market outpaced supply during all of 2015.  Demand for available retail space in the neighborhood community segment was particularly strong during the year.

The average vacancy rate in the national retail market trended downward another 20 basis points in 2015, declining to the low 10% range.  The national average net asking rates increased 2% during 2015.

The first quarter of 2016 marked the fifth consecutive quarter of positive net absorption in the Twin Cities market.  Across all Twin Cities submarkets the 1st quarter vacancy rate sits at a mere 6.0% and average net asking rental rates are $15.66/sf.

The Minneapolis/St. Paul market experienced a moderate decline in asking rents during the first quarter of 2016.  However, due to the number of new retailers and new restaurants entering the market, demand is expected to cause rents to increase in most submarkets.  Market value of retail space has remained constant over the past year, but has now surpassed the all-time highs from before the real estate recession.

Let’s move onto the office market.


Overall the office market has been affected by somewhat slower job growth, increased financial market volatility, and a marked slowdown in the tech sector.  These influences contributed to a deceleration in the demand for office space in the first quarter of 2016.  During that time, the average rent in 87 metro markets in the US was $28.50/sf.  That was up 4.3% from the prior year.

Overall, vacancy throughout the United States is 13.5% in the office sector.  Current vacancy in the Twin Cities market is slightly higher at 15.1%, however that is down 1% overall from last year at the same time.  It is important to note that the vacancy for office space in the new, north warehouse loop is 6.4%, that is less than half of the national vacancy percentage and it is the tightest office market in our metro area.

In the Twin Cities, the average rent is $21.82/sf in the first quarter of 2016, which is up from $20.63/sf for a 5.8% increase from the prior year.  Office values in the Central Business District, or CBD, are the strongest and have experienced an increase over the past year.  The suburban office market in the Twin Cities as well as other cities has remained rather static throughout the past year.


Our fourth submarket is Industrial.

The manufacturing sector has improved in the first quarter of 2016.  US factory activity expanded in March for the first time since last August.  This is a sign that the nation’s economy is shaking off the effects of a strong dollar, depressed oil prices, and weak global growth.  Current production has picked up, with factory orders rising to their highest level since November of 2014.  All signs suggest there is a pickup in industrial production, yet businesses continue to work through the elevated stockpiles accumulated over the first half of 2015, when record inventories outpaced demand.

There has been progress because inventories have declined in four of the past five months, with one exception being a flat reading in December.  But despite these back-to-back inventory declines, the inventory-to-sales ratio remains elevated at 1.4 percent. This suggests that businesses will need to continue to work through the inventory overhang – which is hampering manufacturing and will curb GDP growth through the first half of 2016.

The average asking rent on a national basis in the first quarter of 2016 was $5.44/sf, which is 3.8% higher than the first quarter of 2015.  The United States national average of vacancy for industrial space is 6.1%, which is down from the historical average rate of 6.8% in the first quarter of 2015.

In the Twin Cities market, the overall vacancy for industrial space at the end of the first quarter of 2016 was 9.4% compared to 10.6% one year ago.  The weighted average rent per square foot for industrial space in the Twin Cities market at the end of the first quarter of 2016 was $6.72/sf, which was up 6% from 2015 when it was $6.32/sf.  At the end of the first quarter of 2016, approximately 900,000 square feet of positive absorption occurred in our industrial market.  Over the last five quarters, the industrial market has absorbed 4.4 million square feet of space.

This is a lot of data to crunch… suffice it to say that in my professional opinion, we can conclude from these numbers that, in the Twin Cities area, the industrial market is healthy and will likely only get stronger.

During 2016, we expect to see an increase in market values or pricing of industrial space that will set new high water marks for industrial property.

Another proof point for this expectation is that the average price per square foot on a national basis increased 9.5% in 2015, which reaffirms the strength of the industrial market.


I would like to wind down by sharing a brief listing of real estate and development opportunities for 2016.

Investment opportunities in gateway markets like the Bakken fields have come and gone. However, opportunities now exist in:

  • Technology Centers. Companies are collaborating on larger facilities with enhanced security to safeguard data and confidential records.
  • Neighborhood development. There is some small neighborhood development available for retail, such as coffee shops, small stores, and specialty services. Anything that starts with an “R” is a safe bet – renovation, rehabilitation, re-position, re-lease, refinance.
  • Residential condominium development. Opportunities exist in spot markets, such as downtown Minneapolis, where there is an acute shortage of “for sale” condominiums. But a 10-year clawback by homeowners is a deterrent.
  • Most Mixed-use urban infill development and redevelopment will be strong, if strategically located.
  • Prime retirement land. Development opportunities will be back as demand for retirement homes in warm places like Florida and Arizona reignites.


  • Last opportunities to lock down favorable long-term, fixed rate debt. Commercial mortgage-backed securities (CMBS) are back, the competition in the lending market is strong and interest rates are below long-term norms. Some owners are refinancing and leveraging up with cheap debt – in a sense, selling to themselves without paying income taxes by using non-recourse debt. But the interest rates are rising and the time is limited to lock down favorable long-term debt.
  • Bargains in Downtown Minneapolis leasing. As Wells Fargo moves to new offices, look for bargain pricing on Class B office lease and subleases in the core of downtown Minneapolis.


Before I close today’s presentation, I want to make a few cautionary comments about market pricing for 2016.

Market pricing is strong across all submarkets; bargains can still be found in large, high-end luxury housing.  There is a strong risk of overpricing in apartment buildings, while hotels are not far behind.  The expectation of low capitalization rates, i.e. sub-6%, is not sustainable.  Corporate balance sheets are strong and earnings are holding, but for foreign exchange issues for multi-nationals.  Unemployment is tightening, but wage growth will be slow because the US competes in a world market of lower wage levels.


Closer to home, here are the takeaways for Minnesota’s economy:

  • Our state’s economy is growing ahead of national trends in the 16-county metropolitan area, and ever so slowly in the outstate areas.
  • Minnesotans are back to work and consumer spending will continue to improve, due to increased “housing wealth,” a recovery stock market, and confidence from de-leveraging.
  • Minnesota businesses will postpone spending and hiring decisions because of a lack of confidence in our current politicians and their strategies for government spending in the future.
  • The Minnesota economy will continue to recover, but it will not boom until the federal government restores confidence in the marketplace on key factors such as employment, inflation and bipartisan cooperation on balanced budgets and deficit reduction policies.

