City Business (Minneapolis)
August 26, 1991

Chicago firm finds bargain in Twin Cities real estate:
Northwestern Financial Center to be bought at discount
By Dale Kurschner

Two years of negotiations and three attempts at securing financing have finally led to the apparent sale of the 24-story Northwestern Financial Center (NFC) in Bloomington.

As CityBusiness went to press late last week, Zeller Realty Corp. of Chicago was closing on a $17 million purchase of the 434,000-square foot building from Prudential Insurance of America.

The building and its 17-acre site, located at Interstate 494 and Xerxes Avenue, carry an assessed value of $23 million. Chicago-based Prudential put the building on the market in 1989 at an asking price of more than $33 million.

Zeller was able to buy the property at a deep discount in part because the NFC tower needs renovation, said Jim Gearen, vice president and one of two principals in Zeller. The real estate management and investment firm plans to spend $5 million on renovations over the next nine months.

“It’s a terrific deal,” Gearen said. We’ve made similar transactions in the suburban Chicago market with good property that is 15 years old and needs hands-on management and some renovation.”

But the NFC deal is even more attractive to Zeller because the site includes enough land for future development of another 300,000 square feet of office space along the heavily traveled I-494 strip, he said.

The deal is also attractive to Prudential, according to Gearen and Prudential’s local real estate broker, CB Commercial Real Estate Services, Inc. of Bloomington, Gearen and CB commercial’s Terrence Kingston said Prudential won’t lose money on the sale because of the profits it has pulled from the building in lease payments over the years. However, they refused to say how much Prudential has invested in the building.

The imminent sale is significant in the Twin Cities commercial real estate market because it will increase the investment presence of Montreal, Quebec-based Bank of Montreal, which put up the first mortgage on the NFC tower for Zeller.

Bank of Montreal has interests in the Southdale Office Center in Edina and Lake Calhoun Executive Suites in Minneapolis, Gearen said. Bank officials could not be reached for comment, and Gearen would not disclose the financial details of the NFC deal.

The NFC transaction also would be in the largest commercial office property to be sold in more than a year and a half in the Twin Cities - a sign, according to some in the industry, that the commercial office market may have bottomed out.

A slightly smaller deal was completed last December when Prudential sold its 300,000-square-foot Northland Center office tower to ITT Hartford Insurance Group for about $21 million.

That deal was also brokered by CB Commercial, whose officials point to the deals as proof that, even today, corporate office towers can be sold in the Twin Cities.

The key, said Kingston, CB Commercial’s senior vice president of Investment properties, is to sell owners on the idea that a 50 percent return on their investment is OK.

That proposition might sound ludicrous to property owners, many of whom remain optimistic that property values will rise within the next year or two.

But Kingston predicts gradually rising values over a longer period of time, and instead offers an immediate return to an owner who otherwise would have to continue paying improvement costs, taxes and maintenance fees on a building that has low occupancy and lease rates that may be 50 percent lower compared with fie years ago.

The concept is to cut one’s losses, take the remaining money and invest it in something with a more promising rate of return.

Both NFC and Northland sold for the same reason, Kingston said: Prudential wanted to unload the properties and eventually adjusted its price to current market values to do it.

“It’s not uncommon to see hits in value of roughly half of what they paid for it,” Kingston said. “In the 1980s, $100 a square foot was a good range [for Class A or upper-end Class B property]. Today, $60 is really good.”

Prudential currently owns or controls about 3 million square feet of commercial space in the Twin Cities area.

The overall office space glut in the Twin Cities brought lease rates down by about 50 percent from where they were in the early 1980s. The value of office buildings dropped proportionately, according to Brian Carey, a leasing representative for United Properties Brokerage and Management Co. of Bloomington.

“On top of that, there are either lenders or owners who are forced to get out of their real estate properties at this time,” because the no longer yield the kind of returns necessary to fit their investment portfolios, he said. “There are also many cases where [owners] have taken the building back because of a defaulted loan, and it’s not their business to hold real estate.”

The problem is how to reach a decision on a building’s market value.

“People don’t know where or what the values are on these buildings,” Kingston said. “Sellers are having sort of a reverse sticker shock. They thought it was worth $100 a square foot, and then were able to convince themselves that it was worth $70 instead because of the times. But the market value has since dropped to $50.”

Kingston uses a formula that considers a building’s quality, such as Class A or Class B, as well as its leasing status, to determine its value.

A Class A office building that is 70 percent occupied, for example, would be valued at about $70 a square foot. Class B property leased at about 50 percent would have a value of about $30 per square foot.

That general concept worked relatively quickly on the sale of Northland Center, which is located on I-494 at France Avenue. The transaction went from initial discussions to closing within five months because both buyer and seller already knew that $70-a-square-foot was an appropriate price based on today’s market standards. It also helped that ITT Hartford paid cash for the deal.

The more recent sale of the NFC property, however, was much more confusing to sort out. Two U.S. banks refused t fund the initial Zeller proposal, which was said to include participating debt from a Chicago real estate developer, subordinated debt and letters of credit. In the end, Prudential agreed to foot some of the financing on the deal, and Zeller found additional financing from the Bank of Montreal.

The key to the deal, though, was that Prudential also agreed to lower its price enough so that financing under those terms would work, according to Gearen and Kingston.

On the market for two years, the structure and its accompanying buildings total 434,000 square feet. Prudential will receive a price of about $40 a square foot on the final deal, but it also stands to gain from providing a portion of the financing.

Besides the need for renovation, the NFC tower’s price was lowered because it stands to lose its biggest tenant within the next year, Kingston said. IBM Corp. plans to move most of its operations from the building to downtown Minneapolis by next summer, he said. IBM currently occupies about 150,000 square feet, or about 40 percent of the building.

That means occupancy would drop to around 50 percent and, according to Kingston’s formula, that would bring the building’s value down to about $40 or $50 a square foot.

Gearen, however, said IBM has agreed to continue leasing at least 50,000 square feet in the NFC building. “We also have so much internal expansion going on and other leases, the lowest we’ll drop to is probably about 08 percent occupancy, he said.

The building has about 30 tenants lined up for leases through next year. It’s leasing agent is Eden Prairie-based Welsh Cos.

The NFC purchase is Zeller’s first in the Twin Cities. The 3-year-old real estate investment and development company has a $350 million portfolio of commercial and industrial space.

Gearen said Zeller currently has its sights set only on managing its NFC property, but added that “we would love to acquire more property up here.”

Go back to News