CITY HIGHLIGHT, APRIL 2005

RETAIL IS TOP PROPERTY IN SUBURBAN DETROIT
Gary Gruskowski, Brendan George, David Greene, Albert Berriz

Suburban Detroit’s connection to the Big Three continues to determine the health of the area’s economy, and the growth of globalization and off-shore outsourcing in the automotive industry has hurt more than just the manufacturing segment. Though hardhit by the loss of manufacturing jobs, the industrial market is seeing improvement with 33 new buildings delivered in 2004. Detroit’s office market remains flat with large vacancies, but, on the upside, several new office developments are either planned or underway. A decline in multifamily rents and occupancies has led to a dismal multifamily outlook; however, an increase in interest rates and a slowdown in new homes sales may bring slight improvements during the next few years. Detroit’s retail market is a consistent bright spot on the region’s real estate front with development continuing at a steady pace.

Industrial

The metropolitan Detroit industrial market rebounded slightly in the fourth quarter of 2004 by posting a 13.8 percent vacancy rate, which is down from 14.4 percent in the third quarter. A positive net absorption of 1.8 million square feet was a 300 percent improvement from the 613,315 square feet in the first quarter of 2004. In addition to the absorption of current space, 33 new buildings were delivered to the marketplace in 2004, totaling 1.12 million square feet. The average rent for the industrial segment was $5.55 per square foot at the end of the fourth quarter, which represents a slight increase in quoted rent throughout 2004.

Major moves include McGraw Glass and Visteon, vacating spaces in Dearborn of 900,000 and 375,000 square feet, respectively. Major occupancies include TNT leasing 341,000 square feet at Brownstown Center; Classic Container taking 200,000 square feet at Capital Drive in Livonia; and a 391,000-square-foot lease signed by Digiton Packaging at Pinnacle Logistics Park.

Sales activity fell slightly in the fourth quarter with thirty-six buildings at more than 15,000 square feet selling at an average price of $41.20 per square foot. While the number of buildings sold dipped slightly, the average price per square foot rose approximately 21 percent from the previous quarter. The flex market showed vacant sublease space at 293,000 square feet. This available space represented a 22.2 percent vacancy rate, a consistent quarter-over-quarter increase throughout 2004. The average quoted rent for the flex market was $9.70 per square foot for the fourth quarter, unchanged from the third quarter.

The western Troy area was a bright spot, posting slightly healthier fourth quarter vacancy rates compared to metropolitan Detroit as a whole. With a total inventory in the Troy West area of 438 buildings, the vacancy rate was 9.9 percent. The average quoted rental rate for the area was $6.98 per square foot NNN, one of the highest average rates for the metropolitan area. This central Oakland County location has easy access to Interstate 75 and historically has attracted a number of automotive suppliers, as well as their technical support facilities, to establish locations in this area. Northern Macomb County west of Van Dyke also appeared as a solid market with a vacancy rate of 5.7 percent for the fourth quarter.

The area with the highest vacancy rate was East Macomb County, specifically the Groesbeck Highway Corridor, which was more than 24 percent. The high vacancy rate was due in part to numerous functionally obsolete properties in the area. The Howell/Brighton area also had a high vacancy rate of 20.8 percent; however, for the opposite reason — several new buildings were developed that have not yet been fully absorbed.

The metropolitan Detroit industrial market was built on the manufacturing strength of the automotive companies and their related suppliers. As globalization and off-shore outsourcing has taken hold in recent years, the manufacturing segment of the industrial real estate market has been in a negative growth mode for some time. Older manufacturing buildings are being sold or leased for alternate uses or remain vacant. The one segment of the market that seems to hold promise is the logistics, warehousing and packaging operations, which are needed to manage all the goods streaming through the industrial marketplace. This area will continue to show strength in 2005 as the economy slowly continues to improve.

 — Gary Gruskowski is vice president, industrial division with Southfield, Michigan-based Insite Commercial Group.

Office

The Detroit office market has remained consistently flat during the past 2 years but signs of life exist. Office vacancy in metropolitan Detroit has hovered around 21 percent including the central business district. Enterprising tenants have taken advantage of the weak market to secure early lease renewals or downsize excess square footage. However, uncertainty over client contracts is forcing some users to pursue short-term renewals despite the favorable deal-making climate. As one might expect, nervous landlords are more than happy to accept short-term renewals when tenant retention is the mantra of the day.