And thanks to each of you for the opportunity to share my thoughts on Minnesota’s business climate for commercial and residential real estate, and the general level of profitability for small and large businesses in our state.

Sources for this article:  Standards & Poor/Case-Schiller, U.S. Census Bureau, Bureau of Labor Statistics, Jones Lang LaSalle, CBRE, Colliers International, Metropolitan Council, The Builders Association of the Twin Cities, Duluth News Tribune, City of Rochester Comprehensive Annual Financial Report, Northstar/MLS, NAI Everest, MPF Research, Zillow

Industrial Market – 2015 Recap


Posting positive demand for the 23rd consecutive quarter in the fourth quarter of 2015, absorption in the national industrial market totaled nearly 220 million square feet during the year, with the pace of absorption increasing across most major markets.  Several trends and factors are supporting strong demand in the industrial sector.

Most notably, e-commerce sale activity continues to increase at an impressive rate and companies are responding to consumer preferences by shortening the supply chain to deliver goods more quickly.  Additionally, a number of coastal markets are also benefitting from the anticipated opening of the Panama Canal expansion.  Given the changing landscape, demand in the industrial sector is projected to be healthy through at least the near and into the long term, and to a significant degree, a sizeable amount of absorption in the industrial sector will come at the expense of the retail sector.

Absorption in the industrial sector during the year was led by the logistics segments, though positive demand was also noted in the light industrial segments.  Demand remains robust throughout all regions.  The strongest absorption figures continue to be noted for logistics space in primary industrial markets, including the Atlanta, Chicago, Dallas-Ft. Worth, and Inland Empire markets.  Absorption in the Midwest region is led by the Chicago market, followed by the Indianapolis, Detroit, and Twin Cities markets.

Led by demand for warehouse and distribution space, absorption in the Twin Cities industrial market totaled approximately 3.55 million square feet in 2015.  The light industrial segment in the local market also was consistently healthy during the year.

New Construction

Led by growth in the logistics segment, new construction activity in the industrial sector increased at a rapid pace in 2015, with the amount of new distribution space added during the year particularly impressive.  New construction deliveries involving logistics space, including both distribution and warehouse properties, increased by 2.5% over the year ended December 2015, while new construction in the light industrial segment increased by 0.2% during this period.  Accounting for a significant portion of the sectors pipeline, speculative construction activity in the industrial sector has surpassed pre-recession levels, with sources indicating as much as 40.0% to 60.0% of new logistics properties under construction are being built as speculative projects.

Among regions, new construction activity is strongest in the West and South regions, but construction levels were also strong in the Midwest and Northeast regions.  Over 20 million square feet of new inventory was delivered in the Inland Empire market during the year, while new construction added over 15 million square feet of space in both the and Chicago and Dallas-Ft. Worth markets.  Despite widespread industrial construction activity in the Inland Empire market, the market’s vacancy rate decreased into the low-3.0% range at the close of 2015, down 80 basis points compared to the fourth quarter of 2014.  In the Northeast region, developers continue to remain active in the Lehigh Valley market, with Liberty Property Trust construction a 1.7 million-square-foot distribution building for Uline and Duke Realty scheduled to deliver a 1.1 million-square-foot speculative building in 2016.

Development activity in the Midwest region was led by the Chicago market, but supported by widespread new construction in the Indianapolis, Kansas City, and Twin Cities markets.  Although the pace of new construction activity in the Indianapolis market appears to be slowing, developers added nearly 6.5 million square feet of speculative space to the market over the last 18 months, adversely affecting occupancy levels in the face of healthy absorption figures.  Developers added roughly 1.77 million square feet to the existing Twin Cities inventory in 2015.  Development activity in the Twin Cities was strongest in the Southwest submarket, but developers are active throughout much of the area.


In the face of robust new construction activity, vacancies in the national industrial sector decreased by 40 basis points in 2015, declining into the mid-7.0% range at the close of the year.  Vacancy rates in over 20 major markets have fallen below 6.0%, and on the national level, vacancy rates have declined by approximately 3.5% in the last five years.  Occupancy levels in the light industrial segment noted the most significant improvement in 2015, but vacancy rates continue to remain tighter in the logistics segment, in spite of new development activity.

Occupancy levels further increased within most major markets.  Vacancy rates remain tightest in the West region, but softer occupancy levels were noted within some markets in the region compared to the year prior.  Occupancy levels in industrial markets throughout the Midwest largely remain strong, but a surge in speculative development is testing demand in several Midwestern markets.  Vacancy rates in the Twin Cities market declined by a sizeable amount in 2015, and though excess capacity exists, noticeable improvements in occupancy levels were recorded in the Southwest submarket.

Asking Rent

Over 50.0% of major markets recorded year-over-year asking rent growth of greater than 3.0% in 2015, as rents increased at a robust pace in both the logistics and light industrial segments.  Strong rent growth was noted across several Midwestern markets, and asking rents advanced across all submarkets in the Twin Cities industrial market, but the strongest growth was observed in the Southwest submarket.

Investment Activity

The industrial sector has emerged as a preferred asset type for institutional and foreign investors.  Favorable investment returns and minimal capital expenditures compared to other asset types as well as the emergence of e-commerce have attracted investors to enter and expand their reach into the industrial market.  Sales activity in the national industrial market increased by 44.0% year-over-year in 2015, with sales volume totaling nearly $72 billion for the year.  Sales activity in the industrial market began the year at a robust pace, before reaching a lull in the second and third quarters of 2015, and then finished strong in the final three months of the year.  Sales volume in the light industrial segment increased by approximately 30.0% year-over-year in 2015, but activity in the light industrial segment remains overshadowed by investment in logistics space.

