CITY HIGHLIGHT, JULY 2009

DETROIT CITY HIGHLIGHTS
Laney Cavazos, Anthony Schmitt and Steven Chaben

Detroit Office Market

The medical office building at 26850 Providence Parkway in Novi, Michigan, is part of the new St. John Health Providence Park hospital complex.

In the wake of the collapsing auto industry, Detroit continues to strategically position itself as the destination of choice for businesses in emerging sectors. As in many major markets across the country, though, a number of office development projects have been tabled because of the current national economic downturn. Users and owners with capital are following a more cost-effective trend by purchasing existing office buildings rather than developing new ones.

The quoted average rental rate for office space in the Detroit market is $19.53 per square foot, representing a 0.5 percent decrease in quoted rental rates from fourth-quarter 2008. On average, medical office rates command approximately $5 to $7 more per square foot than general office space. The overall vacancy rate for general office space in Detroit measured 17.5 percent with a net absorption totaling negative 541,668 square feet in the first quarter.

Presently in the metropolitan Detroit market, there exist more than 6,600 general office buildings comprising a total inventory of approximately 178 million square feet. Nearly 31.27 million square feet of that space is now vacant. Development projects such as Developers Diversified Realty’s Bloomfield Park, a 120,000-square-foot, Class A Office development located in affluent Bloomfield Hills, Michigan, have been put on hold, casualties of the sluggish market. The former Volkswagen Group of America Headquarters, located in Auburn Hills, is now vacant after the company relocated to Herndon, Virginia, in April 2008, leaving 120,000 square feet of space empty.

Foreclosure and bankruptcy practices are familiar to Michigan’s brokers. The recent wave of foreclosures is a national epidemic with roots in Detroit — the region has a history of being hit first and hardest during economic downturns. Despite this challenging economic landscape, some commercial real estate firms in the Detroit market have created new business opportunities. Recognizing marketplace realities, NAI Farbman, among other brokerage firms, has been participating in receivership work to turn around properties in default, improve curb appeal, build stronger rapport with current tenants and reduce operating costs, among other initiatives. These Detroit brokers are now sharing their expertise with companies, many of which believed that a foreclosure crisis would never happen to them, on a national level.

The medical office sector is where the majority of development is occurring in the Detroit area. Several large medical developments located in Oakland County have been completed in the last 12 months. Among them is McLaren Health Care Village in Clarkston, a project of McLaren Health Care in collaboration with the Clarkston Medical Group. This three-phase development includes a 135,000-square-foot Medical Office Building, a 42,000-square-foot Cancer Institute, and a 5-acre Garden of Healing and Renewal. However, with metro Detroit residents losing jobs and, subsequently, healthcare benefits, medical office properties are also in less demand. Some developments that were under way have been tabled, while several healthcare corporations have chosen to lease existing space as opposed to embarking on new construction efforts.

Following the northward residential migration, the demand for office space is strong in northern Oakland County, a Detroit submarket. Anticipating enrollment to increase to as many as 1,000 students, the Thomas J. Cooley Law School in Auburn Hills, Michigan, recently completed a 62,000-square-foot addition to its 67-acre campus. The area’s growing population also will eventually require additional retail, banking, restaurant and healthcare services to support the expanding community.

— Laney Cavazos is the director of corporate services and vice president of Southfield, Michigan-based NAI Farbman.

Detroit Retail Market

When it comes to the metro Detroit area, perception may not equal reality. The once-and-future motor city is meeting the challenges of a downsizing auto industry and a national economic slow down head on. The changing dynamics have altered the names of expanding retailers, but this shift has managed to present an opportunity to many local entrepreneurs and market savvy retailers.

Similar to the rest of the country, the metro Detroit retail sector has been impacted by consumer pull back, national big box closures and the reduction in new store openings. Store closures from Mervyns, Circuit City, Cost Plus, Linens N Things, La-Z-Boy and Office Depot have increased the overall vacancy rate to 9.9 percent, and left landlord’s seeking replacement retailers and/or new uses for empty space. Increasing vacancy is pressuring the market, slowing demand for new development in greenfield growth markets and creating better opportunities for new locations in dense, established markets.

