Roundtable: In strong market, Detroiters set to roll development dice

Our first-ever panel of real estate players says Motor City is prime for projects downtown and around town The construction of casinos, sports stadiums and a new airport terminal is hogging most of the real estate headlines in the Detroit area lately. Still, the rest of the commercial market in the Motor City seems ready for take-off. Several developers are considering spec buildings in the suburbs, and at least one professional says he expects a major downtown office project to be announced within 60 days.

As rental rates rise, vacancy rates fall and institutional money flows, national real estate watchers once again are paying attention to the Detroit area. We at National Real Estate Investor wanted to see and hear for ourselves what's happening in the area, so we held our inaugural Detroit roundtable recently at the Southfield Marriott.

Here's what the 12 participants had to say about Detroit and the surrounding areas.

NREI: Word on the street is that rising rental rates in the Detroit area might prompt some developers to soon consider building spec space. Do you think it's time for some spec development in Detroit or the suburbs?

Sharon Strichartz: Definitely in the suburban areas. For one, the Troy area is very, very tight right now in A space and even B space. As far as large continuous blocks of space, anything over 5,000 sq. ft. is difficult to find and we're working with a few clients that are in the 30,000 sq. ft. range, and therereally isn't anywhere to put them right now.

NREI: With GM displacing more than 1 million sq. ft. downtown by moving into the Renaissance Center, it seems some of the center's tenants might not have had the option to stay downtown because there is nowhere else for them to go. Where will those people end up going?

John Godwin: There is a tremendous amount of activity in the downtown market with Wall Street and pension funds and new moneys that are coming in and looking at Class B products and converting C and D products to Wall Street levels. First Federal is now changing hands, and that building is going from a C classification to, in their opinion, an A classification. You have probably six or seven other similar buildings in and around that area that will be target buildings.

NREI: So then would you describe the situation in Detroit as a landlord's market right now?

Godwin: It is a landlord's market from the standpoint of Class-A property.

NREI: I know casinos have been in the news a lot. We have read about them in Atlanta and elsewhere, so I'm sure you have talked a lot about them. I'm trying to get an idea of what everyone thinks about the casinos and their future. Scott, what do you think the impact will be on the casinos, downtown and around town.

Scott Elliott: Why did you start with me with that question? Did I do something wrong here? That is a very good question. I don't know that in my mind that I clearly understand the long-term impact of what the casinos will be. I think short term that it will be very positive, and I think that the casinos will be a big draw for the first few years as they get started. But Detroit, as a travel destination, it is a large convention town from that perspective the casinos will be a good draw. But long term I think that is still a big question in my mind in terms of what casinos will have in terms of impact.

NREI: Do you hear anything from prospects saying, "I don't want to be anywhere near a casino?"

Elliott: We really haven't heard that. It seems like either the prospects either want to be downtown for a specific reason to be close to GM or the federal courthouse or the court system or they want to be out in the suburban market. We really have not heard any comments one way or the other from prospects.

NREI: Jeff, what are you hearing?

Jeff Shell: I think the casino issue is really separate. I think the relatively recent decisions to put the casinos on the river distances the casino issue more from offices. I think more fundamentally the increased residential for single-family multifamily is positive. I've seen a lot of people look at conversions for loft space. I think in order for Detroit to turn around, which I think it is, I think residential needs to be the foundation followed by retail. All of that I think is triggered primarily because of what GM has done.

NREI: Does anyone else have anything to have about casinos?

Tony Rascano: I was hoping that with GM moving into the Renaissance Center, I think that takes away from the available land, and I think that spot was a great spot for additional office space including lofts and residential development. When the decision was made that they were going to be there near the waterfront I just felt it took away from the excitement and the dynamics of the GM move.

Shell: I worked for a while down in the Renaissance Center and on the 22nd floor near the river [the view] was spectacular. I think that perhaps it would have been a very good opportunity to put casinos some place in another area because people don't go to casinos to look at the river they go to casinos to gamble. The river had so much potential for office users and for GM's further expansion, residential, a park-like setting like Chicago that would have been spectacular and that would have been more consistent with the mayor and their task force's original plans.

NREI: What are the job projections with the casinos? Would the economic development people have any projections?

Rascano: I think it's a substantial number, but I can't remember if it's 15,000 or 7,000, I really don't remember right now, but it was a very large number.

NREI: Did Detroit get any major relocations in the past year?

