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United Properties lost two key partners in its $161 million redevelopment of the Nicollet Hotel block in downtown Minneapolis, though the project will pursue new ones, the firm said Tuesday.

The Bloomington-based company, which in February was tapped by the city to purchase and makeover the high-profile site at the north end of Nicollet Mall, has been notified by an apartment developer that it's out of the project. In addition, United's hotel partner has entered talks with another developer for a downtown project.

Still in the early stages of planning and design, United Properties has plenty of opportunity to find other participants and, in an interview Tuesday, Bill Katter, executive vice president of development at United Properties, reiterated the company's commitment to the project. He said it's talking to other potential partners and expects to reach new deals within two months. Its plan for apartments could be changed to condos, he said. "I'm not really concerned at this point," he added.

Even so, the exit of the apartment developer is grist for local real estate executives who these days are looking for any sign of a top to a flurry of apartment construction, particularly in downtown. And the situation with the hotel company signifies the intensity of competition among developers to lock in brands for projects.

The challenges arose shortly after United was selected this winter from among four candidates to redevelop a city-owned block that for decades was the site of the stately Nicollet Hotel and most recently a surface parking lot. United offered about $10 million for the land and promised to spend more than the other candidates by building a 36-story tower and a shorter hotel building around a plaza that included room for a streetcar stop.

United's original apartment partner, Bloomington-based StuartCo, pulled out of the project over concerns about timing.

"We just feel the downtown market is overbuilt right now and the city is on a quick timeline, and we didn't think it was appropriate for us to add more rental housing downtown right now," Stuart Nolan, the company's founder and chairman, said Tuesday. "I hope I'm wrong."

Nolan said that while he wasn't far enough in the process to nail down rents, he said that you'd have to charge $2.50 to $3 per foot to justify such a project. Another bidder for the Nicollet Hotel block, Kelly Doran, a principal of Bloomington-based Doran Companies, said his proposal only made sense if rents were about $2.50 per square foot.

And while Nolan said he doesn't believe the apartment market is crumbling, he added he wasn't ready to take the risk on such a ­project, especially at a time when the cost of labor and materials is soaring.

Vacancy rates rising

Nolan's decision comes at a time of growing debate about the depth of the demand for market-rate apartments in the city, and whether there will be enough people to fill the buildings already under construction and in the pipeline. It's a conversation that's being driven by rising vacancy rates and an increase in rental concessions, including discounted rent and reduced security deposits in some buildings.

After a five-year construction boom that peaked in 2014, apartment developers in downtown are already pulling in the reins. During the first quarter about 300 units came online, but another 866 units are expected during the remainder of the year, according to Marquette Advisors.

Katter said he understood Nolan's reluctance but noted the project is still three years from being complete and says the market could likely quiet down by then. "Some people think that will be adequate time for the market to absorb the supply," Katter said. "Because of that, we are pursuing both apartment and condo alternatives."

At the moment, the vacancy rate and rent growth in the Twin Cities are among the strongest in the nation and there's a long line of national investors on the hunt for acquisitions. Over the past several months those investors have paid record prices for several recently built apartment buildings.

Meanwhile, when United initially unveiled its plan for the block, it presented a new hotel concept by Hilton, called Canopy. But its deal was far from done, Another developer, Minneapolis-based Sherman Associates, has submitted an application to partner with Hilton on the Canopy concept at its Thresher Square project, which is near the Vikings' new stadium and is much further along in development.

Katter cited timing of the finance and permit process with the city and said United wasn't ready to submit the $75,000 application fee to Hilton.

Hilton's regional sales representative did not return phone calls or e-mails, but the process isn't over. Sherman has not received confirmation that their partnership will be approved by Hilton's franchise committee, said Tony Kuechle, senior vice president of development for Sherman.

"Make no mistake, this is a capitalistic business," said Mark Eble, a Chicago-based hotel consultant and vice president of PKF Consulting. "The hotels have to make a bet on who is going to make the deal happen."

As for the Nicollet Hotel block project, Katter said United Properties is in discussions with a variety of other brands, including Hyatt's new Centric concept and Hilton's Curio Collection.

Kristen Leigh Painter • 612-673-4767

Jim Buchta • 612-673-7376