Aside from Taubman Center’s Mall at Partridge Creek, metro Detroit did not get caught up in the over development of lifestyle centers in recent years. Instead, Michigan developers focused on smaller, traditional grocery centers or Walmart, Meijer or Target-anchored endeavors.

A number of these projects have recently come online or commenced construction. Lormax Stern Development Corporation is currently working on three Walmart developments in Hartland, Rochester Hills and Livonia, Michigan. Also, Schostak Brothers and Company recently completed a redevelopment of Wonderland Mall in Livonia. The 650,000-square-foot Wonderland Village power center is home to a new Target, Walmart Supercenter and LA Fitness, as well as a strong collection of small shop retailers. Wonderland’s new retailers have opened above projections and are an example of success being achieved by re-engaging existing core communities instead of chasing rooftops into greener markets.

Other new developments include the 175,000-square-foot Village Lakes Shopping Center in White Lake, which is anchored by JC Penney, Marshall’s and Famous Footwear; the 300,000-square-foot Crossroads Village in Canton, anchored by Target, Kohls, Old Navy and PetSmart; and a 103,000-square-foot redevelopment by Ramco Gershenson Properties Trust of Old Orchard Shopping Center in West Bloomfield, Michigan, which is anchored by a new Plumb Market.

Many retailers remain active in the metro Detroit market. Walmart and Meijer are seeking new locations and capitalizing on the national consumer shift to discount and affordable goods. With new locations in Hartland, Livonia, Rochester Hills, and Clinton Township, both operators continue to gain market share across Michigan. Kroger is keeping pace by reinvesting across the state. Currently, the grocery retailer is expanding many of the stores acquired in 2007 from Farmer Jack/A&P. These stores are located in Detroit-area markets such as Brownstown Township, Schwartz Creek, Westland, Taylor, St. Clair Shores and a new opening in Macomb Township.

Other national retailers taking advantage of market opportunities and seeking/opening locations include Marshall’s, TJ Maxx, Golfsmith, Aldi, LA Fitness, Hobby Lobby, Buy Buy Baby, The Christmas Tree Shop, Plumb Market, CVS/pharmacy, Walgreen’s, Chase Bank, Citi Trends, Pei Wei, Cato, Famous Footwear, O’Reilly’s Automotive, Advanced Auto, Belle Tire, Dollar Tree, Dollar General, Tim Horton’s, Sonic, Jimmy Johns, and Five Guys Burgers & Fries.

Metro Detroit is also seeing local entrepreneurs step up to fill the void left by retreating national retailers. Local companies such as ABC Warehouse and Dunham’s Sports have taken advantage of the market conditions and increased revenues with a number of relocations by back-filling vacated mid-box storefronts. Local franchisees including Five Guys, Jimmy Johns and Noodles & Company, as well as an assortment of family restaurants, are taking advantage of reduced national competition for prime locations and are filling area vacancies. A new apparel concept, Wear District, is picking up where Steve and Barry’s left off. The retailer requires 25,000 square feet and is a great example of local entrepreneurs seeing a retail void, gathering tremendous executive talent and opening in proven retail locations.

Southeast Michigan remains one of the largest metro areas in the country, home to renowned research institutions and a talented work force. While the region rides out the immediate ups and downs of the economy, the area continues to diversify and opportunistic retailers and entrepreneurs are rising to the challenge to meet the community’s needs.

— Anthony Schmitt is vice president of Southfield, Michigan-based LaKritz-Weber & Company.

GM SHUTTERS MIDWEST PLANTS AS PART OF RESTRUCTURING

Detroit — In the wake of General Motors filing for Chapter 11 bankruptcy protection on Monday, the company has announced plans to close or place on standby several of its manufacturing and distribution facilities. As a result of lower demand and the inevitable reduction of the company’s size, GM will also close several manufacturing facilities over the next 2 years. Assembly plants in Wilmington, Del., and Pontiac, Mich., will both be closed by the fall, and plants in Pontiac, Mich., and Spring Hill, Tenn., will both be put on standby capacity in September and November, respectively.