Shell: There has not been a tremendous amount of positive development, but I think some of the things that are happening downtown will position positive input. I think there will be a GM commitment. Every day there is a new aspect of their commitment. Last week they announced that they were bringing 30 of their senior executives from Europe back to Detroit. For every one of those executives there are probably 10 other jobs, either GM related or other- related that will come into the city and if those 30 executives are either in the area or the Renaissance Center, you're going to see other people that want to be there and you will see new buildings downtown relatively soon. I think we're poised to see activity, a lot of activity.

NREI: In line with that, let's talk about hotel development. Doug, do you see any prospects downtown or in the suburbs for new hotels or luxury hotels?

Doug Etkin: The casinos have a very very significant hotel component mandated as part of their initial approval. So that's, I don't know, 3,000 hotel rooms or something; it's a very significant number. I think that there's some people looking at some possible hotels or smaller versions of some of the national brands downtown in relation to the baseball stadium and probably the football stadium when it is built. But hotels tend to follow demand not lead demand, and there's plenty of time to create your hotels downtown when the additional convention business and casino businesses get established. As it relates to the suburbs, there has been all across America a very significant growth in the limited service segmented hotel products and that continues to occur. We have had a lot of hotels in our I-75 north corridor built. We just built two of them, one that opened two weeks ago, a Courtyard, and one that will open in three weeks, a new Residence Inn. Also along the 275 corridor, there's several products under way. I think that is a result of our very strong economy here, that's been strong for six or seven years now. Also a change in the hotel industry in terms of the product type and what the consumer is looking for. So Detroit in that respect is really not that dissimilar from any other suburban area around the country.

NREI: Andy, what are your thoughts on this development in the Detroit area? I know we were talking earlier about investment sales.

Andy Milia: I think there are two significant factors which are going to influence development in metropolitan Detroit. And one of these is the fundamental factors of supply and demand where the demand for office space, retail and similar products is continuing to increase and is caught up now to supply. Several plans have been announced for significant development in terms of office. The other thing is the change in ownership and the change in the capital structure. Detroit historically has been a very locally and entrepreneurial owned market, and we're seeing significant investment by institutional investors coming in and fueling the market. Wall Street has continued to pump a lot of money into the capital market and the two aspects of the fundamentals being good and the change in ownership and the appetite of national investors will help to spur development here as it has helped to spur it in other metropolitan areas.

NREI: Let's talk about money. We have some commercial mortgage people here. What are the capital structures like. What's going on in Detroit; is money chasing deals like in Atlanta?

Tom Ethier: A lot of institutional investors and permanent lenders view Detroit as favorable. We're actually having them accept transactions within the city limits that is loans on property within the city limits are being very well received. From a construction standpoint we're now in an up cycle which I suppose is not surprising when you have a lot of out of town banks and other short-term realty lending institutions coming into town and I would say money is chasing deals is not an inaccurate statement. The structures are weaker than they used to be, pricing is a little weaker than it used to be, and some people are forgetting some of the lessons of the 80's. But I don't think it's at a critical stage yet. But you have the potential for it to reach there in the future.

We have a very strong presence in Detroit. One of the interesting dynamics that we have to deal with in Detroit is that except for a few major companies located downtown, most people with whom you have day-to-day contact come to work in the suburbs. It causes issues to get focused on more from a suburban standpoint as opposed to a city standpoint. We have a very strong desire to see continued real estate development within the city limits.

The big issue that I think you mentioned is, is there going to be, where and when, a major new high-rise let's say Class A office building in the city; that is a goal of the administration. I can't say when it's going to happen, but at some point in this discussion I hope you poll and try to get some comments on that because that is probably the single-most interesting topic you will find if you travel nationally and if you travel in the city. When is the new office tower going to happen in the city is a question that's very important for them because it helps with people leading GM's relocation at the Renaissance Center. It's very important to have suitable space for them. And also there are going to be suppliers, there are going to be people who deal with GM, who are going to be wanting to be located downtown to be near their customer. The First Federal building, I think as somebody mentioned, can be a positive, and there's probably going to be some upgrading of some of the other towers in the area, but development in the city is a very, very key issue for everybody, and the most important development item in the city is not what we're talking about here: single-family housing. That is the hardest thing to see happen. You can see some small projects, but significant residences [aren't being developed]. That is a very important issue for all of us as well. We are very interested to support that but our job is to support, we don't create it obviously. I think overall the dynamics of the Detroit marketplace are very strong. Residential housing in Southeast Michigan is probably the strongest as any city in the nation in the last five years. And we're at the point now where all the national home builders are coming here. I think there's a lot of positives here; there are relatively few negatives. The most hopeful sign we could have is to see some commercial, office development in the city.

NREI: When will new office development occur within the city limits?

