Motor City's engine idled

It's been a bumpy ride at best for the Detroit economy during the first half of 2001. Heading into the new year, the “Big 3” automotive companies announced spending cutbacks on new projects, forcing major automotive suppliers to temporarily close plants and thereby dealing a blow to the state's manufacturing sector.

“The trickle-down effect caused by the automotive industry has taken its toll on the value of facilities, with reductions as high as 25%,” wrote Steve Gordon, president of Southfield, Mich.-based Signature Associates-ONCOR International, in a mid-year market report.

“Several good things have resulted from this slowdown,” wrote Gordon, “and companies have been forced to toughen up and re-evaluate their core policies — i.e., cost savings necessary to be more competitive as they wait for the market to turn around.”

That turnaround may not come as quickly as some had hoped, however, due to the terrorist attacks of Sept. 11 on the World Trade Center and the Pentagon that killed at least 5,000 people. U.S. auto sales, which already were soft through the first eight months of the year, plummeted 25% in the days immediately following the dastardly attacks, prompting more talk of layoffs among automakers.

In the wake of the attack, local newspapers reported that market research firm J.D. Power & Associates cut its forecast for U.S. sales this year by 200,000 vehicles to 16.3 million. The research firm also lowered its 2002 forecast by 200,000 vehicles to 16 million. Meanwhile, David Littmann, chief economist for Comerica Bank in Detroit, cut his national economic growth projection for this year to 1.5% from his previous forecast of 1.7%.

Mixed signals abound

Still, while acknowledging caution all round, most real estate professionals in the trenches in metro Detroit aren't pushing any panic buttons just yet. The lessons of the last real hit a decade ago have been learned too well, they say. And less sizzle than some glamour cities in the boom times will also mean less fizzle in tougher ones.

But the slipping market share for domestic automakers can't be ignored. After a period of resurgence, American car makers have begun to lose market share to European and Japanese competitors. And reduced or abolished bonuses for workers at the “Big 3” translates into less discretionary dollars being pumped into the local economy.

Progress on big-ticket downtown developments such as sports stadiums and the new Compuware Corp. headquarters is offset by gobs of office space already or soon-to-be on the block. Meanwhile, a wave of uncertainty surrounds riverfront development. And if the residential market cools off, so too will new retail developments, including the ubiquitous power strip. But optimism persists.

“We may well find that Detroit as a real estate locale proves itself to be resilient in the face of a downturn,” said Doug Etkin, principal of Etkin Equities based in Southfield. “The current environment is more cautious and the development and lending communities are in sync. New supply will be curtailed appropriately.”

Gordon of Signature Associates echoed that sentiment. “Throughout this downturn, the real estate industry has remained fairly stable,” he stated in the mid-year report. “Several health care and other non-automotive industries are currently fueling the marketplace in Southeast Michigan, whereas automotive activity is virtually non-existent.”

While he acknowledges the region is in the midst of an economic slowdown, Paul Dietz, president of Birmingham, Mich.-based The Dietz Organization, said there is no need for alarm. “It's like going on a diet or shedding pounds. To get back in shape, exercise and avoid excess.”

The Detroit area economy dipped 8.6% for the first seven months of 2001 compared with the same period a year ago, said Littmann of Comerica Bank. (The figures were corrected for inflation.) One source of wealth creation for area residents continues to be home values, which have appreciated 5.5% annually for the past seven years, according to the local economist.

Office vacancies hit double digits

The vacancy rate for all classes of office space in metro Detroit rose 3% in the second quarter to 11.5%, according to the Southfield office of Northbrook, Ill.-based Grubb & Ellis. The good news is that the office market appears to have stabilized somewhat despite an increase of available sublease space, which now totals 1.3 million sq. ft. In the first quarter, the office vacancy rate locally had ballooned to double digits for the first time since 1988, Grubb & Ellis reported.

