• Vacancy declined across the submarket during the second half, with a majority of new leasing activity taking place in Class A and Class C properties. Class B properties still struggled to attract tenants, largely because of the still-favorable conditions among Class A and C properties. This was reflected in the vacancy numbers: the Class B year-end vacancy rate was 22.1% (23.1% with sublease space), versus a 15.6% (19.6% with sublease space) rate for Class A properties and 22.0% (22.8% with sublease space) rate in the Class C market. The total Class C market in the CBD is less than half the size of the Class B market.
• The CBD saw more interest from suburban space users seeking to relocate to the urban core in the second half. It’s the vibrancy of the city that attracts many suburban users. Downtown rental rates are competitive with those in the suburban submarkets, so the decision to locate downtown can be an economically neutral one depending on a company’s transportation and parking needs.
• Residential condominium development remained strong in the CBD, adding to the vitality of the area. But what’s really attracting the attention of real estate professionals is the upsurge in talk about converting existing multi-tenant office properties to hotel properties. The hotel market has bounced back strongly in the CBD in recent years, to the point that some 600 new hotels rooms are potentially being added to the downtown supply via current redevelopment and construction of three projects. But there may be more on the way, with as much as 700,000 sq. ft. of downtown office space potentially suited for hotel conversions according to some local observers. Buildings that have been publicly identified as candidates for hotel conversions include the venerable Foshay Tower, a 160,000-sq.-ft. landmark office tower at Ninth Street South and Marquette Avenue, and the 520 Marquette Building, a 152,000-sq.-ft. structure at Sixth Street South and Marquette Avenue. Owners of a handful of other buildings are rumored to be considering hotel conversions, but their plans have not yet been made public.
• On the surface, Target Corporation’s decision to expand at its Northern Corporate Campus in Brooklyn Center, rather than in its traditional downtown base of operations, seems to be driven by economics. Target is on record as saying new development costs are as much as 40% lower in the suburban location versus building from scratch in the CBD. However, there have been suggestions that the relationship between Target corporate executives and Minneapolis City Hall is not all it could be. In fact, a Minneapolis Star Tribune editorial characterized the relationship between Target and City Hall as “icy.”

Outlook
Demand for Class A space will likely remain at a strong level in 2006, fueling the majority of what is predicted to be a full year of 200,000 sq. ft. of positive absorption.

As the supply of premium space in the upper floors of downtown office towers diminishes, the rest of the Class A market will grow increasingly competitive. No new multi-tenant construction projects are planned for 2006, nor has anything been announced for 2007 or beyond.