The pandemic, rising interest rates and debate over a looming recession are just a few of the factors driving trends in Michigan’s commercial property industry.
As expected, the office market is facing challenges while industrial is hot and retail is somewhere in the middle, according to three statewide commercial real estate experts. The migration of retailers online does limit retail developments somewhat, but that market has been adjusted for a few years. Office remains the industry’s pain point.
The good news is that the next few months will be telling, says Matt Schiffman, CEO and Managing Member of P.A. Commercial, a commercial property firm in Southfield. Developers often look to build in a recession when the market is at or near the bottom.
“It’s also a time when labor costs are low and incentives are more common, so there are opportunities.” Schiffman says. “But not everyone has the capital.”
There is more than 1 billion square feet of unoccupied office space in the U.S. says Van Martin, managing partner of Martin Commercial, a commercial real estate firm in East Lansing. He believes many employers are formulating their longer-term workplace strategies which often calls for less space in a more desirable area with many enduring qualities.
“Everyone needs to attract and retain talent,” Martin says. “More (commercial office) decisions are purpose-driven rather than trying to fit the most cubicles in a given space.”
Chris Atwater, president of Michigan Commercial Space Advisors in Grand Rapids agrees. He says that the pandemic forced all employers to answer the questions of whether they can continue to conduct business if some or all of their employees are working remotely.
“Most employers would love to have everyone back in the office, but employees have gotten used to the flexibility and cost savings associated with working remotely,” Atwater says. “It is hard to put that genie back in the bottle.”
Furthermore, employers who already have determined that hybrid balance and have gotten employees on board are engaging landlords to help design hybrid office space, Atwater says.
For employers whose need for office space was never in question, the available options are more plentiful than they were historically as vacancies have trended up and more subleases have become available, he adds.
Schiffman believes the industrial market should remain strong over the next year, with high demand for desired sites. This is particularly true in the light industrial sector.
“Our team is really busy (in the industrial space),” Schiffman says. “We’re engaged with multiple projects, and we see this as a competitive sector.”
On a national level the Green Street Commercial Property Price Index, a measure of pricing for institutional-quality commercial real estate nationally, was down 16 percent in August 2023 from its March 2022 peak. It remained unchanged month-over-month.
The index, released by California-based Green Street Advisors, is calculated as a time series of unleveraged U.S. commercial property values that captures the prices at which commercial real estate transactions are currently being negotiated and contracted.
JP Morgan’s midyear commercial outlook report in May indicated that commercial real estate remained “resilient” during the first half of 2023 with both retail and industrial showing strength. Notably the vacancy rate in the distribution and warehouse (industrial) space nationally was 4.1 percent throughout the second half of 2022—a record low.
Schiffman (Metro Detroit), Martin (Mid-Michigan/Lansing), and Atwater (West Michigan/Grand Rapids) all provided feedback on a few additional industry questions.
Corp! Magazine: Describe the health of the main commercial property sectors.
Schiffman: Between industrial, retail and office, industrial is performing the best right now. It has the highest occupancy with vacancy rates in Metro Detroit down to 3.7 percent. Our team is working hard to fill (client requests). There’s an additional 8 million square feet of industrial space under construction.
In the retail area, the suburban centers are performing well. The work from home trend helped a bit there.
That market has adjusted somewhat, and occupancy rates are improving. Obviously, the office sector is the elephant in the room. It is at an all-time high for subleasing. I would characterize it as sluggish but not dead.
Martin: Hybrid work continues to curb demand in the office sector. We’re seeing the market stabilize into the new normal. In the industrial space vacancies rose from 3.5 percent to 5.6 percent as available space increased. There’s not a lot of fluctuation with (rent prices). Short-term leases are desired but still come with a bit of a premium.
On the retail side, interest is up, and deals are getting done so we’re encouraged. New retailers are entering the market. It’s notable that we are shedding vacancies at Lansing Mall. The industrial market remains strong. Rent vacancies there have slightly ticked up and we are hoping to find more (desirable properties) in industrial.