Industrial assets have become a favored property type among foreign and institutional buyers, resulting in stronger pricing and capitalization rate compression.  The average sale price on a per square foot basis in the national industrial market increased by 9.5% year-over-year in 2015, while average capitalization rates in the sector decreased by 40 basis points during the year.  Prices increased in both segments of the industrial market, with the average price per square foot in logistics approaching $70 per square foot and surpassing the $80 per square foot in the light industrial segment.  Capitalization rates in both the logistics and light industrial segments compressed at a similar rate during the year, and private investors in the industrial sector remain aggressive in underwriting rents and vacancy.

Some concern in the national industrial market, and in the broader commercial real estate market, is the greater amount of portfolio and entity-level transactions.  Three massive sales accounted for over 20.0% of all industrial sales volume in 2015.  Exeter Property Group sold a 57.9 million-square-foot industrial portfolio for $3.15 billion in December of 2015.  Earlier in the year, Global Logistic Properties and Singapore’s sovereign wealth fund completed an $8.1 billion purchase of IndCor Properties industrial assets and operating company from Blackstone, while Prologis and Norges Bank Investment Management purchased a portfolio from KTR for $5.9 billion.  The KTR portfolio contained 60 million square feet of operating space, 3.6 million square feet of space under construction, and a land bank with a build-out potential of 6.7 million square feet.

A number of large single-property sales also occurred during the year, with a significant amount of activity noted in the Midwest region.  Two of the largest single-property transactions at the national level in 2015 involved Duke Realty selling a mission-critical building leased by Amazon in Delaware for $91 million, equating to approximately $89.50 per square foot, and the sale of a newly-built Home Depot Fulfillment Center in Ohio for $97 million or $59.20 per square foot.

Mirroring trends at the national and regional levels, industrial investment activity in the Twin Cities was strong in 2015.  Several large portfolios in the Twin Cities market were sold during the year, but sales velocity drove sales volume in the local market and investment activity in the local market was consistent throughout the year, with healthy activity noted across all segments and submarkets.  One of the largest transactions in the Twin Cities market during the year included the sale of the BAE building for $46.8 million to Gramercy Property Trust in July.

Economy Market View – 2015 Recap

According to the latest Beige Book, seven of twelve Federal Reserve Districts, including the Minneapolis District, reported increasing economic activity.  Economic activity in four of the remaining five districts was noted as mixed or flat, with economic activity declining in the Kansas City district, due to weakness in the energy and manufacturing sectors.

Construction, business investment, and consumer spending continue to take on leadership roles in driving the domestic economy, while global economic concerns as well as conditions in the oil and gas industry and manufacturing sector continue to serve as drags on more robust growth.  Fostering growth in the construction sector, the pace of homebuilding has begun to accelerate and commercial construction activity remains strong across numerous major markets.  Business investment and consumer spending levels also remain encouraging; with conditions in the labor market continuing to tighten.

The energy industry continues to be hamstrung by a glut of supply and tepid demand, resulting in lower commodity prices.  In the state of North Dakota, the number of active drilling rigs has fallen to the lowest levels observed since 2009.  Spot prices for West Texas Intermediate and Brent crude both declined by over 30.0% in 2015, putting significant pressure on producers, with retail gasoline prices falling by roughly 26.8% providing considerable relief to consumers and supporting healthy retail sales.

Although the overall economy expanded for the 81st consecutive month in February 2016, activity in the manufacturing sector contracted for the 5th consecutive month in this period, yet nine of 18 manufacturing industries continued to report growth.  According to the latest ISM Report on Business, the manufacturing sector showed some improvement in February of 2016 compared to year-end 2015, but the Purchasing Manager’s Index (PMI) remained below the pivotal 50.0% mark.  The PMI registered 49.5% in February 2016, up from 48.0% in December of 2015, but down from 52.9% recorded in February 2015.
PMI chartA strong dollar and the downturn in the oil and gas industry are also adversely affecting conditions in the manufacturing sector, with choppy and uneven results recorded across the manufacturing sector during the year.  Manufacturers that rely on oil as an input cost have fared relatively well, while companies that provide goods to oil and gas companies have suffered.  All segments in the manufacturing sector, however, have been impacted to varying degrees by the strength of the dollar, as international export levels at several major ports have sagged.

Several other economic indicators remain mixed.  Activity in the non-manufacturing sector increased for the 73rd consecutive month in February 2016, with the Non-Manufacturing Index (NMI) standing at 53.4%, yet the most recent NMI readings have fallen below the rolling 12-month average of 56.6%.  After falling by 0.3% in December 2015, the Conference Board Leading Economic Index also slipped another 0.2% to 123.7 in January 2016.  In spite of rising concerns, most economic indicators continue to signal modest economic expansion in the months ahead.

National Employment

While representing a slight deceleration from the 2.2% increase recorded in 2014, non-farm employment at the national level increased by 2.0% year-over-year in December 2015 on the net addition of over 2.7 million jobs.  Employment growth in the service-producing sectors increased by 2.1% over the year ended in December, up from 1.9% posted 12 months prior.  The goods-producing sectors also noted improvements, but the pace of growth decelerated from 2.9% in 2014 to 1.0% in 2015.  Marking the second consecutive year of positive, albeit modest, improvements, headcounts in the public/government sector increased by 0.5% in 2015, on par with the growth recorded one-year ago.  The following chart presents non-farm employment growth at the national level.

US non-farm employment growthFacilitated by employment growth, the national non-seasonally adjusted unemployment rate decreased to 4.8% in December 2015, remaining unchanged compared to the month prior, but down 60 basis points from 5.4% recorded in December of 2014.  Tight conditions in the construction sector are creating significant upward pressure on skilled labor wages, yet wage growth remains uneven across employment sectors.

Conditions in the labor market are healthy in the majority of major markets.  Non-farm employment increased by over 3.0% annually in 18 of the largest 84 metropolitan areas during year, with 16 of the 18 markets also boasting unemployment rates below 5.0%.  The pace of job growth remains strong across a number of markets in the West region, but hiring activity continues to gain momentum in several Midwestern markets.

