In 1955 General Motors' CEO Charlie Wilson famously noted that what was good for GM was good for America. That adage has gone out the window today, unless you believe the U.S. GDP should be “right-sized,” in half with a dose mass layoffs. The domestic auto industry faces an ugly restructuring, and its birthplace is in the path of that broad storm. For better or worse, Midwest retail may be along for the ride.
While the U.S. economy has enjoyed four years of boom, Michigan has endured what Lansing economist Patrick Anderson calls a “one-state recession.” The Wolverine State has shed jobs for six consecutive years, hemorrhaging 290,000 since 2000. This is the longest streak on record, and the state expects to lose another 20,000 jobs in 2006. At 7.2 percent, the state's employment rate is much higher than the national rate of 4.8 percent. Meanwhile, median income has dropped 8.2 percent since 1999 while the national median income increased 9.1 percent.
And there's no light at the end of the tunnel. The full impact of parts-maker Delphi's bankruptcy and the layoff, buyout or early retirement of 60,000 Ford and GM workers has yet to be factored into the equation.
Troubles at the Big Three have been fermenting since the late 1970s, when GM, Ford and Chrysler had 90 percent of domestic market share. Honda, Toyota and Hyundai now control 60 percent of the U.S. market. While foreign carmakers are building more vehicles in the U.S., they have shifted auto production South. Since 1980, auto production has more than tripled in Kentucky, Tennessee, Alabama and the Carolinas. There, manufacturers have found tax breaks, lower wages and few unions.
“The U.S. auto industry is right-sizing itself and doing fundamental things it should have done long ago,” says Steve Chaben, a first vice president of California-based real estate brokerage Marcus & Millichap and regional manager of its Detroit office says. “In that I believe lies the silver lining. In that, we'll find stability and profitability.”
But there's more pain first.
The decline in the industry includes manufacturing of auto parts, which employs 3.5 times as many workers as the carmakers themselves. Since manufacturers prefer suppliers within a day's drive, the parts industry has also moved south. In all, half the top 50 North American parts suppliers lost money in 2005. Delphi, the nation's largest parts manufacturer, has fallen on its face. Spun off from GM in 1999, Delphi is now in bankruptcy and will shut 21 of 28 plants. The company wants to void union contracts, eliminate more than 20,000 domestic jobs and cut wages in half. Most of that will fall on Michigan.
It's a grueling process, but one local real estate pros are hoping Michigan and other Midwest states will emerge from with a diversified job base not so heavily realiant on manufacturing.
“The state's economy has to diversify over time,” says Jim Fielder, vice president of leasing for developer Robert B. Aikens & Associates, based in Troy, Mich. Fielder isn't so sure Michigan is unique in its troubles. “The line workers and other auto workers are going to have to retrain themselves for a new reality. But I don't think that is any different than what is happening in the Midwest, or the service industry, or other areas, where work is getting pushed offshore.”
Amid this, surprisingly, retail developers have still been able to find some success.
The Michigan Retailers Association notes that although sales continue to flag, forecasts are improving, particularly in western Michigan. Marcus & Millichap's Detroit Retail Research Report states that 2.2 million square feet of retail space will come on-line in 2006, with construction levels remaining flat. Rents will likely increase by 3.1 percent to average $17.83 per square foot with a slight rise in vacancy to 9.5 percent.
In part, retail spending has been kept afloat by the single-family home market. So even though wages were being cut, workers could refinance mortgages to generate equity. Moreover, buyouts helped create a cushion, giving laid-off workers some cash to lean on while looking for other jobs.
“Principally, I would point to a lot of disposable income,” says Chaben. “As a result, the fundamentals of the retail market have stayed sound.”
Chaben predicts a rough ride for the next 12 to 18 months as that trend plays itself out and many workers who receive buyouts leave town. But if you are looking to buy real estate and believe the state will rebound, don't dismiss the Motor City. “Because cap rates are higher here than anywhere else, and because we haven't had a run up on appreciation, I think Michigan might be the best buying opportunity in the U.S.,” notes Chaben.
Mike Piette, executive vice president of commercial development for KIRCO, a long-time Michigan commercial real estate developer, shares Chaben's observation. “Up through this spring, real estate has been trading at extremely low cap rates everywhere else,” he says. “In Michigan and the Midwest … there's been a good amount of equity available for the right type of acquisition. You may have to scrutinize them a little more, but we've had a lot of opportunity and access to that kind of capital.”
Not just cars
Most of the state's woes are concentrated in the I-75 corridor from Detroit to Flint and Saginaw. Other cities less dependent on the auto industry are faring better. Responding to $38 million in tax breaks over 20 years, Google will build a new facility in Ann Arbor, a high-tech hub and home of the University of Michigan. The firm expects to hire 1,000 workers over the next five years. Although welcome, knowledge-based jobs have been slow to expand in the state, according to think-tank Michigan Future Inc. Such “smart” jobs grew by only 17 percent between 1990 and 2005, well behind the 31.6 percent national average.
Grand Rapids, meanwhile, is home to furniture heavyweights Steelcase and Herman Miller. The city has less dependence on the auto industry and holds some of the state's most interesting retail developments. “If you look at Grand Rapids over the last eight to 10 years, you will notice that they did some of the things Michigan needs to do in terms of diversifying, improving education, tooling for the jobs of the future,” Fielder says.