Steel keeps going skyward and concrete is being poured on the new $550 million world headquarters for Compuware Corp. in downtown Detroit. The project's first phase of two adjoining 16-story wings that total 1.1 million gross sq. ft., along with above and underground parking for 3,000 cars, is expected to be completed by mid-2003. This first phase will add as many as 3,600 Compuware employees to downtown Detroit's work force.

At the same time, a significant amount of prime downtown office space has become available — perhaps as much as a 10-year supply based on historical absorption rates.

The combination of refurbished properties on the selling block and firms downsizing has resulted in large blocks of available space in several downtown office buildings including: Griswold Place; 1001 Woodward Plaza; the Guardian Building; One Woodward Avenue; Brewery Park; Stroh River Place; and the 500 Tower of The Renaissance Center.

The consolidation of State of Michigan offices into the former General Motors Corp. headquarters in the New Center area also may be contributing to lackluster CBD occupancies.

Jeff Bell, senior vice president of the office services group at Grubb & Ellis, notes that the region has its fair share of “home-run” developments, but he believes the industry should also focus on singles and doubles. In the past 18 months, the Southfield office of Grubb & Ellis has successfully leased one-third of the 300,000 sq. ft available downtown at Stroh River Place.

Grubb & Ellis also has been retained as a consultant to the Hammes Co. of Madison, Wis. Hammes is helping redevelop a former Hudson's warehouse into 200,000 sq. ft. of office and retail space. The redevelopment is part of the new Ford Field complex that will house the Detroit Lions of the National Football League.

Despite these marquee projects, there's no way to soft-pedal the subject of office vacancies. “There's a lot of space available and a lot becoming available,” said veteran downtown broker Fred Klugman, who formed Detroit-based Klugman Commercial Properties LLC. As a result, Klugman expects the gap between quoted rates and “deal” rates to widen. Klugman Commercial Properties handles leasing for 211 W. Fort St., a 450,000 sq. ft. office building that is 95% leased.

Suburban office markets are quiet but faring better than earlier this year, according to David Miller, associate broker and principal of Signature Associates-ONCOR International. “It might seem like there is space and fewer tenants than we'd like, but the new projects in the market are a small percentage of the total office market. It doesn't take much movement to fill what's there.”

Among the office properties being marketed by Signature Associates-ONCOR International is Two Towne Square, the second phase of Southfield-based REDICO's Oakland Towne Square development. Two Towne Square will be a 9-story, 180,000 sq. ft. office tower connected to the existing 18-story, 425,000 sq. ft. One Towne Square.

The asking rate at Two Towne Square is $19 per sq. ft., triple net, reports John Fricke, associate broker and principal at Signature Associates. Fricke expects a similar tenancy to One Towne Square, whose roster includes insurers, auto suppliers, health care professionals, as well as banking and financial planning firms.

“Landlords are not bowing heavily to tenants. We don't see aggressive concessions yet,” noted Len Tosto, senior vice president of investment brokerage at the Birmingham office of Boston-based Colliers International.

While not many office properties are trading, the Detroit area should fare well compared with other markets, predicts Joe Anthony, director of the investment property group at the Southfield office of CB Richard Ellis, headquartered in Los Angeles. “Most office buyers purchased below replacement cost, with only a couple exceptions where properties may be more susceptible to a long-term correction,” Anthony said.

Even the impact of sublease space is less acute in Detroit than elsewhere, Anthony contends. “Where it may represent as much as 80% of all negative absorption in some other markets, here it's only one-third to one-half of negative absorption, and it leveled off in the second quarter.”

Industrial markets feel tremors

Grubb & Ellis reports that manufacturing slowdowns have had a measurable impact on the industrial market in metro Detroit. “Increased vacancy, declining R&D rents and steady warehouse/manufacturing rents are the trend this [second] quarter,” according to Grubb & Ellis.

The mid-year vacancy rate rose to 7.4% for all classes of industrial space in metro Detroit, with available space reaching 37.1 million sq. ft., according to Grubb & Ellis. While average R&D rents declined from $8.02 per sq. ft. to $6.59 per sq. ft., average warehouse and manufacturing rents rose from $4.95 per sq. ft. to $5.17 per sq. ft. in the second quarter.

