One sector of Twin Cities commercial real estate that’s not sputtering: Industrial

Industrial buildings often lack curb appeal, but to developers and investors, they might as well be the coveted big house at the end of the cul-de-sac.

Demand for those nondescript, low-rise concrete warehouses, distribution centers and manufacturing buildings that increasingly dot the Twin Cities suburbs remains exceptionally strong at a time when other key segments of the commercial real estate world are sagging. Yet, construction hasn’t quite surged to satiate the hunger.

The average vacancy rate for industrial buildings across the metro has hovered around 4.5% for the past six months, according to new data from Colliers, a commercial brokerage. That’s a percentage point higher than a year ago and just below historical averages.

It’s also a fraction of the double-digit vacancy rate for the office sector. Demand for offices has sunk, and rents have plummeted. Office development in the Twin Cities is at a standstill, and apartment construction is evaporating.

That means the Twin Cities, like many other major metros, should be in the midst of another industrial revolution. If the rise of e-commerce and online retail — with its reliance on massive warehouses and distribution centers with soaring ceilings and plenty of space for storage of goods awaiting delivery — hadn’t already influenced developers, the flagging office and multifamily markets should.

Yet, while demand for industrial space is strong, supply is still waning. Higher borrowing costs and rising construction costs mean fewer new projects and rapidly rising prices.

“Developers had to put their pencils down because of the cost of debt and inflation,” said Joe Owen, executive vice president at Colliers Minneapolis-St. Paul. “It does not make sense to build.”

By the end of June, only 2.8 million square feet of industrial space was under construction across the metro, down 73% from a year ago, according to Colliers. In turn, industrial rents are on the rise, with the average lease rate at $9.55 per square foot, nearly $2 more than a year ago. Lease gains are especially steep in core submarkets of the metro where supply is most limited.

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

Minneapolis-based Opus Group did start an industrial project this week in Dayton: a 132,200-square-foot distribution and light manufacturing facility on a 10-acre site. The company said the Dayton Parkway Business Center will have 28-foot-tall ceilings, 19 dock doors (expandable to 34) and four drive-in doors. It’ll have 136 vehicle parking stalls and 14 trailer parking stalls, plus room for workers and delivery drivers.

“The Twin Cities northwest industrial submarket continues to lead and outperform the balance of the metro with active users and strong demand,” said Nick Murnane, vice president and general manager of real estate development with Opus. “With this facility, we will have the ability to provide a unique offering for users who require smaller footprints in a submarket that has been dominated by larger spaces.”

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

Opus has several other industrial developments in various phases of development and construction, including the River Valley Business Park in Shakopee, which includes two adjacent industrial buildings with a combined 450,000 square feet on 51 acres. This was a “speculative” project, meaning there’s no specific tenant in mind, so the eventual leaser can tailor the raw space to its needs. The buildings have 28- and 32-foot ceilings, an abundance of dock doors and hundreds of parking spaces for delivery vehicles.

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

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

The appeal, Owen said, is these one-story structures cost far less to build and outfit than most mid- and high-rise office buildings.

“A lot of office tenants are looking for less expensive space,” Owen said. “And they’re consolidating their footprint — and costs — into single-story tech buildings.”

That shift is one of many factors driving increases in office vacancies. The latest data on the office sector in the Twin Cities found the average office vacancy rate across the metro increased to 22%, according to a second-quarter report from JLL. That report showed prospective office tenants are on the hunt for about 3 million square feet, roughly a third of the space industrial users are seeking, according to various sources.

Much stronger demand for industrial space is causing rents in that asset class to increase at a double-digit annual pace, but the cost of that space can be nearly half of what it costs to be in some high-rise office buildings.

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

By a long shot, a combination of office/warehouse users and bulk distribution companies are driving the industrial scene in the Twin Cities. Sweet Harvest is one such company best known for its honey, but it also sells agave and molasses. Earlier this month, the company moved into a 360,000-square-foot “logistics center” Twin Cities-based Oppidan developed on a 23-acre site in Lakeville.

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

Since 2015 when Oppidan started developing industrial buildings, the company has completed nearly 5.5 million square feet in several other states, including North Carolina, South Carolina and California.

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