Marcus & Millichap compiles research monthly for Heartland Real Estate Business. The research is run concurrent with our City Highlights and Snapshots sections, and additional information on each market can be found in the Midwest Markets Summary. Contributing to this section are Greg Moyer, managing director of Marcus & Millichap and regional manager in the firm’s Chicago office; Steven Chaben, regional manager in the firm’s Detroit office; Jonathan Lee, regional manager in the firm’s Cincinnati and Columbus, Ohio, offices; and Yitzie Sommer, research services manager in the firm’s Chicago office.

To complement our City Highlights and Snapshots, Marcus & Millichap has provided an overview of the Milwaukee and Columbus, Ohio, markets, highlighting sales and vacancy statistics and specific influences for each property type.

MILWAUKEE MULTIFAMILY

There is no doubt that the Milwaukee multifamily market has been negatively impacted by the weak economy and the increasing affordability of single-family homes. Compared to other metropolitan areas, however, Milwaukee has fared relatively well.

Vacancies have increased since year-end 2002, from 9.4 percent to 10.14 percent at mid-year 2003. Although this is a sizable increase, the majority of new vacancies have been created by the interest rate-driven surge in single-family homeownership, not by an oversupply of product like in other markets.

Even though owners are offering concessions, the actual rental rate has not been severely affected. The most prominent concessions have been giveaway items, such as DVD players, VCRs or small televisions. While these concessions still negatively impact an owner’s current net operating income, the actual rental rate remains the same, putting the owner in a better operational situation for the renewal period. The surge into single-family homes appears to have subsided, but owners will probably feel the necessity to offer concessions for at least another 6 months to keep their vacancies from increasing further.

The multifamily investment market has exhibited a few noticeable signs of strain from the soft leasing market. The pricing gap between buyers and sellers has widened, extending the marketing period for available properties. Lenders are also cautiously examining the income stream of properties.

Conversely, cap rates have dropped in tandem with the decrease in interest rates, providing a rich environment for buyers to obtain cheap debt, while maintaining cash flow. These lower cap rates translate into a larger pool of buyers, thus allowing sellers to seek higher prices. Minimal gains were seen in prices through the first half of 2003, but further gains continue to be hampered by rising vacancies and, consequently, the widening pricing gap. However, as interest rates continue to decline — with no significant rise in sight through the remainder of the year — cap rates should continue to decline, with prices showing small gains through the second half of 2003.

Overall, transaction velocity will remain strong, but could trail last year’s figures by as much as 5 percent. However, the Milwaukee area is generating interest from some institutional investors and larger private investors as more large properties are being offered, which could entice more sellers to offer their properties for sale. There is no doubt, though, that the second half of 2003 will be a dynamic investment period in the Milwaukee multifamily arena.

MILWAUKEE OFFICE

While other markets have faced oversupply, Milwaukee’s office market has been plagued by a simple, but sharp decrease in demand. Its proximity to Chicago has always made it difficult to attract large corporate headquarters or regional offices, and this problem has been magnified with the national slowdown in demand for office space.

Properties in downtown and in suburbs such as Brookfield, Waukesha and Menomonee Falls that cater to large users have seen vacancies rise substantially during the last 2 years. In contrast, properties across the metropolitan area with small floor plates that cater to local users have fared much better and are maintaining occupancy levels of more than 90 percent, compared to a market average of 84 percent.

These occupancy levels have not deterred owners from attempting to raise rents, as the average asking rent increased by 0.3 percent in the first half of the year. Effective rents, however, continue to move in the opposite direction, falling another half of 1 percent through mid-year 2003.

Concessions are prevalent in the market with increases in tenant allowances being almost universal. With new supply entering the market during the next 6 months, the double shot of weak demand and increased supply will push vacancy rates even higher. Effective rents will continue to drop through the remainder of the year, and probably into 2004, until some positive momentum envelops the market.

The office investment market mirrors the multifamily market in several ways. Softening operations, contrasted with falling interest rates, have widened the pricing gap between buyers and sellers. Yet the market remains active, with a strong number of properties being offered for sale. Predominately, the properties trading are smaller properties that have maintained strong occupancy and that have little big-tenant risk. These properties are commanding prices 15 percent to 25 percent higher than the market average and are attracting hordes of investors.

Larger properties that are struggling with occupancy issues and have future lease risk are receiving considerably less attention and are not securing strong prices. The market for properties $5 million and less will remain strong through the remainder of the year, while larger properties and trophy properties struggle to attract buyers.

MILWAUKEE RETAIL

The Milwaukee retail scene can aptly be described as being in a state of flux. Several of the area’s major malls (Northridge, Southridge, Bayshore and Brookfield) are in the process of or will soon be embarking on medium- to large-scale renovations or a complete rehabilitation.

The impact on retailers within these malls and in other areas has been profound, with tenants hesitating to sign long-term leases and owners unsure of the impact a refitted mall may have on the local retail market. Thus, a leasing paralysis has engulfed the market and has pushed vacancies to more than 10 percent for the first time in more than 5 years.