Strichartz: I know that our firm does a lot of work within the city of Detroit. Certainly our principal does a lot of work within the city of Detroit. About six months ago we did a study as far as what the costs would have to get a Class A type building in order to support a new Class A development downtown. And the outcome was the rent would have to be, minimally speaking, $28 a sq. ft. and that was at probably at $35 a sq. ft., and I don't see that happening within the next six months or within the next year. And certainly when you're talking about the river front being a wonderful place for a high-rise building I think one of the reasons that has not happened here is because ... Doug's a developer. I don't know whether he would want to go into the city right now and put up a class A building with rent that he would have to in order to support it at $35 a sq. ft. I think before that would happen, what might happen is, dependent upon what goes on with the city/county building. If the city actually does move out and move into the New Center area, that is prime for redevelopment into a Class A building, or maybe the first development that we will have will be all the buildings in the Campus Martius area where Hudsons is, and that's got proposals out right now for redevelopment that would encompass hotel and office and retail and maybe some residential. If I were to put money on it, I think I would say that would more than likely be the first development.

Larry Hadley: The question I want to ask is I think we're all assuming here is that we build it, they'll all come. And I think that for business owners looking to locate in the city of Detroit, I think affordable rent and desirable location is one piece of the puzzle for those business owners. But there are other aspects to locating their business that they have to look at in terms of the operating costs for their business. They have to look at the city income tax structure which puts them at a disadvantage in attracting and retaining employees as do the traffic issues and the parking costs. An employee takes an immediate pay cut right now the moment they move to downtown Detroit by virtue of the income tax, the parking, etc. And so therefore the power and demand generators needs to be substantial enough I think to offset those kinds of issues that maybe General Motors and some of these other things will be powerful enough demand generators. But I would submit that the city administration and others when looking at the attractiveness of Detroit need to look at the entire picture and look at issues like taxation, parking costs and all those other factors because I have to believe those weigh just as heavily in tenant decisions to relocate downtown as do the other aspects. And I haven't seen those issues on the table, and I think they need to be.

NREI: Creighton, what do you think about development downtown? You said business in Bloomfield is good but is the money you're lending or originating, is that mainly for suburban projects?

Weber: We do represent Metropolitan Realty Corp., which is essentially trying to provide union jobs and looking for buildings to construct in Wayne County and Macomb County essentially to create jobs so we put some of that union pension fund money into construction. Some of that is going downtown. But most of the mortgage business is all in the suburbs. The refinances, the acquisitions. I agree quite frankly with the things that have been said here. I think one of the things that the city needs to be look at the other advantages of cheap housing in the city of Detroit and if they can make it desirable cheap housing costs in Detroit you could maybe bring some people back in the city. That's something would just have to happen before you're going to have a demand for the office space because people look at is as a penalty to have to go work downtown in a lot of cases. Until that perception changes, you won't get the demand that you want. Just to go to a different topic a little bit, we see that it is definitely money chasing deals. The whole distribution of money in the commercial real estate business is changing. There is a tremendous fight for market share at the moment. Wall Street is providing all of the funds, essentially; the insurance companies are now buying all of the CMBS and giving their money to Wall Street. Wall Street is turning around providing all of the funds and the distribution channels are very muddled right now as to who is going to lend the money. Are they going to have their own direct offices, are they going to have correspondents or if there going to be a middle tier of companies that grow up and become national mortgage origination offices. That's what we're struggling with and there's tremendous opportunity as long you make the right decisions.

Hadley: You've seen a lot of consolidations and amalgamating in the commercial mortgage banking field. I was at a seminar put on by one of the major lenders a couple of weeks ago and one of the questions they asked, and there were about 30 or 40 mortgage bankers in the room from all over the country, how many of us had considered either merging with another mortgage banker or amalgamating or forming a strategic alliance with a lending institution in some fashion. And 70% of the people in that room, ourselves included, had answered 'yes' to that question. And you're seeing a lot of the national entities acquire mortgage companies. GMAC for example, has been very much on the acquisition trail. So I think to add on to Craig's point, I think the mortgage banking landscape is going to change because if it is to a certain extent a cottage industry, and I think that's going to change over the next couple of years as well as the distribution system evolves.

NREI: Let's talk about consolidation. That's a big term everywhere, obviously, Tom you know firsthand. But when it comes to real estate, has consolidation affected Detroit companies yet, or are there companies being bought?