One of the healthiest submarkets is Macomb County, where the vacancy rate declined to about 6%, with both R&D and warehouse/manufacturing rental rates remaining constant at $7.50 per sq. ft. and $5.58 per sq. ft., respectively, reported Grubb & Ellis.

On the flip side, vacancy rates in southern portions of Oakland County surged during the second quarter. For example, in the first quarter of 2001, the vacancy rate in the southeast portion of Oakland County registered 3%, but by the end of the second quarter it had risen to 7.1%.

The industrial real estate market in metro Detroit remains relatively healthy with no landlords at risk of foreclosure, according to Dan Labes, senior vice president at the Southfield office of Grubb & Ellis. The automotive sector is still the engine that drives the market, added Labes. For example, in Brownsfield Township, General Motors Corp. leased 630,000 sq. ft. of what had been speculative space at Brownstown Business Center, a development of New York-based Ashley Capital.

Larry Kelly, senior vice president of the industrial division at the Bingham Farms office of Colliers International, noted an evolution of the warehouse and distribution segment of the industrial market. “Six to 10 years ago, the need for bulk warehousing was painfully obvious,” Kelly said. “We didn't have any state-of-the-art facilities.”

Then came Ashley Capital, whose warehouse and distribution facilities offered 30-ft. clear height ceilings with docks, updated sprinkler systems and lighting. “As fast as they could build them, Ashley filled them up,” Kelly said.

“The growth of distribution has been a key element in the growth of our economy,” Kelly added. The veteran real estate professional acknowledged that a combination of other players “jumping on board” and a slowing economy has led to a surplus of warehouse and distribution capacity.

REITs, most notably Chicago-based First Industrial Realty Trust, have been net sellers of industrial property in the metro Detroit area, according to Tosto of Colliers International.

Retail: Slow but steady

This is not the time to build the retail equivalent of the Taj Mahal in the Detroit area. And as a result, some of the more ambitious developments on the drawing boards will likely proceed more slowly than anticipated.

On the other hand, “Detroit is still attractive to national retailers and we are strong in the grocery-anchored segment,” said Dan Jacob, senior broker in Signature Associates' retail division.

The key ingredients for today's popular town center-like developments include a mix of density and urban traffic, an office component, and nightlife for residents. One project that Jacob believes fits that criteria is Meadowbrook Village, a 375,000 sq. ft. tear-down and rebuild of Meadowbrook Mall by Troy, Mich.-based Robert B. Aikens & Associates. Located at Walton and Adams roads in Rochester Hills, Meadowbrook Village will be completed in the fall of 2002.

Home Depot, Lowe's Home Improvement, Kohl's, Target, Wal-Mart and Super Kmart still are moving forward on infill sites in trade areas, according to a retail overview prepared by Signature Associates. “They are not, however, aggressively pursuing marginal trade areas,” the report stated.

One trend picking up steam in metro Detroit is the retail food service segment that offers fresh food and beverages at a premium price, according to Signature Associates. Starbucks Coffee, Caribou Coffee, the Panera Bread Co., Atlanta Bread Co. and others are procuring multiple sites in metro Detroit and surrounding areas. Signature reports that the store formats demand high-profile, freestanding and end-cap locations in trade areas with a high concentration of population during the daytime, and customers with relatively high disposable incomes.

Many national food and service chains are faring well in metro Detroit, confirmed Chris Piwowarczyk, sales associate in Colliers International's retail division. Piwowarczyk worked with the Tim Hortons chain during its expansion into the Motor City.

The Detroit area now boasts about 40 Tim Hortons locations, either stand-alone or combined with Wendy's, its parent company. The way was eased by acquisition of a number of Hardee's sites. Another plus has been Tim Hortons' compatibility with a relatively small footprint, Piwowarczyk added.