In 2002 Robert B. Aikens & Associates opened the Village of Rochester Hills, Michigan's first outdoor lifestyle center. The 375,000 square foot center, located in Detroit's affluent northern suburbs, has been so successful. Sales per square foot at the property average $400 per square foot and traffic has increased by 10 percent a year.
Aikens & Associates are taking the concept out West and adding a twist. The 388,000-square-foot Village of Orchard Hills in Grand Rapids Township will add a residential component and use the village square concept to create a mixed-use project. Expect completion by Fall, 2007.
Joining forces
There's enough of a market in these parts of the state that KIRCO has teamed with another Michigan real estate institution, the Gershenson family, to form a joint venture building four mixed-use projects primarily within the state.
“We're very big on mixed-use,” says Richard Gershenson, one of three brothers formerly with Ramco-Gershenson Properties Trust before forming the joint venture with KIRCO. And Gershenson gushes about the possibilities in Detroit. “Metro Detroit has four million people, Oakland County is the third wealthiest in the country, and we have a highly skilled workforce.”
Gershenson and KIRCO are going vertical in Grand Rapids with the entertainment-based E Street development. The project is located in the heart of the downtown and will include a movie theater, restaurants, retail, a hotel and condos.
Closer to Detroit, Gershenson and KIRCO are also developing the Gardens of Rochester Hills, a 350,000 square-foot upscale lifestyle center that will compete with Aikens' Village of Rochester Hills. Also in the joint venture's pipeline are the 650,000-square-foot Village at Springfield and White Lake Township. which will combine a 77,000 square feet of medical office space with 147,000 square feet of retail.
Marcus & Millichap's 2006 National Retail Report warns that without enough residential base, retailers should not jump on the mixed-use bandwagon so quickly. Sure, it's urban and key to reviving downtown, but will there be enough traffic?
KIRCO's Piette isn't so skeptical. “Communities are looking for more urban in-fill type development. The social experience is changing and people are looking for more of a work/life balance with residential and retail right next to each other.”
Some developers are looking at the underserved inner cities. Big Midwest cities like Chicago and Detroit are home to many lower income or immigrant communities who, in aggregate, have substantial untapped buying power. As more people look to the city over the suburbs, these areas will continue to revitalize. The trick for developers is to correctly match the needs of underserved consumers to the right retail.
“If you're doing your job as a developer, you have to get into the psychographic of your marketplace,” says Aiken's Fielder. “You can't just say the average income is $40,000, we should therefore put in three Wal-Marts, two Marshalls, etc.We think there is more to matching a product to the marketplace.”
Urban in-fill
A lead proponent of developing the inner city is Dallas-based Archon Group, a subsidiary of Goldman Sachs. Archon recently completed Phase I of Fairlane Green, a 404,000-square-foot retail and recreational development built on a landfill in Allen Park, near Detroit's industrial southern edge. Archon purchased the land from the Ford Motor Company, who sought an environmentally sound reclamation of the largely inorganic landfill. The Target-anchored site is the first multitenant retail development to attain LEED certification in the country. Eventually, the development will include another 600,000 square feet of retail, a 43-acre park and 3.5 miles of trails.
“We've had outstanding sales at that project,” says Archon's Chicago director of retail investments Curt Bailey, who also oversees the Detroit market. “We've had great sales there, which proves that even in a market where there has been significant economic news for the whole area, if it is a well-placed project with a strong demographic, the project can still do very well.”
Archon has a greater focus on Chicago, where it is developing Chatham Market, a 420,000 square-foot power center built on the former Ryerson Steel Plant site on Chicago's South Side. Archon joined with Monroe Investment Partners on the project.
Last May, Archon's Poplar Creek Crossing opened in the northwest Chicago suburb of Hoffman Estates. Like Chatham and Fairlane, the 400,000-square-foot Poplar Creek was designed with an eye toward environmental considerations.
Prior to July 2006, Archon had been bullish on development prospects in Chicago. Now, turbulence in the U.S. economy has Bailey sounding a note of caution. “For new development, you will see a flight to quality, which means urban in-fill. That means high-barrier entry projects that have an existing shopping base that is captive and the development is not dependent on large growth. You would have a difficult time forecasting anywhere in the Midwest.”
The Chicago City Council's recent passage of the Big Box Ordinance has also cooled Bailey's enthusiasm. “Until this legislation shakes out a bit, you're not going to see any of the big-box retailers doing things within Chicago city limits,” says Bailey.
Chicago-based U.S. Equities Realty has found its niche developing downtown areas like the West Loop and Michigan Avenue. As Vice Chairman Camille Julmy explained, “Downtown Chicago has so much to offer and many people want to avoid the long hours of commuting.”
In this case, Julmy has helped serve up MetraMarket, a food-oriented 200,000-square-foot development in the West Loop next to the Ogilvie Transportation Center. Anchored by a 15,000-square-foot French-style market run by the Bensidoun family, the development will tempt 95,000 daily commuters with fresh cheese, meat, baked goods and quality produce. Restaurants and additional tenants like CVS pharmacy will help fulfill the retail needs of the areas trendy new denizens.
Julmy is confident a more European lifestyle is what area residents and commuters seek. “It's nice to get fresh fish, cheese, fruit on a daily basis. It's more the concept of the farmers' market. You want produce that people seek out because they can't get it anywhere else.”
With downtown residential real estate in such demand and stigma still haunting the suburbs, MetraMarket seems like the right idea in the right place. Construction begins late 2006.