The following tables present the nation’s top 10 leaders and laggards in unemployment rates and employment growth.

unemployment rate

Leading non-farm employment growth in the Midwest region were the Sioux Falls and Grand Rapids metropolitan areas, which witnessed year-over-year employment growth of 4.1% and 3.8%, respectively.  Non-farm employment in the Twin Cities metropolitan area increased by 1.8% year-over-year in 2015 on the net addition of approximately 34,000 jobs.  Job growth within several of the Twin Cities largest employment sectors, including education/health services, professional/business services, and financial activities, remained particularly encouraging, though the strongest growth was within the leisure/hospitality sector during the year.

TC non-farm employment growthUnemployment rates within 68 of the largest 84 metropolitan areas were below 5.0% at the close of 2015.  Labor markets are tightest in the Midwest region, with seven of the largest metropolitan areas enjoying unemployment rates at or below 3.5%.  The non-seasonally adjusted unemployment rate in the state of Minnesota stood at 3.6% in December 2015, unchanged compared to the year prior, but up 60 basis points compared to 3.0% posted in November of 2015.  Labor markets in most Minnesota metropolitan areas remain relatively tight.  Unemployment remains lowest in the Mankato area (2.5%), followed by the Rochester (2.9%) and Twin Cities (3.1%) areas, while unemployment stands above the statewide rate in the St. Cloud (3.7%) and Duluth (5.5%) areas.

MN unemploymentFor-Sale Residential

Sales activity and prices increased by sizeable margins in the national for-sale residential market during the year.  Existing home sales activity increased by 6.3% in 2015, compared to a decline in 2014, while the pace of new single-unit home sales advanced at a more rapid rate, increasing by 14.6% in 2015.  Activity within both the single-unit and multi-unit segments also showed improvement, as renewed demand continues to build for townhome and condominium product.  In turn, the national median home sale price increased by 6.9% in 2015, rising from $208,400 to $222,700 during this period.

Among regions, pricing increases in the for-sale residential sector were led by the West region, which witnessed the region’s median home sale price increase to $323,600 at the close of 2015, up 8.4% compared to the year prior.  In the West region, the for-sale residential sector remains strong across most markets, with an aggressive pace of growth recorded in the Denver, Portland, and Seattle markets during the year.  In the Denver market, the median home sale price has increased by over 20.0% within the last 24 months.  Sale prices also are rising at a robust pace in markets hit hardest by the subprime crisis, with the median sale prices increasing by at least 9.0% in the Las Vegas, Orlando, and Phoenix markets in 2015.  Although noting significant upward pressure in 2015, for-sale residential product remains a relative bargain in the Midwest region, with a median home sale price standing at $171,600 in the fourth quarter of 2015, nearly 20.0% below the national average.

Progress continues to be noted within the for-sale residential sector in the Twin Cities market.  Increasing from approximately 49,600 in 2014 to 56,390 in 2015, the number of closed home sale transactions in the Twin Cities market increased by 13.7% over the year ended December 2015.  Indicating healthy demand, the average days on market decreased by 2.6% and the percentage of original list price received increased by 1.0% during this same period.  Due to stronger competition among buyers, the median home sale price in the Twin Cities metropolitan area increased by 7.0% over the year ended December 2015, increasing to $220,000 at the close of the year.


Employment growth and progress in the for-sale residential sector have supported a more optimistic outlook from homebuilders, and confidence among homebuilders rose to the highest levels in more than a decade in 2015.  The National Association of Home Builders/Wells Fargo Housing Market Index increased to 60 in June 2015 and remained at or above that level through the close of 2015.

Both commercial and residential construction activity remains strong in the Twin Cities market.  In the city of Minneapolis alone, construction permits were issued for development projects valued at nearly $1.4 billion in 2015, marking the fourth consecutive year of over $1.0 billion in permitting activity.  Construction is scheduled for completion on the new Vikings Stadium and massive Downtown East project in 2016, yet a number of significant development projects remain in various stages of the construction pipeline throughout the region that will support healthy activity into at least the intermediate term.

Apartment Market

Facilitated by healthy employment growth and favorable demographic trends, the apartment market continues to remain strong at the national, regional, and local levels, in spite of a wider new construction pipeline.  Asking rents at the national level continued on an upward trend in 2015, marking the 6th consecutive year of asking rent growth in excess of 2.5%, while vacancy rates in the national apartment market remained essentially unchanged.  Conditions in the Midwest regional and Twin Cities apartment markets closely mirrored trends observed at the national level, as underlying fundamentals and investment activity remain strong.

Sales volume in for 50+ unit apartment properties in the Twin Cities market increased by approximately 6.4% over the year ended in December 2015, reaching nearly $900 million during the year.  Apartment pricing in the Twin Cities market also continued on an upward trend during the year, and the average price per unit in the Twin Cities market increased by 32.0%, rising from $112,850 in 2014 to nearly $150,000 in 2015.  Upward pressure on pricing in the Twin Cities market has been supported by a greater composition of sales activity involving newly built Class ‘A’ properties in the region’s core.

TC 50+ unit sales activity

Notable transactions in the Twin Cities market during the year involved several Class A buildings in the core of Minneapolis, including 222 Hennepin, The Paxon, and The Walkway.  These three transactions combined to account for approximately 22.0% of sales volume involving 50+ unit properties in the Twin Cities market in 2015.  Several large suburban apartment assets also traded in 2015.  Valley Creek Apartments, a 402-unit apartment property in Woodbury, sold as a value-add property for $54.25 million in May of 2015, after selling for $33 million five year prior.  Sales activity involving small- and mid-size properties also remained healthy through 2015.

CRE Market

Fundamentals across the industrial, office, and retail sectors also continue to demonstrate improvement, with the most robust growth recorded within the industrial sector.  Led by demand for logistics space, market conditions in the industrial sector at the national, regional, and local levels continued to improve in 2015, with strong absorption figures driving vacancy rates lower and putting upward pressure on asking rents.  Absorption in the office sector has been supported by a more intense pace of employment growth within the traditional office-using employment sectors.  Vacancy rates in office sector continue to trend downward, putting upward pressure on asking rents.  In spite of the rise in e-commerce and the pursuit of smaller footprints by retailers, the retail sector also noted positive absorption in 2015.  Combined with a more restrained pace of new development activity, demand for retail space facilitated improvements in occupancy levels and asking rents.