Atwater: The current challenge for users in the industrial property sector is finding space that is both physically suitable and reasonably priced, either for sale or for lease. Vacancy rates remain at historically low levels of between 2-3 percent depending on the data source. Pandemic-driven closures seem to have weeded out many retail businesses that were unprofitable. As a result, the long-term stability and outlook for the retail sector is generally good, although less so for downtown (Grand Rapids) because of the reduced office occupancy.
The office property sector continues to feel the effects of COVID, with vacancy levels ranging from 8-12 percent depending on the data source. Asking rents remain flat, and construction activity in the sector is focused on medical space and remodels.
Corp!: How has the remote working trend following the pandemic impacted the commercial market?
Schiffman: Remote working on Mondays and Fridays is popular. During (Tuesday through Thursday), the highways are noticeably busier, and the parking lots are fuller. We’ve noticed it in office buildings around us. In the office space, there are still instances of dark rent, where the end of the lease has not arrived, but a floor or building is not fully occupied because or (remote or hybrid) working or other factors.
COVID clauses are generally not being negotiated anymore. There has been less of an impact on the industrial sector because most of those jobs require onsite work. We will see what the impact will be if more employees start coming back to work in the office.
Martin: Remote and hybrid work has become the status quo and has lowered demand with national trends toward placing more desks in less spaces and greater shifts to automation. Lansing in particular has experienced a significant number of vacancies (in the office sector) so this is a critical moment for the market. State government (remote capabilities) is having an impact.
Atwater: West Michigan’s office market has thankfully not been impacted as severely as major metropolitan areas like San Francisco or New York City. Cities dominated by high-rise buildings and mass-transit options saw the highest percentage of remote work and are having the toughest time enticing those workers to return to the office.
Corp!: What are landlords doing to improve their prospects for higher occupancy rates, especially in the office sector?
Schiffman: Tenants are in a flight to quality so landlords that are reinvesting in their properties are (at an advantage). For many renters, having a nice office building and location for their employees to go to makes a big difference. Smart landlords are open to renewing for shorter terms. Often, they need to fill (office) space with three of four leasers where previously the same space may have been used by one leaser. We still see early termination clauses and more concessions from landlords, especially in Class A properties.
Martin: Most landlords will aggressively negotiate if space can be occupied with minimal investment. They are having to invest in the property and look to provide features like wellness centers and (multiple) kitchens. Tenants are electing to sign shorter-term leases for less space. Building amenities may help a property stand out from the field; however, return-to-office strategies will require more than office perks to gain long-term traction.
Atwater: Near term, the answer is “not much,” at least in West Michigan. That is because building improvements are typically driven by user demand, and most users are still trying to figure out what their long-term work model looks like. Buildings with well-capitalized owners will upgrade common areas and add amenities while office suites will be reconfigured to capitalize on the hybrid work model.
Long term, the lessons learned by the forced remote work experience should have an impact on how office spaces and buildings are designed/constructed and remodeled.
Corp!: How are higher interest rates impacting the market?
Schiffman: They are having a major impact. We do see some landlords giving buildings back to the banks. It comes down to cash flow. If cash flow was positioned at interest rates of 3 to 4 percent, the (building) owner might be in trouble even if they are art 100 percent capacity. Additionally, the smart cash buyers are generally sitting on the sidelines unless they find a great deal.
Martin: Debt is playing a major role. Higher rates make it difficult. The wealthy (developers) can take advantage of this. It is having an (adverse) effect on speculative construction. Many projects that had started are now on the sideline. But we expect interest rates to have largely peaked and will slowly start to come down over the next 12-24 months, just not at the low rates we had been seeing.
Atwater: It has motivated legitimate buyers who were dragging their feet while pushing less serious buyers out of the market altogether. I am also hearing about some lenders who are putting restrictions on existing customers as interest rates create downward pressure on property values. Finally, any property owner who has a variable rate mortgage sees a material increase in ownership costs.