For those tenants willing to make longer commitments, landlords have been offering highly competitive deals. Asking rates remain largely unchanged, but effective rates are much lower due to concessions such as rental abatement, moving allowances and high improvement allowances.

Despite the challenges of the leasing market, Detroit office developers are pushing forward on a cautious basis to add new inventory to the market. Low interest rates are the primary reason why developers are carrying vacant product much longer than in the past. Building in a down market also provides the opportunity to beat the curve for office demand. When the market turns, these developers are ready to house users in need of new space immediately. The vast majority of this planned development is located in suburban markets. Given the high cost of land and materials, these new buildings are typically Class A in nature. While smaller projects are started on a speculative basis, larger multi-tenant buildings are typically held in check while the developer attempts to secure a user.

A handful of developers are subscribing to the “build it and they will come” mentality and breaking ground without a tenant pre-committed. A prime example of this strategy is Kojaian Companies’ Farmington Hills Corporate Center. This four-building complex, which totals roughly 640,000 square feet, completed its first phase in 2002. Kojaian secured several sizable users for the first and second phases and now continues with the balance of the development.

Another notable project is REDICO’s Oakland Towne Square phase II. This building is the second phase of a three-building master planned project totaling 826,000 square feet. Several leases are in negotiation; however, the majority of the building remains vacant to date. Southfield also had completion of Meadowbrook Plaza, a 160,000-square-foot office building located along the Interstate 696 freeway. Meadowbrook Insurance occupies one-half of the building with the second half available for sale, lease or joint ownership.

The impact these large vacancies have on Southfield is not positive, especially for a submarket already struggling with significant vacancy. The buildings do fill a necessary niche, however, for users desiring a prime location and the amenities that only a new building can deliver.

So what does the future hold? Despite efforts to diversify, Detroit’s economy is largely tied to the ups and downs of automotive industry. When the automotive market for the Big 3 improves and the economy sees consistent job growth, the demand for office space will increase.

When the Detroit market shows signs of measurable growth, there is no shortage of new office development projects waiting for the green light. Developer Burton Katzman is particularly active with two sizable projects: Sterling Corporate Center, a 300,000-square-foot development in Troy, and Park Place, a 350,000-square-foot development in Livonia.

Auburn Hills is an active market with two large developments now in the planning stages. These include the three-building 450,000 square foot Pitcarin Place and Auburn Financial Center, a two-building 500,000 square foot development by Adams McApline Group. Auburn Financial Center is scheduled to break ground in 2005 with a fall 2006 completion date.

College Park in Livonia is another notable mixed-use development now underway. The site is master planned to include office and retail space and is situated on a 45-acre parcel just south of Schoolcraft College in Livonia. Once completed, the development will include up to 470,000 square feet of commercial space in up to six multi- or single-tenant, build-to-suit corporate buildings. Three restaurants are now operating at College Park, which is a joint development by Southfield-based Etkin Equities and Walkon Development.

— Brendan George, CCIM, is vice president with Southfield, Michigan-based CB Richard Ellis.

Retail

In contrast to the office and industrial markets in southeast Michigan, the retail market continues at a steady pace. As local and national residential developers are building at a feverish pace, the need for grocery-anchored shopping centers and lifestyle centers continues. Major lifestyle centers are planned for a number of areas, such as Romeo in Washington Township, where a 535-acre multi-use development is currently under review. The proposed development includes a lifestyle center, senior housing, residential, township facilities and a hotel. In Clinton Township along Hall Road, The Taubman Company is planning a 590,000-square-foot mixed-use development. Taubman is also planning a lifestyle center in Commerce Township where M-5 ends at Pontiac Trail. Other large developments include the de-malling of Wonderland Center, as well as the conversion of Northland Plaza to a big box use. Both are Schostak Brothers & Company projects. Schostak is also in the planning and pre-leasing stages for a major open-air project at Haggerty and Seven Mile roads. Lormax Stern Development Company is redeveloping the former Veteran’s Administration Hospital, which will be primarily big box users such as Target, Lowe’s Home Improvement Warehouse, Barnes & Noble, Bed, Bath & Beyond, Pier 1 Imports, Michaels and Old Navy. Grocery-anchored centers are still active, and Kroger is the predominant player with centers currently under construction in Hamburg — a 143,000 square foot shopping center being developed by First Commercial Development of Southfield — Independence Township and Springfield Township. In Macomb Township, Grand-Sakwa is planning a mixed-use development on the former GM property located at Mound Road between 12 Mile and 13 Mile roads.