Fueled by improving to strong underlying fundamentals, the availability of low interest rate financing, and attractive yields relative to alternative investments, investment activity in the commercial real estate market remained strong in 2015.  Sales volume for property and portfolio sales of more than $2.5 million increased for the 6th consecutive year in 2015, with sales volume increasing on a year-over-year basis in three of the four major property types.  The strongest year-over-year growth in sales volume was recorded within the industrial sector, yet overall sales volume continued to be led by the apartment and office sectors.  The following chart presents national sales volume in the four major property types for property and portfolio sales of greater than $2.5 million.

CRE investment activityFor additional details on the performance of the national, regional, and local commercial real estate markets, please see our 2015 property sectors recaps at www.shenehon.com

Data referenced in this report was current as of March 7, 2016, and includes preliminary employment numbers as reported by the Bureau of Labor Statistics, which are subject to revision.

Market View Q3 2015

Economic and Real Estate Market Snapshot

Article Highlights:
• National economic activity on the upswing
• Homebuilding, business investment and consumer spending drive economic growth
• Housing Market Index increased to highest level since October 2005
• Non-farm employment increased by approximately 513,000 jobs
• Unemployment is under 5% in 49 of the 82 largest metropolitan areas
• Manufacturing production growth is uneven among industries
• Capital markets – when will the Fed raise rates?
• Homeownership rate falls to lowest level in 50 years

National landscape – economic activity on the upswing

According to the latest Federal Reserve Beige Book, eleven of twelve Federal Reserve Districts, including the Minneapolis District, reported increasing economic activity. Largely due to weakness in the energy sector and a stronger dollar, the Kansas City District reported a slight decline in activity. After a brief pause, the dollar rally resumed in earnest following the close of the third quarter, and upward pressure on oil prices observed in the second quarter dissipated, with WTI Crude and Brent Crude spot prices down 17.3% and 19.5%, respectively, year-to-date in the first week of November.

Markets highly correlated with the oil and gas industries have been feeling the pressure of low commodity prices, but lower prices have given consumers more spending power, as retail gas prices have decreased by over 25.0% year-over-year as of the first week in November. The following graph presents year-to-date crude oil spot prices through the first week in November.

spot oil prices

A deceleration in the pace of growth was also noted within the Chicago and Richmond Districts. Similar to the Kansas City District, economic activity in the Chicago District was restrained by softer conditions in the manufacturing and agricultural sectors. Although year-to-date twenty-foot equivalent unit (TEU) activity was up over 8.0% at the ports in Baltimore, Charleston, and Norfolk, a slowdown in overall port activity was noted in the Richmond District during the third quarter, while persistently weak fundamentals in the coal market also continue to adversely impact economic conditions in the region.

Homebuilding, business investment, and consumer spending are taking on new leadership roles in driving economic growth and are supporting growth in the face of global economic turmoil. Facilitated by a healthy employment market, the housing sector has been a bright spot for the economy, while outlays for capital equipment are bolstering business investment. Demonstrating optimism within the housing sector, the National Association of Home Builders (NAHB)/Wells Fargo National Housing Market Index increased to 64 in October of 2015, marking the highest level recorded since October of 2005. The following graph presents the historical NAHB/Wells Fargo National Housing Market Index.

National Housing Market

Retail sales show improvement

Although consumer confidence decreased in the final month of the third quarter, retail sales levels continued to show improvement through the close of the third quarter. Retail sales volume is up nearly 2.5% year-over-year, with food and beverage expenditures increasing by over 3.0%. Though overall consumer spending levels are encouraging, sales of automobiles and other long-lived, low threshold items are fostering a significant portion of retail sales growth, which creates some caution looking forward. The following graph presents national retail sales figures and the Consumer Confidence Index through the third quarter of 2015.

Retail salesIn addition, public spending is on pace to add to the nation’s economic growth for the first time in five years.

National employment levels increase

Mirroring the pace of growth noted 12 months prior, non-farm employment at the national level increased by 2.0% year-over-year in September of 2015 on the net addition of approximately 513,000 jobs in the third quarter of 2015. A stronger dollar is proving to be a significant obstacle for growth in the manufacturing and leisure/hospitality sectors at the national level, with weakness in the energy sector also resulting in cutbacks at some manufacturers and declining average weekly hours and overtime of production in the manufacturing sector as a whole. In spite of these obstacles, solid job growth figures drove the nation’s non-seasonally adjusted unemployment rate down to 4.9% in September of 2015, down 30 basis points from the month prior and down 80 basis point from 5.7% reported in September of 2014. The following graph presents year-over-year non-farm employment growth at the national level.

Employment GrowthConditions in the labor market are healthy in the majority of major markets across the nation, with a significant percentage of markets noting strong job growth in already existing tight markets. Over the year ending in September of 2015, 16 of the 82 largest metropolitan areas in the nation noted year-over-year employment growth in excess of 3.0% at the close of the third quarter of 2015, with 12 of the 16 metropolitan areas also boasting unemployment rates below 5.0%. Only two of the 82 largest metropolitan areas, including New Orleans and Richmond, noted year-over-year job losses during this period. Unemployment rates remain below 5.0% in 49 of the 82 markets, with a growing number markets reporting unemployment rates below 3.0%. The following graph presents employment conditions in the nation’s 82 largest metropolitan markets.

Employment ConditionsAs a whole, unemployment rates remain lowest within markets in the Midwest region, while employment growth remains strongest within markets in the West region. The following tables present the nation’s top 10 leaders and laggards among unemployment rates and employment growth.

Unemployment Cities

Economic indicators remained flat

Several leading indicators slipped or remained essentially flat during the third quarter, but readings still suggest a moderate pace of economic growth will continue into the near term. The Conference Board Leading Index® dipped to 123.3 in September, down from 123.5 reported in the prior two months, yet the index continues to suggest a moderate pace of economic expansion in the months ahead. The NFIB Small Business Optimism Index stood at 96.1 in September and into October of 2015, compared to 95.3 reported in September of 2014 and 96.1 noted in October of 2014. Increasing dramatically over the last 12 months, the quality of labor has risen into the top three most important concerns among small business owners, moving ahead of concerns over sales in priority.   According to the most recent NFIB Small Business Economic Trends report, other major concerns include taxes and government regulations and red tape.

