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Saturday, 21 July 2018 11:36

Commercial real estate industry healthy, but execs expect a slowdown

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Commercial real estate industry healthy, but execs expect a slowdown PHOTOS: JEFF HAGE

West Michigan commercial real estate industry insiders see signs of a genuinely healthy market, albeit one that’s likely plateaued. 

With several large-scale projects currently under construction around the region, many wonder what comes next for the area. Given the pressures from rising interest rates, increased construction costs and a higher regulatory burden, many insiders expect a slowdown for the industry at some point in the foreseeable future.

That’s according to a panel of executives convened by MiBiz for a roundtable discussion on the commercial real estate industry. They included:

  • Chris Beckering, executive vice president of Pioneer Construction, a Grand Rapids-based general contractor
  • Jeff Karger, senior vice president in the Grand Rapids office of Jones Lang LaSalle IP Inc. (JLL), a commercial brokerage
  • Patrick Lennon, partner and real estate attorney in the Kalamazoo office of law firm Honigman Miller Schwartz and Cohn LLP and the Western Region Chair for the Michigan chapter of Urban Land Institute (ULI), a commercial real estate trade association
  • David Maxam, principal with Maxam Architecture PLLC, a Grand Rapidsbased architecture firm
  • Ryan Schmidt, vice president of real estate development and management for Inner City Christian Federation (ICCF), a Grand Rapids nonprofit real estate developer

Here are some highlights from the conversation.

What’s your near-term outlook for West Michigan’s commercial real estate sector?

KARGER: Overall, the market is very healthy. We’re seeing some new developments downtown (in Grand Rapids), but that’s just replacing old tenants so it’s leaving vacancy behind it. We’re not really seeing an increase in occupancy rates or anything like that in the northern core. (As a) conservative market … anything that’s new development is either owner-occupied or conversely has a lead tenant to go into it as well. Overall, I think the market’s pretty healthy, though it has plateaued. We’re not going to see rates rising or anything significant in the foreseeable future unless you see a large employer take action and come to West Michigan. If you look at the industrial side of business, it’s very strong. You can’t find product — that’s the biggest issue. But Grand Rapids is pretty conservative in its nature, so speculative development we don’t see much of at all. It really needs to be tenant driven or owner-occupied driven.

LENNON: We’re seeing the same things and have the same sense of the market and where it’s at. It’s busy — that’s for sure right now. But it feels like it’s sort of a sustained level of activity. It’s not snowballing really the way it was maybe in the last two years, and so it’s hit a peak and maybe it’s leveled off a little bit. In looking forward, I think there are going to be some obstacles to continued growth primarily … as a result of the availability of labor and the cost of labor. The cost of materials has been going up, and that’s hindered some development. Interest rates are out there clicking up a little bit from where they were. So it’ll be interesting to see if we sustain this level for the next year. MAXAM: I’m seeing increasing pressure on the schedule for that very reason. I had some residential clients who … like to take their time, think about building their dream house and whatnot. Then by the time they get ready to actually build, they find the cost of construction has gone up another 5 or 10 (percent), perhaps even more. The longer you wait, the less you get.

SCHMIDT: For the last five years, we’ve been seeing increasing construction prices consistently, really through every development. Every time we would have a conversation with a contractor, we ask the question of, ‘Where is it going to stop? When is this going to stop? When do we see a plateau of the construction price to help us meet our development budget?’ We really haven’t seen that yet. That continues even today. We also self-perform some work. The availability of labor, even on a smaller scale for us, is very challenging.

Construction companies and end users are also dealing with higher costs from certain energy-efficiency mandates that took effect in Michigan last year. In some cases, the American Society of Heating Refrigerating and Air-Conditioning Engineers (ASHRAE) determined the codes are presenting upfront cost increases of 10-15 percent. How’s that impacting the viability of projects?