Elliott: CB Commercial has gone from being a West Coast based company with global affiliations to acquiring Koll last summer to recently acquiring Richard Ellis. The name CB Commercial is going to incorporate the name Richard Ellis worldwide. So from our perspective it has, and I think that as we look around other markets, there have been some other acquisitions or at least some things talked about. You hear a lot about that as well.

NREI: Do outside companies come looking at your company, do they try to buy you?

Etkin: We entertain a lot of visitors, and because of our position here in this market, we seem to be a regular stop.

NREI: Have you had a lot more visitors lately?

Etkin: Detroit is entirely on the radar screen in the last 18 months to a degree that I've never in my career never seen it before.

Godwin: I had conversations two years ago with a pension fund and Wall Street investors that were just wanted to take an initial look at Detroit. They came into the market a year later and they were upset with themselves because they left a significant amount of dollars on the table from acquisition they were looking at. It definitely is on the radar screen. These institutions that are just beginning to come in and understand the components of Oakland County and Wayne and Macomb and the strength and it's driving prices to an all time high, significantly high and getting better.

Hadley: When these people can come to town and not be spitting nails after having gone through the airport, think how much more business we'll do.

Strichartz: We must be on the radar, I mean you (NREI) came here to talk to us.

Elliott: The face of Detroit is changing, and all of us real estate companies that provide information and I know that the requests for that information have just jumped dramatically. People from all over call frequently to get market statistics, information, market reports, that type of thing. But the scope of the ownership has changed immensely, too. Detroit is on the top 20 acquisition cities for REITs. We have seen a number of of REITs become very active in this marketplace. The national players that had become active, major assets changing hands over the past two years, beginning with the Renaissance Center, within the Prudential Town Center, now Southfield Town Center, changed hands a year and a half ago. Some of the major high-rises virtually every major building in town has changed ownership hands over the past two to three years or so. I think that trend began when Mutual Benefit Life ending up taking back a number of properties in foreclosure, and many of those people that acquired the property early on in the cycle made tremendous plays and eventually sold to the REITs at a significant profit. That continues to be strong. The opportunities are not as abundant now that many of those plays have been made but many players continue to look at Detroit right now.

Milia: The other thing that we haven't talked about is just the tremendous increase in value and appreciation of investment real estate. The prices were artificially low because of the fall out of the recession that Detroit as well as the rest of the nation experienced. When you start having office buildings that three years were trading hands at $50 to $60 a sq. ft. for suburban office buildings, and now you can't really buy Class A for under $100 a sq. ft., you've had close to a 70-80% appreciation on the same asset over a short period of time. So Detroit has been very good tothose people who have acquired here recently, and that's part of the attractiveness of the market.

Clarence Gleeson: We're starting to see trading prices approach that which would substantiate or support new development. The concern that I bring to the room here is how are activity as well as construction over the next two to three years, how is that going to affect the delivery of speculative, or for that matter any level of development? What effect is construction cost going to have on that overall picture?

Etkin: We are about to start three buildings, and we are very much concerned about construction costs - more so than we have ever been before, and we've found that essentially the same buildings can be built today that we built five or six years ago costs us $20 to $25 a sq. ft. more. And that says two things. One is rents have to be up today to support new construction. It also says there is significant room relative to replacement costs for the existing buildings which ties into your comments that people who bought buildings at $50-60, or office buildings are now traded in Detroit at $550 a sq. ft., I think that was Liberty Center's number. So we're seeing two things, we're seeing an increase in value of the existing stock and we're also seeing a self- regulating situation. Yes, we have low cost of capital but our costs of creating a product is higher than ever. I think in essence you have to have rents that are 14 to 15 net in the suburbs, at a minimum, to make a new building work and in the old days whenever we were called to ask to quote on a build-to-suit for someone, I just probably said $11 net, and it worked. Or maybe $12 if they wanted a lot of TI. So in essence you have a $2 to $3 increase in going- in rent that you must have to make a building work now. And the tenants are willing to pay that now.

Weber: Do you think the airport, the casinos and the stadiums will aggravate that factor when all of those people are actually starting construction?

Etkin: Undoubtedly, but not yet. Probably another year yet. There's a lot of talk now it hasn't happened just yet. Although there's been an awful lot of school construction that people don't even look has made a lot of people busy.

Rascano: I think a factor in the construction of industrial space and R&D, is the automotive. We have the luxury of GM, Ford and Chrysler in Southeast Michigan, which is a real blessing right now, it's times during slowdowns, it can work against you of course. But they're pushing decisions down to the suppliers, and these suppliers are coming into Southeast Michigan and putting in their North American headquarters and R&D divisions in Oakland County; there have been several in the last two years, either in Auburn Hills or Wixom, Farmington Hills and Novi. I think that has created many, many new facilities in Southeast Michigan with respect to new construction. Right now we don't see that changing in the near future. I think the casinos, the stadiums and all of this have a significant impact on it but also with the automotive companies requiring their supplies to be more of the R&D, and asking them, if not demanding them, to be in the area, I think that has made us blossom right now when it comes to the R&D and those types of facilities.

