Navigating the shifting Twin Cities office leasing market

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Like any other sector of the business world, the office leasing market is in a constant state of motion, subject to micro and macro trends, depending on the state of the economy, supply and demand and a host of other factors.

In Minneapolis, the office space status quo is best understood as “a tale of two markets,” according to Pete Kostroski, co-founder of the Minneapolis tenant rep firm Rokos Advisors. Those two categories are downtown — where a number of office properties are suffering from sub-par occupancy rates and values that have declined — versus West End (in St. Louis Park) and the North Loop — both of which are thriving, with low vacancies and prospective tenants hotly competing, for newer class A office space.

“You need to have a good strategy for each one of those markets when you’re trying to create best opportunity for your company,” Kostroski said.

“Above all, the most important thing is to make sure you give yourself enough time to negotiate a new lease, at least 12 months in advance,” Kostroski advised. “Your ultimate goal is to create leverage and the one best way to do that is time.”

Also, “when you start the process, the most important use of that time is” to define your size requirements. You don’t want to take too much or too little and then find yourself in a reactive position, Kostroski said.

One thing tenants often overlook, he said: “a landlord might know you are leaning toward renewal. Don’t treat it like a renewal and only talk to your own landlord. You have to get out in the marketplace, and you might be surprised at the opportunities out there with landlords who are hungry.”

While tenants tend to focus on lease rates when evaluating a lease arrangement, there are a number of other things they need to consider, Kostroski said. “Things like phased occupancy, contraction rights, and renewals are a way more important part of a lease than just the rental rates.”

On the bright side, for tenants, the fact that some downtown office buildings are under performing, translates into opportunities for companies in need of leased space, he said.

“There are some opportunities downtown right now, buildings that are going back to the bank or lender, buildings that have just been resold on a new cost basis. In some cases, lenders are continuing to hold assets to try to create some kind of leasing activity, before selling it,” Kostroski said. “Because of that situation we’re seeing some incredible deal structures that significantly benefit tenants.”

In the downtown micro-market, “the majority of landlords have some serious concerns because of lack of rental demand and higher interest rates, which have made refinancing more difficult for some property owners.” Given the financial challenges, “we’ve been seeing buildings going back to the bank,” Kostroski said. “Once a building goes back to the lender or bank, you have the chance to negotiate directly with them.”

Due to the downtrends, some landlords have been under pressure to find additional revenue streams, impacting the agreements they are willing to make with tenants, according to attorney Robert Olson, partner in the real estate group at the Dorsey & Whitney law firm. Administrative fees levied against tenants are one way to achieve that. “We’re starting to see 5 to 15% administrative fees slapped on everything,” Olson said.

“We’re starting to see them charge construction management fees, whether or not they are having the work done,” Olson said. “They might also add on a 5 or 10% fee on any future [space] alterations. It’s been difficult to get landlords to back off on some of the new fees we are starting to see.”

And, “we’re starting to see ‘triple net’ provisions which are usually hidden” within lease agreements, as “any expenses I incur I am allowed to pass on to the tenant.” For landlords “that has always been a mainstay in single-tenant building leases.”

Another post-COVID change in the office marketplace is that landlord’s lease-length expectations have changed, Olson said. “As companies are figuring out how adapt to hybrid work models, landlords are more open to shorter lease terms than they have been in the past — three to five years rather than five- to 10-year leases that were the rule, pre-COVID.”

When negotiating, it’s also important to factor in each landlord’s motivation(s) which can vary depending on a variety of different factors, Olson said.

Typically, office leases grant the tenant the right to sublease excess space if necessary. But, with sublease rights, “There might be language requiring you have to share any profits with the landlord. You’ll want to ‘soften’ that language.”

Real estate taxes are another issue that can be problematic in lease agreements, Olson said.

Real estate taxes are due a year in arrears; in other words, property taxes payable in 2025 are based on the assessed value calculated in 2024. “If you have a building with artificially high or low base year taxes, the tenant could end up paying more than he should have,” Olson said.

Taxes assessed when a building is only 50% occupied might jump in subsequent years if occupancy has risen significantly — which commonly happens when a market is rebounding from a slump.

Buildings have been going through a value “reset” based on lower occupancy rates, Olson noted. The base rate for taxes should also be reset, “although it can be difficult to get a landlord to do much about it.”