Given the sluggishness of the economy, retailer expansion plans have slowed, said James Bieri, president and CEO of the Bieri Co., Detroit. “Everyone is bracing for a soft Christmas. Investors will be cautious with retail until after the first of the year.” He expects new concepts from European retailers such as Ikea, which is expected to open a store in Troy. With reduced trade barriers encouraging expansion into new markets, Detroiters can expect to see more “bread- and-butter” retailers, not just luxury names.

Among Detroit-area developers, Lormax Stern of West Bloomfield is working on a 75,000 sq. ft. expansion of the 300,000 sq. ft. Northville Village Center in Northville Township. The developer also is building the 250,000 sq. ft. Ford Sheldon Center in Canton Township, which includes Target, Lowe's and Linens 'N Things, reported Lormax Stern partner Chris Brochert.

Matt Kiriluk, a principal at Kirco Development, reports that Kirco and Lormax Stern have broken ground on the 450,000 sq. ft. Shelby Creek in Shelby Township. The five-store regional strip mall is expected to open next year at the corner of Van Dyke and 26 Mile in Macomb County. Among the major tenants will be Target, Home Depot and Michaels Arts & Crafts.

Hospitality takes a hit

These are interesting times for the hospitality industry, noted Mike Blahosky, first vice president and regional director of CB Richard Ellis' Southfield office.

Business travel, the bread and butter for urban hotel markets, is down everywhere, but Blahosky reported that destination resort traffic was still going great guns, at least prior to the Sept. 11 terrorist attacks that have devastated so many hotel markets for the short term. Maybe it's the “I'll treat myself no matter what” syndrome.

Hotel occupancy in metro Detroit was down 9% across all hotel types through August 2001, compared with a year ago, reports Blahosky. “Chicago is off 7.6% by comparison. But look at San Francisco, it's off 14% year-to-date. Few markets are showing any occupancy growth at all,” Blahosky said. “There is not much investment activity. Sellers are trying to hold on, and buyers are thinking, ‘Why buy now? I can get a deeper discount if I wait.’”

Multifamily market chugs along

Apartment rents in the Detroit area have caught up with other U.S. markets, said Jonathan Holtzman, CEO of Farmington Hills-based Village Green Cos. “Three years ago, we were 90 cents per sq. ft., with no higher rental rate or renter-of-choice apartments. Now we have people who can afford to own, choosing to rent units with attached garages, elevators, better bathrooms and kitchens, closets and services in in-fill cities,” Holtzman explained. “At Regents Park, our new high-end brand, we are achieving $1.35 per sq. ft., the highest rents ever achieved in Detroit and there are no objections. These renters are coming from a very expensive home or condominium.”

The apartment industry now offers different price points for varying incomes and attitudes, Holtzman said, much like the auto and hotel industries. “And we are reaching the Internet renter. Some 20% to 25% are applying online, maybe before even seeing one of the communities.” Village Green offers flexible-length leases as an alternative to the traditional one-year lease. The company also has established a lease equity program in which renters can earn up to $2,000 of “equity credit” toward the purchase of a home.

The luxury apartment market will remain strong in metro Detroit, predicts Gilbert “Buzz” Silverman, president and CEO of Bingham Farms-based the Silverman Cos. Silverman's firm is active in apartment acquisition, construction and management. “Well-positioned apartments have always provided a less cyclical return profile for investors in real estate,” said Silverman. “In the Detroit area, the lack of developable multifamily land creates a barrier for new apartment entry, and we have a steady supply of renters replacing those who move out primarily for home purchases.”

Apartment rents in metro Detroit have risen about 5% annually for the past five years, according to Silverman. Currently, the average monthly rent for a one-bedroom apartment is $900 and $1,250 for a two-bedroom apartment, garages not included.

In the luxury apartment category, Silverman will add 120 apartments to the original 240 units at Lake Village of Ann Arbor. Silverman also will develop the 320-unit Fairways of Woodfield in Grand Blanc for a private investor group. Silverman also is active in the furnished apartment niche. There are now about 20 Town Suites locations in Southeast Michigan. Silverman said the concept “mirrors the hotel industry at the top end.”

David F. Stein is a Farmington Hills, Mich.-based writer.

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