Signature Associates

Detroit’s resiliency in full effect as local CRE market remains healthy

Posted By: REjournals on August 14, 2024.  For more information, please click here to read the source article.

It wasn’t too long ago that the news coming out of Detroit was always negative. Today, though? There’s plenty of positivity surrounding Detroit, its suburbs and the region’s commercial real estate market.

That’s largely because the Detroit real estate market has proven to be remarkably resilient, even as high interest rates throw challenges its way.

Just ask the commercial real estate pros working this Midwest market.

Dennis Bernard, president of Southfield, Michigan-based Bernard Financial, said that overall Detroit’s commercial real estate market remains mostly healthy. This is good news and, in some ways, unexpected.

“I say that a little cautiously and with a little bit of surprise,” Bernard said. “Metro Detroit often suffers when the economy is challenging. Today, though, both statistically and feel-wise, we are doing better than many other cities.”

Andy Gutman, president of Farmington Hills, Michigan-based NAI Farbman, said that he agrees that Detroit’s commercial real estate market has been especially resilient today.

“This is the best I’ve ever seen Detroit hold when the economy is struggling,” Gutman said. “Historically, Detroit has been ground-zero for distress. It is a statement on the strength of Detroit today that it is not in any level of distress.”

Gutman points to other major Midwest cities that are seeing bigger slowdowns in commercial real estate sales and leases, cities such as Chicago. Detroit is an outlier in that its commercial real estate market has not seen a big drop in activity.

“Detroit is strong today,” Gutman said. “It’s a testament to the turnaround that we’ve seen in the city over the last decade.”

Why has Detroit been so resistant to the country’s economic challenges? Gutman said that the amount of public and private investment in the city is a major factor. Local government officials are focused on bringing a string of new businesses, restaurants, entertainment venues and other tenants to the city, Gutman said.

The government has also invested in infrastructure so that when new businesses target Detroit, they have easy access to travel, power and water.

“There was a time when you never knew if the streetlights would turn on,” Gutman said. “The mayor and the local government have done a fantastic job of making Detroit a place where people want to go. We have also benefitted from several billionaires who have invested heavily in Detroit, the Dan Gilbert effect. The Ilitch family, too. It has brought attention to the city. We have a lot of outside money coming in. We are still not Silicon Valley or New York City, but Detroit now has cache.”

Holding steady in the office sector

This doesn’t mean that the Detroit region’s commercial real estate market doesn’t face challenges. The office market is still suffering a hangover from the work changes that resulted from COVID. This means that office vacancies are up. But they haven’t soared like they have in some cities, Bernard said.

“Downtown is still strong,” he said. “No office buildings in downtown have been given back. Some of our suburbs such as Birmingham are doing better than ever. We do have some office buildings that are struggling. Those are mostly the ones that offer bigger floor plans. The ones that are high-rise or mid-rise buildings, those are doing OK.”

Like other CRE markets, the Detroit-area office sector is seeing a flight to quality, with tenants seeking out higher-quality office space with more amenities. Because of hybrid work schedules, these tenants are willing to pay more per square foot for higher-quality office space while renting a smaller amount of square footage.

This gives these tenants higher-quality space without boosting their overall rent expenses by a significant amount.

Bernard said that older office buildings or those whose owners have not invested in improvements are discounting their rents. Higher-quality office buildings? They are able to increase their rents, Bernard said.

Bernard said that his company provided financing for a client purchasing an office building in Troy, Michigan, for close to $140 a square foot. The reason for the high price? The office building was of a far higher quality.

“We continue to finance office,” Bernard said. “But it’s the larger offices that have 200,000- to 300,000-square-foot floor plans that are suffering today.”

Gutman said that while Detroit’s office sector does face challenges, it is performing better than many others. Gutman points to the high number of office properties falling into foreclosure in Chicago as an example. Detroit’s office sector isn’t experiencing the same trend, he said.

Part of the reason? Detroit’s office sector was not overbuilt before COVID hit.

“Our market is pretty right-sized,” Gutman said. “We are not seeing that level of distress that you are seeing elsewhere.”

Industrial still strong

Bernard pointed to Detroit’s industrial market as one sector that remains especially strong. The only difference today? Industrial activity isn’t booming quite as much as it did during the height of the COVID-19 pandemic.