Though bordering on contraction, economic activity in the manufacturing sector expanded for the 34th consecutive month in October. According to the ISM Report on Business®, the Purchasing Manager Index (PMI) was recorded at 50.1% in October, down slightly from 50.2% noted in the prior month, with seven of 18 manufacturing industries reporting growth in October. Indicative of slower growth, the Manufacturers Alliance/MAPI Foundation reports manufacturing production is very uneven among industries, but anticipates the overall level of manufacturing activity will increase by 2.0% in 2015. The following graph presents the historical PMI from 2000 through October of 2015.

Purchasing Managers Index

State of Minnesota employment still growing

Non-farm employment growth in the state of Minnesota increased by 1.3% over the year ending in the September of 2015, slightly outpacing the 1.1% year-over-year gain noted in September of 2014. The following graph presents historical year-over-year non-farm employment growth in the state of Minnesota.

MN EmploymentFacilitated by positive job growth, the non-seasonally adjusted unemployment rate in the state of Minnesota fell to 3.2% in September of 2015, down 30 basis points from 3.5% noted in the prior month as well as in September of 2014. The unemployment rate in the state of Minnesota continues to track below the national level, and unemployment levels remain tight in markets throughout the state. As of September of 2015, the unemployment rate remains lowest in the Mankato area (2.6%), followed by Rochester (2.7%), Minneapolis-St. Paul (3.1%), St. Cloud (3.1%), and Duluth (4.4%). The following graph presents unemployment rates for MSA markets in the state of Minnesota, the state of Minnesota, and the United States.

Unemployment by MSATwin Cities employment up

Non-farm employment in the Twin Cities metropolitan area increased by 1.8% over the year ending in September of 2015 on the net addition of approximately 35,300 jobs. Combining to add nearly 22,000 jobs, the leisure/hospitality (4.8%) and professional/business services (4.4%) sectors led job growth during this period. Employment gains in the leisure/hospitality sector were driven by hiring activity within the food service and accommodations industries, while rising payroll figures within the professional/business services sector were bolstered by strong growth within the computer system design and services industries. Further growth in the region was held back by losses in the public, information, and traditionally, low-wage other services sectors.

Capital markets – when will the Fed raise rates?

Anticipation of the Federal Reserve lifting its benchmark rate for the first time in nearly a decade continues to build, yet officials are reinforcing that any rate increases will occur at a measured pace to avoid disrupting a fragile global economy. As of the second week in November, the CME Fed Watch indicates there is a 70.0% probability of a rate hike in December, while 85.0% of respondents expect an increase in rates at least by March of 2016. According to a more recent poll of business and academic economists conducted by The Wall Street Journal, approximately 92.0% of respondents expect the Fed to raise its benchmark federal funds rate in December. Regardless of exact timing, a rate hike in the immediate term appears inevitable, yet interest rates will remain at historically low levels through at least the near-term.

Key RatesAlthough rallying in the first week of November, the 10-Year Treasury is unlikely to increase in lock step with any increases in short-term rates, due to robust demand for risk-free assets, though volatility is anticipated.

10 Year TreasuriesRising yields for corporate bonds may pull some capital away from the commercial real estate sector in the near-term, but the bigger impact in rising corporate bond yields is on the return expectations from commercial real estate assets. Alternative investments, such as commercial real estate assets, continue to offer far greater upside than bonds. While the bond market offers investors greater liquidity, commercial real estate assets provide an investor the ability to take advantage of net operating income growth and property appreciation. Competitive pressures and robust flows of capital will continue to support improvements in the commercial real estate market, putting further upward pressure on prices and downward pressure on capitalization rates as spreads narrow closer to historical norms.

Rates and Spreads 2Among property types, the average capitalization rate spread over 10-Year Treasuries remains widest compared to historical norms within the apartment sector. Capitalization rates continue to compress for apartment assets in most markets and across all property classes, and spreads between primary and secondary/tertiary markets as well as among the upper and lower tiers are tightening, demonstrating strong competition for riskier assets as investor search for higher yields. Spreads tightened in the second quarter of 2015 compared to the first three months of year across all property sectors, with the most substantial compression observed within the industrial sectors.

Cap Rate SpreadApartment market projected to remain healthy

Employment growth and new household formation is driving healthy to strong demand for apartments units across most major markets, though the pace of new construction activity is also accelerating in most major markets and on the verge of outpacing absorption at the national level. In spite of a robust construction pipeline and signs of stronger competition from the for-sale residential sector in a number of major markets, national and regional vacancy rates have not been materially affected. At the national level, the average apartment vacancy rate has remained in a tight band within the low 4.0% range over the last ten quarters. Tight vacancy rates are facilitating rent growth, with asking rents increasing across all tiers. Asking rents are forecast to increase in the mid 3.0% range by the close of 2015 compared to the year prior, essentially matching the pace set in 2014. Effective rent growth in the Class ‘B/C’ segment is outpacing effective rent growth in the Class “A’ segment.

Conditions in the apartment market are projected to remain healthy through at least the near term and into the long term. Favorable demographic trends are expected to support demand, and the apartment market is expected to continue to capitalize on improvements within the labor market, as the brighter employment picture and outlook for entry-level workers and recent college graduates helps to unleash pent-up demand and new household formation from this cohort.

Homeownership rates fall to lowest level in 50 years

While the for-sale sector has demonstrated some renewed vigor, homeownership rates have fallen dramatically and are not likely to reach back up to peak levels in the foreseeable future. Homeownership rates have fallen to the lowest levels recorded in nearly 50 years, decreasing from a peak of 69.2% in the fourth quarter of 2004 to 63.7% in the third quarter of 2015. Homeownership rates have declined across all age cohorts, but have decreased most noticeably within the prime first-time home buyer cohort, age 35 to 44. The national homeownership rate for this cohort declined to 58.1% in the third quarter of 2015, down from 70.1% recorded at peak in the first quarter of 2005. As of the third quarter of 2015, homeownership rates are lowest in the West region (58.7%) and highest in the Midwest region (68.1%), but rates across all regions are significantly lower compared to pre-recession peak levels.

