Chaben

While Detroit’s economy continues to diversify, a recovery in the office market depends on the future of the automotive industry. “This dependence underscores the anemic outlook for a near-term recovery in the office market,” says Steven Chaben, vice president and regional manager of Marcus & Millichap’s Detroit office. Recently released auto sales statistics shed light on the pressures facing the Big Three Detroit automakers (General Motors, Ford and DaimlerChrysler). Despite the heavy $3,500 per-vehicle incentives offered by domestic automobile manufacturers, imports have captured 40 percent of new car sales even with about 50 percent less than the domestic offerings.

“This is one example of the competitive imbalances that challenge Detroit, and that has U.S. automakers fighting to achieve profitability,” Chaben says. “Automakers operating in the red is a deterrent to a rebound in the office market.” As a result, submarkets with significant concentrations of auto-related industries, such as Pontiac, Troy, Dearborn and Detroit, will continue to feel the pinch of consolidation and restructuring during the near term. On the other hand, Farmington Hills, with a high concentration of Japanese auto-related firms, could outperform its peers.

The Detroit metropolitan statistical area has the 10th largest economy in the nation and, in 2002, had a total gross metropolitan product of $161 billion. Detroit is home to General Motors, Ford, DaimlerChrysler’s North American base, more than half of the world’s top 100 auto suppliers, and two-thirds of all automotive research and development firms. Collectively, the Big Three automobile manufacturers employ 172,000 people, or 8.3 percent of Detroit’s total employment base. In addition, the auto manufacturers are closely aligned with a large network of suppliers and subcontractors in the region. Detroit also serves as the headquarters for many large corporations in other industries, including retail (Kmart and Borders Books & Music), energy (CMS Energy and DTE Energy), home building (Pulte Homes), banking (Comerica) and staffing firms (Kelly Services).

“Detroit’s economy faltered in 2001 due to the combination of the recession and the aftermath of September 11, 2001,” Chaben says. “It has since shown modest recovery, and the outlook is for moderate growth of 2.7 percent per year from 2004 to 2006 as the national economy improves and economic diversification continues.”

Employment growth has had positive effects on the local office market. Following 24 months of layoffs and consolidations, Detroit employers added 11,000 jobs, or 0.6 percent, to their work force last year. Payrolls are expected to increase by 1.9 percent this year, with the business and professional services sector gaining 4.6 percent.

Detroit’s construction pipeline remains thin compared to historical numbers, with 1.1 million square feet of new office space expected to be delivered this year. While job growth will generate positive absorption, it will continue to lag new construction. The second phase of Kojaian Companies’ Farmington Hills Office Center, which will add 235,000 square feet to the Farmington Hills office submarket, is the largest project nearing completion. Two high-profile corporate construction projects, The Compuware Corporate Headquarters and the American Axle and Manufacturing facilities, which total more than 1.3 million square feet, are close to completion.

Sublease space continues to haunt the market, making it even more difficult for property owners to capture tenants and boost revenues. The 2003 overall vacancy rate closed at 18.7 percent, as continued restructuring in the automotive industry left vacant space behind. While the outlook is tenuous, vacancies should rise slightly this year to 18.9 percent. Two submarkets that reported an improvement in vacancy during 2003 were the diminutive Macomb office submarket at a 9.6 percent vacancy rate, and the Birmingham/Bloomfield submarket at a 12.5 percent vacancy rate. Occupancy losses were greatest in the Ann Arbor, Detroit central business district and North Southfield submarkets, all of which recorded substantial vacancy bumps last year.

Rents will stabilize this year as vacancy increases slow down. The average effective rent will remain relatively flat, at $17 per square foot, following the 5 percent decline recorded last year. During the past 3 years, effective rents have fallen 8 percent, from $18.37 to $16.95.

“Due to the uncertain outlook for the office market, investment activity in Detroit has slowed considerably,” Chaben says. Investors have taken note of the economy, and transaction velocity in 2003 was off nearly 50 percent when compared to 2002. Prices have begun to ease as well. The median price recorded in late 2003 was down nearly 8 percent, at $99.95 per square foot. While transactions have been concentrated in Southfield and Farmington Hills, buyers continue to venture out to Ann Arbor to place capital. Despite high vacancies, Birmingham and Bloomfield Hills have retained investor interest, but finding available product has been a challenge.

“The Southfield, Auburn Hills, Bloomfield Hills and Birmingham submarkets will be the largest benefactors of 2004’s renewed job growth in the business and professional services sector,” Chaben says. “Expect transactions in the office market to remain slow until local economic indicators present evidence of sustained growth.”

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