Corp!: Is there any concern with lower occupancy rates and the impact on new construction in the commercial space, especially in office or retail?
Schiffman: For some asset classes, yes. I think we’ll continue to see new construction in medical office, retail and industrial.
Atwater: The only property sector with occupancy rates currently below historical levels is the office property sector. There is still construction occurring in this sector, but it is limited almost exclusively to health care. Going forward, additional construction activity should also pick up in the form of interior remodels, either with tenants creating hybrid work environments or landlords constructing building amenities.
Occupancy in the retail sector is relatively balanced at the moment; new construction consists primarily of national tenants moving into the West Michigan market area and investors rehabbing properties purchased at a discount. Construction in the industrial sector should continue until supply is more in line with demand, limited primarily by high construction costs and interest rates.
Martin: I wouldn’t call it a concern, more of an understanding of current market realities. I don’t see occupancy rates dropping further in the office or retail space. With rates where they are and the higher cost of financing and construction, I think any new construction especially in the office space will be muted. Most of the new developments you are likely to see will be where a specific (organization) has a need for their own building.
Corp!: What do you see rates headed in office, retail and industrial in Michigan over the next 12-24 months?
Schiffman: For office, I believe the CBD and Suburbs will continue to experience decelerating rent growth. Our metro office market has about 33.8 million square feet of office space with nearly 2.8 million of that being sublease space (*Data from Co-star, Inc.) Many tenants are taking advantage of fully furnished offices at great rates. As far as retail we’ve seen the smaller downtown suburban markets like Northville, Farmington and Birmingham remain stable with rents increasing slightly.
Atwater: The overall outlook in the office sector is either flat or slightly decreasing rental rates until the vacancy rates come down to more balanced levels. Retail rental rates should at least keep pace with inflation because of the relatively balanced supply and demand as well as the area’s continued appeal to national retailers.
Look for the rapid increase in industrial rents to slow down compared to the dramatic increases seen over the past 2-3 years. Buildings recently constructed or nearing completion are listed at top rental rates, a direct function of the cost to build them. Those rates may see downward pressure as supply and demand come more into balance, although I would expect landlords to offer short term concessions such as free rent rather than materially altering long term contractual rates.
Martin: It’s going to be much of the same for office and retail with (steady) rates. I expect industrial will experience year over year growth for (the Lansing region) and throughout the state. Nationally the best assets that have the greatest demand and the best amenities will experience rising rates in all sectors, but that is commonly the case.
Corp!: What other trends do you see in the commercial industry?
Schiffman: There is activity in converting properties in all types of spaces, but especially in office. For example, we are in the process of working on converting a 100,000 square-foot building that (previously housed a call center) to a self-storage development. You also see more downtown conversions from office to multifamily units and condominiums, especially in Detroit. It’s no secret we had too much office space in Detroit for many years so this is a good thing in my opinion.
Martin: In retail, big box retailers such as Trader Joe’s, Dave & Buster’s, Ross Dress for Less, Harbor Freight and more continue to make commitments to the market. Small retail is also strong with brands like Crumbl Cookies and Firehouse Subs (opening) among many others.
Market vacancies averaged 16.5 percent (in the Lansing market), up from 15.8 percent at the same time last year. The most dynamic retail corridors in the area include Grand River Ave. from Michigan State University to the Meridian Mall (in Okemos). Construction will soon be underway for Haslett Village, a new $65 million mixed-use project later this year which is an important development. Within industry, we see few if any concessions, especially compared to office or retail. Additionally speculative projects across all sectors are largely non-existent.
Atwater: The real impact on office space in West Michigan is slowly showing itself as leases come up for renewal. In most cases, employers are not yet at a point where they have decided what an ideal office environment looks like. As a result, they are asking for short term renewals to buy time until they have a clearer picture of what the ideal office layout is and how they should balance remote and in-office time.
Those employers who already have determined that balance and have gotten employees on board are engaging landlords to help design hybrid office space.