At minimal expense to the apartment market, the for-sale residential sector continued to gain traction through the first nine months of 2015. The national median single-family home sale price rose from $217,100 in the third quarter of 2014 to $229,000 in the third quarter of 2015, increasing by 5.5%. Rising home sale prices were noted across all regions, but growth was strongest within the South and West regions. Median single-family home sale prices in the San Jose (12.2%), Denver (11.9%), and San Francisco (10.7%) markets all increased by over 10.0% year-over-year in the third quarter of 2015. A number of markets in the state of Florida also reported year-over-year growth in excess of 10.0%, including the Tampa-St. Petersburg market, which witnessed the median single-family home sale price increase by 20.7% over the year ending in September of 2015.

Twin Cities for-sale market – increased activity and prices

Highlighted by growth in several important metrics, activity continues to increase in the Twin Cities for-sale residential market. Year-to-date closed sale transactions in the Twin Cities market were up 15.6% in September of 2015, increasing from 38,185 in the first nine months of 2014 to 44,138 through the first three quarters of 2015. Increasing competition among home buyers drove the median home sale price up 6.8% year-over-year in September of 2015, while the number of days on market decreased by 2.6% during this same period. Increasing from $206,000 in September of 2014 to $220,000 in September of $220,000, the median home sale price in the Twin Cities market is up nearly 15.0% compared to 2013. Meanwhile, the average number of days on market has decreased by over 40.0% compared to 2010. Positive trends within the local market are encouraging potential sellers to bring inventory to market, with new listings up 5.6% year-to-date in 2015, but momentum within the for-sale residential sector is likely to take a significant hit if and when interest rates tick upward.

Industrial market continues to be healthy

Although the strong dollar and weakness within the energy sector have held back further growth at the national level, the emergence of e-commerce has led to demand outstripping the pace of new deliveries within the industrial sector. Encouraging demand for warehouse and distribution space, e-commerce sales growth is far outpacing sales growth at traditional brick-and-mortar stores. Although less robust, absorption within the light industrial and flex/R&D segments also remains positive through the first nine months of 2015. Vacancy rates have ticked downward in the face of stronger levels of new supply, facilitating a health pace of rent growth.

Demand in the Twin Cities industrial market continues to be healthy, and strong operating fundamentals are encouraging speculative development in the region. Mirroring trends observed at the national and regional levels, demand in the Twin Cities industrial market has been strongest within the warehouse/distribution segments. Warehouse/distribution and bulk warehouse space accounts less than 35.0% of all industrial space in the Twin Cities market, but has accounted for over 55.0% of all year-to-date absorption in 2015.

Sparking a sizeable amount of demand in the local market, the rise of e-commerce has been a significant boon for the Twin Cities market and other tertiary markets in the state of Minnesota. Positioned at the intersection of Highway 169 and Highway 14, the Mankato area is a prime example, as demonstrated by FedEx and Wal-Mart selecting sites along the Highway 14 corridor in Mankato for new distribution centers. Wal-Mart officially opened the company’s $75 million distribution center in August, while the FedEx facility was sold in September for $7.45 million or approximately $81.85 per square foot.

Office market recovery is accelerating

Surpassing previous peak levels by approximately 5.0%, employment among the traditionally office space using sectors has reached new record levels. The pace of absorption within the national office market was is up nearly 25.0% year-to-date compared to the first three quarters of 2014, as improvements in the labor market are spurring demand for office space. Headwinds, including denser tenant space requirements, continue to linger and the recovery remains moderate compared to historical norms, yet the pace of recovery is accelerating, and vacancy rates at the national level have fallen to the lowest level since 2009. In turn, the pace of effective rent growth in the office market is increasing and now on par with the growth rate observed in the apartment market. Positive momentum in the office market continues to build, but the new construction pipeline is also widening, though speculative building remains at relatively low levels yet increasing.

Occupancy levels in the Twin Cities office market are above the national average, but new construction is underway on several major developments that will introduce a significant amount of new supply to the market’s existing inventory. Combined with smaller per employee space requirements, a number of tenants are simply shuffling into new space from existing footprints, which will put upward pressure on vacancies as new supply is delivered and likely result in softer vacancy rate within segments of the local market.

Retail market experiencing expansions and demand

Although remaining bifurcated, the retail sector at the national level is moving along swiftly in the recovery process. Retailers are following through on planned expansions and increasingly signaling an appetite for new space. Stronger demand and historically modest levels of new construction activity are pushing occupancy levels higher and facilitating a solid pace of rent growth, as landlords gain more leverage in negotiations. Absorption in the retail sector outweighed new supply for the 14th consecutive quarter in the third quarter of 2015. New construction activity remains relatively muted, and trends within the sector include new space being delivered within mixed-use projects and entertainment destinations.

Investors have a seemingly endless appetite for single-tenant net lease assets, while demonstrating a renewed interest in community shopping centers and regional malls in response to improving fundamentals. Sales volume for single-tenant net lease assets remains strong across all retail categories, and strong competition has pushed capitalization rates into the low-4.0% range for well-located net lease assets with lengthy remaining lease terms and investment-grade credit tenants. Investment activity in regional shopping centers and malls surged through the first nine months of 2015, pushing sale volume in the segment up significantly and shifting cap rates downward by a sizeable amount.

Hotel market setting new average occupancy levels

Average occupancy levels may well reach new record levels in 2015, and year-over-year Average Daily Rate (ADR) growth is expected to surpass 5.0% in 2015, outpacing the 4.4% gain noted in 2014. RevPAR is forecast to increase by over 7.0% in 2015. In response to stronger operating fundamentals, new construction activity is rapidly accelerating at the national, regional, and local levels, with new deliveries at the national level forecast to increase existing supply by approximately 2.0% by the close of 2015.

