FEATURE ARTICLE, APRIL 2004

MOTOR CITY INVESTMENT REVS UP
Detroit’s investment market is showing signs of improvement this year.
Steven Chaben

Retail property investments are faring the best in Detroit’s investment market this year. Despite the high unemployment rate and the lingering effects of personal bankruptcies recorded during the past 24 months, the overall economy is starting to improve. Job growth is expected to increase with total payrolls expected to expand by 1.5 percent this year. As a result, retail sales should also be on the rise.

Retail Market Surge

Due to ongoing consumer spending and restrained development, Detroit’s retail market has been spared the vacancy challenges seen in its office and industrial markets. Retail vacancies continue to ease from the cyclical peak recorded in 2002, and further improvement is expected this year. Investors’ appetites for single-tenant properties remain high, but opportunities have been limited. As a result, values in this sector continued to climb in 2003 (when compared to 2002), while prices for multi-tenant properties slipped slightly.

While Detroit’s economy has not fully supported the local retail market, the retail development community can be applauded for its marked restraint. This year, 1.4 million square feet of new space is expected to come online, which is 15 percent less than last year’s deliveries. Approximately 65 percent of the space expected to come online this year will be occupied by big-box home improvement stores and discounters, along with freestanding drugstores.

The overall retail vacancy rate in Detroit is expected to decline by 30 basis points this year to 7.9 percent from the year-end 2003 rate of 8.2 percent. The overall asking rent is expected to rise by 2 percent this year to $15.98 per square foot. Consistent with the vacancy outlook, rent growth will be greatest in South Oakland County and Macomb County. Both of these areas are expected to report rent growth in excess of 3.5 percent.

The 2004 retail investment environment will likely mirror that of 2003, with buyers outnumbering sellers, and prime retail properties being held off the market. As a result, transaction velocity will continue to be moderate, and investors will be forced to consider older, strategically located centers throughout the metropolitan area. Activity is expected to be greatest in Macomb County, the Interstate 275 corridor and the northern outlying areas. Values should rise as fundamentals improve, but the overall median price will remain relatively stable due to the greater number of older centers likely to trade this year.

In 2002, 56 multi-tenant centers and 110 single-tenant stores were sold. Last year, 41 multi-tenant centers were sold for a median price of $84 per square foot. This figure was down 8 percent from 2002, due to the shift in sales volume to older properties. The median price for the 66 single-tenant transactions recorded last year rose to $134 per square foot, up 16 percent from 2002.

Navigating the Apartment Investment Market

Transaction velocity through the first half of this year will maintain its modest pace as investors remain perplexed by Detroit’s inability to get in sync with the accelerating national economy. However, current forecasts for increased job growth will boost the apartment market, which should bottom out during the next 6 months. Velocity should accelerate in the latter half of this year, and it will ultimately outpace the number of transactions recorded in 2003. Values are not expected to gain much ground, however. Instead, values could slip slightly from the median price of $41,700 per unit recorded in 2003 if a material rise in interest rates occurs while rental demand remains low.

Similar to 2003, apartment investors will continue to scour the outlying areas and submarkets, such as Macomb County, where pricing has been more favorable. In 2003, Macomb County and the northern outlying areas, including Flint, White Lake and Fenton, accounted for more than 30 percent of the transactions recorded at a median price of $36,000 per unit. Additionally, with new construction all but halted, opportunities for the more risk-tolerant investor should be found in Class A locations where current vacancies are running well above historical averages.

Owners can anticipate vacancy rates stabilizing in 2004 and closing the year at 6.9 percent, unchanged from the figure recorded at year-end 2003. The overall average asking rent will remain flat at $790 per month throughout this year. Marketwide rent growth is not expected to resume until 2005.

Office Market Looks for Stabilization

The weak outlook for a near-term recovery in the office market is linked to Detroit’s reliance on the auto industry. Submarkets with significant concentrations of domestic auto-related industries, such as Pontiac, Troy, Dearborn and Detroit, will continue to feel the pinch of consolidation and restructuring in the near term. On the other hand, Farmington Hills, with a high concentration of Japanese auto-related firms, could outperform its peers.

Office investment activity has slowed in Detroit due to the uncertain market outlook. Sublease space continues to hit the market, making it even more difficult for property owners to capture tenants and boost revenues. Transaction velocity should remain moderate this year, but prices may ease to better reflect market fundamentals. The Southfield, Auburn Hills, Bloomfield Hills and Birmingham submarkets will continue to garner interest because they will be the largest benefactors of next year’s renewed job growth in the business and professional services sector.

Office vacancies are expected to rise slightly this year, and rents will stabilize. The average effective rent will remain relatively flat at $17 per square foot, following the 5 percent decline recorded last year.

Disciplined Industrial Development Keeps Vacancy Increase in Check

Detroit’s industrial real estate market has fared relatively well in the regional economy. Manufacturing employment, the lifeblood of the Detroit area, dropped another 1.5 percent in 2003 after a similar contraction in 2002. Ironically though, the auto industry does not have a significant impact on the distribution/warehouse sector. The vast majority of auto parts manufacturing, storage and distribution is dispersed throughout North America. In Detroit, the warehouse space occupied by auto firms tends to be flex facilities that can house both the engineering and fabrication sides of the business.

Industrial vacancy increased marginally during the last 12 months as demand waned and completions mounted. However, absorption will start to surpass completions this year. This trend will continue as new construction remains at minimal levels and absorption rebounds during the next 12 months to 18 months. Investors shunned challenged properties in 2003 and focused on more stable, risk-averse purchases. Most sales this year will continue to center around single-tenant properties as investors and developers shy away from highly speculative investments. Areas that have traditionally performed well, such as the Troy, Airport, Downriver and Northwest Oakland County submarkets, will continue to attract interest from both tenants and buyers.

Steven Chaben is vice president and regional manager of Marcus & Millichap’s Detroit office.

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