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Sunday, 30 August 2015 22:00

Investors flee volatile real estate markets for opportunity in West Michigan

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Citing strong demand for multifamily housing in the Grand Rapids market, 616 Development LLC has announced plans for a handful of new mixed-use residential and retail projects around the city, including the 616 Lofts on Michigan, shown here. Citing strong demand for multifamily housing in the Grand Rapids market, 616 Development LLC has announced plans for a handful of new mixed-use residential and retail projects around the city, including the 616 Lofts on Michigan, shown here. PHOTO: NICK MANES

As warning signs begin to emerge about the health of the global real estate industry, experts in West Michigan believe there’s not much reason to worry about the fundamentals of the local market — at least not yet.

In fact, the volatile global market with its escalating transaction volumes and skyrocketing property valuations may be creating opportunities in smaller markets like Grand Rapids as real estate investors make a flight to quality, according to local brokers.

“We continue to see capital from elsewhere come into West Michigan. People can’t find deals in major markets — that trickles down into a market like Grand Rapids,” said Colin Kraay, a principal in the Grand Rapids office of Colliers International.

The real estate market in West Michigan remains sound because the local industry has avoided risky behavior, particularly with underwriting standards, Kraay said.  

While the perfect storm of high rents, high occupancy and low interest rates may have kicked off a wave of new investments across the region in recent months, developers remain focused on new construction projects that serve existing demand in the heavy industrial, downtown Class A office space and multifamily housing sectors, Kraay said.

Nationwide and globally, however, industry watchers have started to take note of some troubling trends, driven largely by a dramatic spike in commercial real estate prices, as The Wall Street Journal reported this month. In the first half of 2015, commercial real estate transactions in the U.S. rose 36 percent from the same time last year, totaling $225.1 billion in deals or ahead of where the market was in 2006, according to the report.

“The reason they are talking about (bubbles) is because of the flood of capital we are seeing,” Kraay said.

But the concerns in markets like New York City, Chicago, London and Hong Kong over a new real estate bubble have not trickled down to more conservative markets like Grand Rapids, sources said.

“Every deal I’ve seen has been fundamentally sound,” said Patrick Lennon, a partner focused on real estate, zoning and land use at the Kalamazoo office of Honigman Miller Schwartz Cohn LLP. “There’s real competition for transactions from the financing side. That’s resulting in a softening of terms and a softening of prices. The last quarter we’ve seen a modest increase in pricing, which may reflect lenders building in more risk.”

Kraay agreed, noting that the warning signs of buildings staying vacant for long periods of time, rapid rises in interest rates and risky bank behavior have not popped up in West Michigan.

Taking advantage of the times

Despite global concerns, multiple sources MiBiz spoke with for this report noted that the West Michigan commercial real estate market continues to have positive momentum. In particular, brokers cite the multifamily sector as the strongest segment, especially since the Grand Rapids market has a vacancy rate of just 1.6 percent, according to March report by real estate research firm Zillow.

Because of the tight market, developers around the city are scurrying to get new units on the market. An MiBiz analysis in April found approximately 1,400 apartments were in various stages of development in Grand Rapids, and developers have announced new projects since then.

The demand for apartments, coupled with job growth in higher-wage sectors such as health care and technology, should go a long way toward inoculating the West Michigan area when another downturn hits, according to Kraay.

“A Wall Street Journal story talking about over-inflated pricing doesn’t scare me,” Kraay said. “West Michigan has historically been more conservative, more careful — and that continues today despite the fact that, yes, values have risen.”

For proof of rising valuations locally, one needn’t look beyond several recent transactions involving out-of-state investors. In July, principals at Rockford Development sold a student housing facility in downtown Grand Rapids to East Coast buyers for $12.5 million, or $192,000 per unit. A month earlier, New York City-based Berkadia Commercial Mortgage LLC announced that Atlanta-based investment firm Cocke Finkelstein Inc. had acquired Ramblewood Apartments in Wyoming for $100.4 million, or $58,713 per unit. The deal included 1,710 apartments as well as a tennis and health facility.

Cocke Finkelstein plans to invest an unspecified amount into improving the units at Ramblewood, which were built in stages between 1971 and 1983, said David Walstrom, a senior director at Berkadia in the firm’s Troy office. While the prior owners hadn’t focused on renovating the units for a number of years, an investor could get significant rent premiums just by upgrading the facility, said Walstrom, who declined to speculate what that premium might be.

Additionally, Berkadia recently brokered the deal of an unnamed, 380-unit apartment complex in Kentwood that sold for a per-unit price in the low six-figures, Walstrom said.

“The investor sees upsides and value-add potential in unit upgrades,” Walstrom said. “That’s taking place in West Michigan and across the country.”

Rates still a question

While the West Michigan commercial real estate market remains strong, brokers and developers said industry concerns still keep them up at night.

Namely, rumors that the Federal Reserve Bank will begin to raise the historically low interest rates remain top of mind for industry professionals. When that does happen, industry experts expect the market will experience a slowdown in both development projects and transactions.

“It’s going to cool off,” Walstrom said. “Hopefully, it doesn’t get to 2008 or 2009 levels. I can see things slowing down in probably 2017.”

Rates have edged upward, albeit minimally, in recent months, but not to a level that has cooled activity, sources said.

A late August report in the New York Times noted that during the July meeting of the Federal Reserve, regulators said they were still hesitant to substantially raise rates, largely because inflation concerns remain minimal.

Colliers’ Kraay also noted that developers seeking financing are aware that interest rates won’t always remain this low and are working increases into their pro formas.

The current lending environment and the flurry of activity have bankers watching for concerns of a new bubble, as well. Some sources expressed concern that banks in the West Michigan market could be falling back into old habits, specifically noting that the low cost and relative ease of obtaining financing for multifamily projects is reminiscent of pre-recession times.

However, banks assert they are taking appropriate measures when it comes to underwriting and providing financing.

“We need to underwrite deals that not only work at the peak of the economic cycle but work throughout the cycle,” said Bill McGee, senior vice president of commercial real estate lending for Huntington Bank in Grand Rapids. “We’re in the Midwest. Our highs aren’t as high and our lows aren’t as low. That was tested during the last recession.”

Good times end?

Brokers and developers told MiBiz it’s only a matter of time until the cyclical real estate industry hits another downturn.

But unlike in the years leading up to the previous recession, recent developments have clearly addressed existing demand, said Sam Cummings, managing partner at Grand Rapids-based CWD Real Estate Investment, a development and property management firm. He’s also hopeful that underwriting standards do indeed work as intended.

“One thing is certain: That is that recessions happen,” Cummings said. “What goes up, goes down. It’s important in business and life to prepare and underwrite conservatively because business cycles are a reality.”

As a veteran of the commercial real estate sector, Cummings said he hopes some of the newer developers are aware of the inherent risks of doing business in a cyclical industry.

“There’s always a problem when people treat real estate as an annuity — it’s not,” he said. “It’s a delicate, tender and rewarding beast and it needs to be handled by professionals. It’s a product, not a financial instrument, and that’s where we got into trouble before.”

Read 7989 times Last modified on Sunday, 30 August 2015 22:31

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