While the renovation or rehabilitation of significant portions of space will eventually decrease the available supply — consequently decreasing the vacancy rate — the inactivity of tenants has mitigated this benefit through the first half of the year. Surprisingly, effective rental rates dropped only 1.3 percent in the first half of the year, even with a 40-basis-point increase in the vacancy rate.

The quicker the renovations and rehabilitation projects begin, the faster tenants will begin to emerge from their indecision and raise the overall activity level in the market. The direction of the retail market will be impacted by the ability of the various city councils and departments to approve and facilitate the prospective projects that the various mall owners have put forth.

Retail offerings have been limited to smaller and mid-size community and neighborhood centers in the Milwaukee area. The price paid for Southridge Mall last year ($62 per square foot) may have dampened the expectations of sellers, who thought that the interest rate environment would offset any operational challenges they were facing. On the other hand, the purchase of Southridge Mall by Blackstone Real Estate Advisors, a premier opportunity fund, alleviates any doubt about Milwaukee being on large investors’ radar screens.

However, the indecisiveness of local retailers has stymied a further inflow of institutional capital, which has limited the number of buyers for larger properties in the market. Activity will remain strong on transactions priced at less than $10 million, which offer attractive cap rates to local and regional retail investors, and 1031 exchange buyers from various other property types.

MILWAUKEE INDUSTRIAL

Like many markets across the country, and especially the Midwest, the manufacturing sector of Milwaukee’s economy has been the hardest hit sector. Manufacturing was already in a substantial decline prior to the recession, which has since served to exacerbate the situation.

In the last 5 years, Milwaukee has lost 30,000 manufacturing jobs, a number that is projected to increase during the next 5 years. As a result, Milwaukee is repositioning its industrial economy from heavy industrial to light industrial/flex, and warehousing and distribution.

Due to their proximity to Mitchell Airport and major highways, the south suburban markets such as Franklin, Oak Creek and Greendale have made tremendous strides during the past several years. These areas, and others along the southern portion of Milwaukee County, have vacancy rates significantly lower than the market average. Rents across the market have dropped during the last 18 months as the competition for tenants heats up not only within the Milwaukee metropolitan statistical area, but also from strong competitors in Lakeview Corporate Park in Kenosha County. Rents will continue to see minimal retreats during the next 12 months as the industrial sector remains mired in its current slump.

The investment market has maintained an almost inverse relationship with the leasing market. Transaction velocity has been strong in the first half of the year, with another 50 or more properties being offered on the market. While many of these offerings are owner/user properties, several are investment transactions ranging from 20,000 square feet to more than 500,000 square feet.

Following on the heels of last year’s strong market, buyers eschewing other product types have been actively seeking well-leased industrial properties. Properties with strong tenants that alleviate any leasing worries are commanding strong prices and receiving multiple offers. Unfortunately, there are many sellers in the market that are attempting to achieve similar prices for lower-performing assets and that are not responding to the market. Obviously, there is a strong disconnect between cap rates and subsequent pricing of these two property groups.

In general, well-leased properties are achieving prices in the high $30s per square foot and sub 9.5 cap rates. Properties that are facing operational challenges are achieving prices in the low $30s and even high $20s, with cap rates that are consistently more than 10 percent. The market’s dualistic nature should maintain its course during the next 12 months as the direction of the industrial sector remains murky and investors remain unwilling to gamble on potential.

COLUMBUS, OHIO MULTIFAMILY

With no respite from the soft economy, the Columbus, Ohio, multifamily market was unable to bounce back after a negative 2002 that witnessed vacancies rise from 5.6 percent to 7 percent. A great portion of the increase in vacancy can be traced to the weak economy and to the effect of historically low interest rates on the single-family home market.

However, there are other reasons Columbus finds itself with its highest vacancy rate in more than 20 years. Although not to the same degree as markets such as San Francisco, Boston or San Jose, California, Columbus experienced a surge in job growth, especially in high-tech, during the second half of the 1990s. In response, developers increased their multifamily pipelines to accommodate the surge in employment.

Between 1991 and 1997, the Columbus market never delivered more than 2,200 units in a single year. However, from 1997 through 2002, the market delivered 2,900 units per year (on average) to the market. The market was able to absorb these units as long as job growth maintained its torrid pace. But once the job market began to slide, Columbus was left with an oversupply of apartment units.

The investment market, however, has surged forward despite softening rental market fundamentals. Through the first 3 months of 2003, Columbus had already equaled half of the total transactions completed in 2002. Dollar volume was equal to nearly 75 percent of the total in 2002 as investors flocked to multifamily properties. Investors are maintaining a more positive view on the impending rebound of the multifamily market due to the dominant role that oversupply has played in its weakness.

As developers reduce new deliveries during the next 12 to 24 months, vacancies should begin to plateau and then recede as the economy gains steam. The confidence investors have in the local multifamily market is evidenced by the strong increase in the price-per-unit paid and decreasing cap rates. Cap rates are hovering at slightly more than 9 percent, while prices have climbed to more than $45,000 per unit. While it is possible that these pricing trends can continue, it is more likely that the market will see a slight correction during the next 12 months before it resumes growth along with the operations side.

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