Several stamping plants will also be shuttered. This month will see the previously announced closing of a Grand Rapids, Mich., plant, followed by the Mansfield, Ohio, plant in June 2010 and the Indianapolis plant in December 2011. The Pontiac, Mich., stamping plant will be put on standby capacity in December 2010.

Finally, five manufacturing plants for powertrain components will close in 2010, including the company’s engine plant in Livonia, Mich. The other facilities are located in Flint and Willow Run, Mich; Parma, Ohio; and Fredericksburg, Va. A castings plant located in Massena, N.Y. closed last month.

“In general terms, it’s a situation that has been a long time in the making,” says Cameron McCausland, director of brokerage services and principal with the Southfield, Mich., office of Colliers International.

While the short-term impact will consist of increased vacancies and lower rents, McCausland believes that reorganization will ultimately be the best thing for General Motors. The company will now be able to rid itself of extraneous divisions and properties, which will give it a better chance to become profitable again. Once that happens, the company will once again be able to expand into new facilities and increase production.

“Although, in the short-run this will possibly be painful, it’s a new day [for GM.] It’s a new start going forward,” McCausland says.

— Coleman Wood

Detroit Multifamily Market

While a rapidly deteriorating local economy is weighing on apartment operations in Detroit, weakness is expected to be mitigated by residents remaining hesitant to transition away from rental units. The Detroit metro area has one of the most affordable housing markets in the country, as overbuilding and a declining population have resulted in a significant supply/demand imbalance. Nonetheless, many local inhabitants are exhibiting caution when considering a move into a home due to still-falling prices and the high-risk employment market. The weak national economy is limiting options for job seekers outside of the metro area, which could stem the tide of out-migration in the short term, boosting demand for area apartments. On the supply side, development activity is minimal again this year, as construction costs continue to outweigh attainable rents. Competition is emerging from fractured condominium projects, some of which are offering units for lease until demand rebounds.

Early estimates indicate that employers decreased payrolls by 6.8 percent, or 130,700 jobs, in the 12 months from second-quarter 2008 to first-quarter 2009. As auto-related companies restructure, 102,000 area positions have been eliminated in the last 6 months. While vacancy does not fluctuate significantly in Detroit, mounting job losses will force some local residents to double-up. As a result, vacancy is expected to finish the year at 7.9 percent, an increase of 120 basis points.

Local apartment community owners will continue to increase leasing incentives this year to help keep renters in units. Asking rents in Detroit finished the first quarter at $834 per month, while effective rents slid to $766 per month, annual losses of 0.2 percent and 0.6 percent, respectively. Average concessions have widened to nearly 30 days of free rent during the past year, the highest rate since early 2005. During the last 12 months, Class A rents have retreated 0.2 percent to $1,038 per month, while Class B/C rents have dipped 0.4 percent to $721 per month. Average revenue has decreased by 0.9 percent year over year due to lower occupancy levels and rents. As fundamentals soften through year end, the average revenue is expected to recede another 1.4 percent.

Although modest, deal flow in Detroit reached a sustainable pace early this year and is expected to remain relatively flat in the coming months. Most of the transactions in 2009 will likely involve local buyers exchanging assets to meet individual investment goals. Value-add plays in the Midtown/West Detroit submarket could attract some owners with a penchant for improving vacancy, although the current climate may challenge this approach. Additionally, underperforming properties in some high-end Oakland County, Michigan, submarkets, including Troy and Farmington Hills, could provide significant revenue gains for owners willing to adjust concessions to firm occupancy levels. Lower home prices in the county, however, are expected to limit rent growth over the next few years. Long-term strategies can be achieved in the Ann Arbor, Michigan, submarket, where the student population supports Class B/C demand. Regardless of investors’ goals, cap rates in Detroit offer buyers some of the highest initial returns in the country.

— Steven Chaben is a managing director of Marcus & Millichap Real Estate Investment Services and regional manager of the Detroit office.

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