On the investment front, the retail sector continues to be very hot. Solid performance and excellent fundamentals continue to entice investors to buy retail properties over other property types. Low interest rates and above average household income have kept consumers spending and demand for retail space high. Supply remains limited, driven by an influx of out-of-state investors. Cap rates are in the 7 percent to 9 percent range with prices hovering around $100 per square foot for properties built in the 1960s and 1970s. These properties offer upside potential via repositioning, re-tenanting and better property management. In a recent transaction, a 93,000-square-foot neighborhood center was purchased for $5.1 million, or a 9 percent cap rate. In the center, a 30,000-square-foot space, which was formerly occupied by Farmer Jack, sat empty for more than 4 years. Upon the re-leasing of the vacant store by an alternative use for $3 dollars per square foot more, the value was increased by approximately $1 million, showing just how re-tenanting can add value.

With retail chains aggressively expanding, rental rates continue a slight increase — although overall vacancies have also increased marginally. Rental rates range from the $4 per square foot for large big box stores to $30 per square foot for prime locations for smaller service-related stores. Average rates are in the $14 to $18 range with landlords providing additional incentives above the standard “white box” to secure credit tenants. Deep discounters and fixed-price stores continue to expand at a record pace. Drug stores are looking to go from in-line locations to freestanding facilities, noting that sales increase substantially when moving into freestanding buildings — even in the same shopping center. The largest number of transactions comes from the retail service sector, including fast food, casual dining, nail salons and hair salons. Jimmy John’s, Wireless Giant, The Cash Store, Great Clips, Caribou Coffee, Baja Fresh, Potbelly, Rio Wraps and Panera Bread continue to see aggressive expansion. New names like Johnny Carino, Carrabba’s, Ci Ci’s, Moe’s Southwest Grill, Maggiano’s Little Italy and Brio Tuscan Grill are either currently open or will open soon. In the big box arena, the Sears-Kmart merger will create a new concept called Sears Essentials with plans to open 25 stores in the first year. Also, in the department store arena, May department stores has agreed to be bought out by Federated. This merger will create the largest department store chain with more than 1,000 stores.  

— David Greene is the director of brokerage with First Commercial Realty & Development Company.

Multifamily

Overall, the multifamily market in metropolitan Detroit is not a pretty picture. This is consistent throughout the region, including Wayne, Washtenaw, Oakland and Macomb counties, with Macomb and Wayne being the hardest hit in the region. Washtenaw, which had been somewhat recession-proof in earlier economic declines, has seen its highest vacancy rates on record with a corresponding decline in rental rates. Rental rates in 2005 in Washtenaw County are lower than rates for similar unit types in place in 2000. An increase in interest rates and a slowing of the brisk new home sales market may bring slight improvement in the market in 2006, but a much needed resurgence in the economy is not likely for the next 12 months given the factors highlighted above.

Ann Arbor/Washtenaw County remains the one bright spot in the Michigan economy, having lost more than 7,500 manufacturing jobs during the past 5 years and replacing them with more than 9,000 high tech/intelligence economy-based jobs. The University of Michigan, and its significant investment in the life sciences, continues to be the backbone of the economy in the Ann Arbor/Washtenaw County area. Additionally, Washtenaw County has seen both a conversion of some existing product to condominiums and no significant amount of new construction. Therefore, along with the economic picture, it should be one of the first markets in the region to begin to see a recovery in 2006.

It is important to have context for the Michigan economy when assessing the state of metropolitan Detroit’s multifamily sector. Michigan is in its fourth year of a serious recession while the rest of the country enjoys a brisk expansion. Michigan is a state trying to transition from a manufacturing economy to an intelligence economy, but it still has 22 percent of its economy in manufacturing — well above the national average and concentrated specifically in automotives. To make matters worse, automotives are undergoing a global restructuring where it’s not clear that the now Big Two are going to do anything other than continue to see their global market share decline compared to their competitors. As Michigan aspires to attract a new breed of workers and employers, it has a lower proportion of high salary and high value-added service sector jobs — lagging the nation by up to 10 percent. Couple that with historically low interest rates giving homebuilders a significant edge vis-à-vis all segments of the renter market, and metropolitan Detroit has a decline in multifamily rents and occupancies far worse than was experienced during the 1990 to 1991 recession in this area.

— Albert Berriz is CEO of Ann Arbor, Michigan-based McKinley.

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