That’s not surprising. During COVID, companies rushed to build or fill warehouses and distribution centers to serve customers who, stuck at home, wanted their products delivered as quickly as possible. Today, with most people out and about again, the demand for quick online delivery has lessened a bit, as has the demand for new industrial space.

Bernard, though, said that the Detroit-area industrial market is still seeing both high occupancy rates and strong rents. Those rental increases and occupancy rates just aren’t quite as strong as they were back in 2020, 2021 and 2022.

The biggest problem in industrial might be one of perception, Bernard said. During COVID, the industrial sector was seeing rental increases that were, as Bernard calls them, ridiculous. As Bernard says, developers could build any industrial product and it was leased before construction finished.

That has now changed, Bernard said.

“Now we are back to the market where it should be,” he said. “We got spoiled by the rental increases and demand during COVID. Now industrial space will sit for a little bit before it is leased. But it will still get leased. Again, our industrial market is still a very strong one.”

Gutman said that when people refer to the industrial market as being choppy because it has vacancy rates of 4% to 6%, it’s a testament to how strong the Detroit-area industrial market has been for so long.

“We didn’t overbuild in industrial, either,” Gutman said. “We have good access to roads and waterways. We have infrastructure that is strong. Our industrial market has been incredibly strong and robust. During a time when we had an opportunity to build and build, Detroit didn’t overbuild. We are in a good place here.”

While it’s true that developers did build a larger number of industrial properties during the height of COVID, they still didn’t add too much supply to the Detroit market.

“We didn’t add enough to hijack the market,” Gutman said. “The brokers who are smiling today? They are the ones working in industrial.”

And the retail sector? That’s strong in the Detroit market, too, with one exception.

“In retail, as long as you are not a mall, you are doing just fine,” Bernard said.

Bernard said that grocery- and restaurant-anchored retail centers are doing especially well, and that many of the area’s power centers have restabilized. And while several Rite Aid drugstores have closed throughout Detroit – as they have across the country – tenants are filling these empty spaces quickly, Bernard said. That’s because these Rite Aid stores were usually in good locations.

A looming threat in the multifamily sector

The multifamily sector is performing well, too, Bernard said. Monthly rental rates in this sector are still growing, though the pace of that growth has slowed. This isn’t unusual: Cities across the country are reporting the same thing.

Multifamily property owners, though, do face a challenge. Several properties were developed at low cap rates, with their owners borrowing money at low interest rates. Now that interest rates have risen, many of these owners are struggling to refinance their loans.

“That has led to a situation in which some multifamily properties that are full are also on their way to foreclosure or are being listed for sale because they were not bought or built or initially financed properly,” Bernard said.

Gutman said that while multifamily is still an attractive sector, for both renters and investors, the higher interest rates today pose a big problem for the owners of apartment buildings.

Many investors purchased multifamily buildings at 3% interest rates and many developers built properties while borrowing money at the same rates. Unfortunately, rates are far higher today. If owners have to refinance to a new loan with a higher interest rate, they might no longer be able to afford to hold onto their multifamily properties.

“A lot of multifamily owners are kind of stuck,” Gutman said. “It could have been even worse had interest rates continued to rise. Fortunately, they have started to fall. But even so, if you are a multifamily owner with a loan at 3% interest and you have to refinance to a new loan with an interest rate of 8%, what do you do? I think we will see some level of foreclosure and some drop off in multifamily development.”

The hospitality sector is another that is growing in the Detroit market. There is a shortage of hotel rooms especially in downtown Detroit, Bernard said.

“Depending on the night, downtown Detroit hotel rooms might be renting for $400 a night,” Bernard said. “Who would have ever thought we’d see that?”

The good news? More hotel rooms are coming to the city. Some developers are converting multifamily properties into hotels.

“There is a lot of energy downtown,” Bernard said. “Many of the companies, led by Rocket Mortgage, are getting people back into the office at least part of the week. But our night life in downtown Detroit is incredible. The number of restaurants and entertainment options in Detroit at night is incredible.”

Gutman agreed that the positive momentum in downtown Detroit continues today.

“I am a big believer in our downtown,” Gutman said. “We have award-winning restaurants, and we have new ones popping up every day. There is a true desire among people to live, work and play in the city. There are more entertainment venues. Having all our sports teams in downtown has helped. Detroit itself is a great place. There is so much to do in the city of Detroit now.”