Gleeson: Suppliers, as I understand, are given a decision point that is fairly aggressive and a time table too so they're asked to deliver a product fairly quickly to the marketplace which obviously then brings a higher price point to deliver that product which allows that developer and that contractor to bring the skilled trades to them.

Hadley: The other thing we can't overlook, I'm mean it's there now and so everyone says OK, great, but the relocation of the Chrysler headquarters from Highland Park to Auburn Hills. That's an economic hydrogen bomb in terms of what that's going to do from a positive standpoint. The spinoff in my estimation has just begun. You've moved thousands of jobs out there. They themselves have taken up millions of sq. ft., they're already out of space and they're adding on to it. So the spinoff of all these vendors that need to be there near them and then all the economic development that generates is just going to put that stretch of the I-75 corridor just into warp-speed from a development standpoint.

Elliott: The other thing, we tend to focus on the office market because it's visible, but if you get into the outer ring of metro Detroit, starting over in Macomb County and then jumping over to I-75 and then out to I-96, the Wixom corridor, M. 14 and then down to the airport area, all of those areas are experiencing tremendous growth on the industrial front. Build-to-suits, smaller industrial buildings, anywhere from five to 50-60 thousand sq. ft. buildings going up. The growth is just tremendous. Then you have the growth that is taking place around the three or four major shopping areas starting with Lakeside on the east, working over to the Sommerset Mall area, and probably the hottest area right now is Novi. There's just many things going on in the Twelve Oaks mall area, Novi Town Center, a number of projects are on the drawing boards that will take off here shortly and those encompass retail, banks, office uses as well as some residential.

NREI: As the attention shifts to areas like Novi and Farmington Hills, does that hurt the downtown area? Or as Troy explodes, does it pull away the attention?

Elliott: I think with GM going downtown, that is probably the largest real estate play in this metropolitan area for a long time, and that is just going to fuel downtown as well. So I look at downtown as just being one more pocket that is experiencing growth, and as other people have said, we need some residential, we need retail downtown, some new hotels, those types of things, but they are beginning to happen. So I really don't look at them as drawing or pulling away from the downtown market.

NREI: Today in the newspaper, there's a Page One article about construction of a new terminal at the airport. How important is airport expansion and/or renovation to economic development?

Ethier: The airport is a two-edged sword. You have one of the top two or three carriers in the United States as its major hub. So you do have the advantage of having a very very major airline with a hub here, which allows all of us to enjoy the benefits of non-stop travels to virtually any city in America, most cities in America. The disadvantages of that is the amount of traffic within Metro that never leaves the airport is substantial. I don't know the percentages is, but it's a very high percentage of the people that land in metro Detroit never leave the airport, they just transfer to another airline. And their image of Detroit is generated almost exclusively by the airport. And that negative impact of that psychologically can not be overstated. It is a very serious issue which they are currently working on. The other issue at the airport is it needs an efficiency for the people to move the goods and then move the people. That does have a very negative impact on the area beyond just the image it creates.

Hadley: If we can hold our breath for the new terminal, the statistics that the airport people are putting out that indicate that once we get this new terminal and the capacity increases there, plus increase the Asian flights because it's quicker to go to the Orient from the Midwest than it is from the West Coast because they can go over the north pole and cut a couple of hours off the trip, we could become a real international gateway. Once we have good airport accommodations and maybe some good competition in fares, the airport could be a very positive economic generator for us, but we just have to tough it out until that new terminal gets built.

Strichartz: That should start hopefully by the fall of this year, and then they'll be adding a new runway.

Etkin: If I could change the subject a little bit. I think one of the stories that has not received much press at all relative to our office market here is the absolute incredible resurgence of the Southfield market. Four years ago we had four or five buildings that were in mothballs. Each of them is now occupied, has been renovated, Southfield rents have increased 30-40% over the rents of three years ago. And I think it is important because we spent some time this morning talking about the downtown area. But in fact, Southfield is our largest office market in metropolitan Detroit. So something that is not typically addressed is the health of Southfield, which is extremely good now, and there's not a lot of land left. Any land that's there will likely be built on fairly soon. Downtown is not our principal market for office in metropolitan Detroit.

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