Heartland Real Estate Business presents suburban Detroit city highlight, compiled by the following individuals at Marcus & Millichap: Greg Moyer, senior vice president and managing director; Alon Yonatan, research services manager; and Yitzie Sommer, research services manager. With 34 offices nationwide and sales in excess of $6.4 billion last year, Encino, Calif.-based Marcus & Millichap is the largest commercial real estate brokerage in the nation focusing exclusively on real estate investments.

Office

Like many suburban office markets around the country, suburban Detroit has experienced rising vacancies and falling rents over the past 12 months. This result has been the combination of a softening economy and increased deliveries of new office space, especially in Troy and Southfield.

Between 1995 and 1998, new completions in the suburbs averaged 1 million square feet a year, but over the last 3 years that average has doubled to more than 2 million square feet. This has placed an added strain on the market, already struggling with a weak economy. While market conditions have worsened, however, investment activity has actually increased in 2002.

Sales velocity year-to-date is running 10 percent higher than last year, with close to 80 transactions taking place above $1 million, compared to 62 transactions last year. Reflective of current market conditions, the transactions in 2002 have been much smaller, with sales dollar volume on pace to reach just half of 2001's total. However, prices for these buildings have increased over 2001 levels. The average price per square foot is up almost 10 percent, from $110 per square foot to more than $122 per square foot. The main impetus for this price increase has been the cheap cost of debt. The dramatic drop in interest rates towards the end of 2001 and into 2002 has allowed investors to pay a higher price for properties while maintaining positive leverage.

Another primary reason for the increase in price has been the type of investor in the suburban Detroit market. This year's investors have been almost exclusively private buyers as opposed to institutional investors. These private investors have large cash reserves and have more flexibility than most institutions.

Price increases also have been reflected in the cap rate, which has dropped to an average between 9.75 and 10 percent, a reduction of 25 to 50 basis points from last year. This trend is most likely to continue for the next 6 to 9 months, during which private buyers will continue to purchase small properties and be willing to pay a slight premium as long as debt remains cheap.

The majority of institutions will remain on the sidelines, unwilling to purchase properties at these low cap rates and high prices per square foot, and unable to sell their larger properties due to limited alternative investments to trade into. If the anticipated economic recovery materializes, the higher cost of debt will serve to temper buyer demand, thus relieving the upward pressure on prices.

Industrial

The suburban Detroit industrial market has been reeling since the fourth quarter of 2000. Vacancies have increased more than 5 percent, from 6.4 to 11.7 percent, while the average rent has dropped from a high of $6.98 per square foot to it current $6.25. In addition to the weak economy, contraction of space within the automobile industry has been a major force in producing these adverse conditions.

Tenant contraction and relocation have placed an added risk into the industrial market that has repelled some buyers, but there are still many investors that look to industrial product as a safe harbor during a weak economy.

Transaction activity through the first half of the year was down slightly, but the amount is not alarming. The first half of the year did witness the largest industrial deal since June 2000. The property, a 407,000-square foot single-tenant building in Flint, sold for an undisclosed amount believed to be more than $20 million. The price per square foot was also believed to be above the market average for 2002, which illustrates not only the strength of this particular deal, but the appetite for large industrial facilities in the Detroit area. In fact, this transaction and several other large properties currently being marketed appear to have brought institutions and out-of-state investors back to the market.

Institutional investors and private entities from out of state made significant purchases in the suburban Detroit market over the past few years, but in 2002 these two groups have operated almost exclusively on the sell side, foregoing almost all buying opportunities in the market. However, the recent marketing of some large institutional-quality deals at attractive cap rates seems to have changed the tide. Although cap rates have dropped over the last 2 years, they remain safely above 10 percent, which assures a healthy return due to the cheap cost of debt. Similar to the office market, the industrial market has seen an increase in prices, due to the cheap cost of debt.

Additionally, investors have turned to industrial properties as a flight to safety during the current economic climate. Investors are more willing to pay a higher price for what is viewed as a more secure asset, especially if it has a higher return. Even as the economy rebounds and interest rates increase, the industrial market should see some price appreciation in 2003. Expect more institutions and out-of-state buyers to return to the market with larger-sized transactions taking place toward the end of 2002 and into 2003.

Retail

Retail investors in the suburban Detroit market continue to concentrate mostly on the grocery sector, although strip center and drugstore activity have also garnered investor interest. Big-box retailers such as Lowe's, The Home Depot and Target are also creating high levels of investor interest as these companies continue their expansions.

With the economy in the Detroit area slowing much in line with the national economy, fundamental demand for retail goods (and in turn retail space) is not as strong today as it has been in the past. Although economic challenges do remain, key drivers of the Detroit economy such as the manufacturing sector and specifically the automotive sector have posted better than expected results, leading many to believe that as the economy recovers during 2003, demand for both retail products and retail space will improve.

To compound the reduction in demand, additional retail space in the form of new construction has been coming online. This combination has led to increased vacancy levels and generally flat rent growth, although actual average rents in the suburban market are expected to increase slightly this year over last year due to the shifting of some tenants from older, more obsolete retail centers charging lower rents to newer space at higher rent levels.

In terms of development, submarkets in suburban Detroit are seeing substantially more development than the city itself. The most active of these submarkets include Northern Oakland, Macomb and Livingston counties, all of which offer some aesthetic advantages of living in the suburbs while still offering access to major transportation arteries and major employment centers.

Depending on factors such as the specific location, quality of the tenants and duration of leases, some of the best retail properties are trading at capitalization rates in the 9 percent to 9.5 percent range, while unanchored retail centers in less attractive but still highly viable locations are trading at capitalization rates in the 10 percent to 10.5 percent range.

Multifamily

Most investors in the suburban Detroit multifamily market are local private investors who are familiar with the local economy and the various business cycles that have historically occurred. As such, even with some of the uncertainty that currently exists in the local economy, most private investors that have historically been active in the multifamily investment market remain active, with the vast majority continuing to seek additional investment opportunities.

Even with vacancy levels higher this year than last year (most noticeably among Class A apartment complexes) and rents relatively flat, affordable and widely available debt, combined with a lack of alternative investment options have helped motivate private buyers to continue to pay aggressive prices. Despite willingness on the part of buyers to pay aggressive prices, some of the same reasons that buyers are willing to buy at aggressive prices are deterring some sellers from coming to the market.

Construction levels have also remained relatively in check in suburban Detroit and, in virtually all cases, the levels of construction are well in line with the demand for the submarket. In part, this is due to constraint on the part of developers.

Two additional reasons why construction has been relatively limited include relatively high land costs and a reluctance on the part of community leaders and residents in the various suburban markets to actively support new construction in their neighborhoods. This contrasts sharply to development efforts in the city, where most apartment construction and revitalization, when proposed by developers, continues to find strong political and civic support. Over the next 12 months, rent growth is expected to return to the suburban Detroit market when the economy turns around, which will contribute to stability and appreciation in the multifamily sector.


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