An emerging trend within the hotel sector is the development of on-site airport hotels. A 14-story, 515-room Westin is scheduled to open at Denver International Airport in the fourth quarter of 2015, and over the last 18 months, Minneapolis-St. Paul International Airport, San Francisco International Airport, Baltimore/Washington International Thurgood Marshall Airport, Hartfield-Jackson Atlanta International Airport, and Kennedy International Airport have all announced plans for hosting on-site hotels. This trend is being driven by strong occupancy rates at existing on-site airport hotels, and a desire from business travelers for lodging in close proximity to airports in order to maximize productivity

CRE investment activity is strong

Favorable financing opportunities and higher yields compared to other investment alternatives are inspiring investor interest in the commercial real estate sector, particularly for high-quality core-plus apartment and net lease assets with long remaining lease terms and investment-grade credit tenants. Through the first three quarters of 2015, sales volume in the office sector has accounted for approximately 35.0% of all sales volume among the four major property types at the national level, followed, in order, by the sales of apartment, retail, and industrial properties.

Assisted by several massive portfolio and entity-level transactions, year-over-year sales volume growth has been most robust in the office and industrial sectors, which each noted increases of roughly 30.0% in sale volume over the year ending in September of 2015. The apartment and retail sectors also recorded healthy sale volume growth during this period, with volume increasing by 9.0% and 14.0%, respectively, in these sectors. Nationwide per unit of comparison prices in the apartment, retail, and industrial sectors were all up over 10.0% in September compared to the year prior. Largely due to suburban office assets accounted for a greater composition of office sale activity, per unit prices in the office sector were essentially flat, though upward pressure on CBD office assets remains significant.

A more limited amount of availability inventory has provided investors with a challenge in placing capital, but instead of retreating from the sector, strong interest in commercial real estate assets has forced investors to expand comfort zones in term of depth and breadth of investment. Prices in primary markets and within the four main property types are reaching up to record levels, due to strong investor demand and limited available inventory. Surpassing previous pre-recession peak levels, Commercial Property Price Indices (CPPI) in the third quarter of 2015 were 14.5% above November of 2007 levels on a nominal basis and 1.5% above previous peak levels after adjusting for inflation. As a result, investors are increasingly moving into secondary markets with healthy, broad-based economies, including the Austin, Denver, Nashville, Portland, Raleigh, and Twin Cities markets. Investors are also expanding into alternative assets and niche markets on the fringes of the commercial real estate industry, and increasingly demonstrating strong interest in self-storage, data center, parking garage, and life science assets. In addition to expanding investment horizons in terms of geography and product type, investors are increasing their appetite for taking on lease-up and development risk to achieve higher returns.

Illustrating the demand for alternative assets within niche sectors along the fringes of the commercial real estate market, Blackstone agreed to purchase BioMed Realty Trust for approximately $8 billion. BioMed owns 18.8 million rentable square feet of space catering to life science tenants in the United States and United Kingdom, with a high concentration of assets in the biotechnology hubs of Boston, Raleigh, San Francisco, San Diego, and Seattle. A transaction is anticipated to close in 2016.

Identified as one of the Top 20 US Markets to Watch in 2016 by Urban Land Institute’s Emerging Trends in Real Estate report, the Twin Cities market continues to emerge among the national landscape and is taking on more of a leadership role with the Midwest region. Achieving the highest ranking of all markets in the Midwest region, the Twin Cities was trailed closely by Indianapolis (22), followed by Chicago (26), Columbus (27), and Detroit (33).

Sales velocity and volume in the Twin Cities market as well as throughout the broader Midwest region have been healthy through the first three quarters of 2015. One of the most recent notable transactions in the Twin Cities market involved Ecolab purchasing Travelers Cos. 17-story North Tower building in downtown St. Paul for $47 million in August of 2015; however, an increasing portion of sales activity and investment in the first three quarters of 2015 has included suburban office assets.

Increasing investor attention to suburban office assets has also been noted throughout the broader Midwest and national regions. In August of 2015, Duke Realty sold a portfolio of five suburban office assets to Apollo Global Management for over $100 million. A significant number of suburban office transactions in 2015 have involved portfolio sales from sellers that are transitioning away from the office sector.

Rising sales prices and valuations combined with more limited available inventory have restrained further growth, but investor interest still remains strong for CBD assets and some CBD markets are more active than their suburban counterpart. The Chicago market is a prime example of strong activity within the CBD office sector. Following a significant amount of activity in the first half of 2015, Piedmont Office Realty Trust sold the 80-story Aon Center in downtown Chicago for $712 million or $260 per square foot in July of 2015, just after signing Kraft Heinz Co. to lease 170,000 square feet at the property. Healthy demand from users and favorable operating fundamentals have been and projected to continue driving investment activity in the Chicago CDB, with Con Agra announcing plans to move the company headquarters from Omaha to downtown Chicago. Con Agra will lease 168,000 square feet in the Chicago Merchandise Mart beginning in the summer of 2016.

Development trends – development interest remains strong

In addition to strong competition from investors for existing assets, many secondary markets are witnessing intense interest from developers, including the Twin Cities market. For the fourth consecutive year, more than $1 billion worth of construction permits have been issued in Minneapolis. Construction in the Twin Cities has remained strong for apartments in the region’s urban core, but new development activity has not been confined to any one property type or submarket. Similar development trends are being observed in other secondary markets throughout the nation.

More than 100 new construction projects, with an estimated combined value of $2 billion, are currently underway or planned to begin construction in 2016 within the Nashville market. Development in the Nashville market is concentrated on previously underutilized parcels of land in the downtown area of Nashville. Scheduled for completion in 2017, construction is underway on a 30-story, $220 million office building that will serve as the headquarters of Bridgestone Americas. Construction is also in progress on a 27-story, $120 million Westin, which is slated for completion in late 2016. Both of these developments are located within the South of Broadway (SoBro) neighborhood core of the Nashville market, but development is also occurring along the fringes of the urban core and suburban areas.


Latest Valuation Viewpoint newsletter is available online

Shenehon Company’s latest issue of Valuation Viewpoint is now available to view online. Articles in this issue include:

• Shenehon’s Joshua Johnson offers insights on business valuation matters
• Waterfront residential market market toward full recovery
• Are there any prevalent trends in discounts? It depends.
• Real estate transaction: Northland Plaza in Bloomington, Minnesota
• Business transaction: Small rural radion stations still in demand

View the latest Valuation Viewpoint newsletter.