BECKERING: The most recent update to the Michigan Uniform Construction Code absolutely has a tangible, quantifiable increase on construction costs — initial costs especially — some of which I think will pencil out in terms of lifecycle cost savings. But it’s no longer the user making a decision to spend more money upfront to save money in the long term. Some of them maybe don’t think it will provide much, if any, financial return at all. The updated building code, I think, has caught some people (off guard) who had projects in the planning stages or who had received early preliminary budgets a year prior. Then they get them updated now that they’re ready to start and are going to be subject to the new requirements and there’s increases.

Given this dynamic of rising construction costs, rising interest rates and increasing regulations, do you see that leading to a slowdown in the coming year, or fewer cranes dotting the skyline?

LENNON: It’s kind of what we were saying earlier. There are some real headwinds right now with the cost of labor, the cost of materials, rising interest rates. Fortunately, I think one of the good signs and really the prevailing sign is that some of the other things have been so strong particularly in this region (that they) outweigh some of the headwinds. What results is kind of what we’ve been talking about, which is sustained growth, but not necessarily anything that’s really snowballing like it was. There’s sort of a plateau that seems steady. It appears to look very good into the future.

KARGER: I, for one, don’t see any cranes coming into the market, at least not from a developer standpoint. From a residential/urban perspective, I don’t know many banks that are even lending into it at the moment. They want to see how it all shakes out with the new inventory coming on. Most of the large office tenants … have found new homes. It would take somebody from the outside coming in from an office perspective to see cranes downtown for sure.

BECKERING: I can speak to a handful of specific examples on cranes. Our sitting crane at the (Embassy Suites hotel project) came down three weeks ago, and that crane is being remobilized and will be at Studio Park here in about three weeks. We will have a second sitting crane on that site. There will be one for the ramp and one for the Canopy Hotel. The tower crane that is at 601 Bond, when that comes down, it’ll be redeployed to 333 Michigan for the GVSU Health Sciences building. Then we are purchasing another city crane that will be going up on the parking deck for Spectrum as part of that project. There are two going down and four going up just for our work.

What are you seeing as far as outside institutional capital coming into the market?

LENNON: In my mind, that’s the real litmus test of how strong your market is. ‘Are external investors attracted to it?’ Because what they’re really looking at is the financial profile of each project and deciding to invest in that and deciding that their investors want to invest in that. So many of our communities, historically, have been developed from local sources, people that really know the market and know the community, know the local governments, and have sometimes wealth, sometimes partially philanthropic goals. When you see national investors looking at a market and making investments, whether it’s loans or directly into the real estate, I think that tells you a lot about the fundamental strength of your market. Because they aren’t doing it for any reason other than their belief in the product or the market itself.

BECKERING: I know that there’s tons, but one big(example) would be 601 Bond. Time Equities is a major (New York City-based) national developer and they have a pot of money to build apartment buildings around the country, and they chose Grand Rapids. They’ve chosen many other markets as well, but we’re on the radar.

LENNON: Grand Rapids is a great example of a market that’s transitioned from what may have been done on some levels in a philanthropic endeavor or some very community-oriented individuals into something that now sustains itself and actually more than perpetuates itself. It’s a great example of a really successful downtown renaissance.

SCHMIDT: I think Bond is also an indicator of where multifamily development has been going on the market-rate side in terms of the size of the development. If we look back at like 2012 to ’17, there were a lot of deals that were smaller than 50 units. Now, a lot of the new product that’s coming into the market is Bond at 202 units, 234 Market has 235 units. The Brix at Midtown has 200 and some units. The Hendrik on the West Side has 116 units. Three of the four grouped there are outof- market money. You get The Hendrik, which is locally financed or invested, so that is a very different shape with a multifamily market. These are very large developments.

Why do you think we’re now attracting these larger projects?

BECKERING: To some extent, that’s been a selffulfilling prophecy because there’s this magic number of 100 units for financing. You’re getting into a whole other tier of financing options when you’re over 100 units … so developers like to build them because they can finance them. When they’re done and stabilized, there’s a huge market for selling them. One of the issues I think in this market was that there had been very few 100-plus (unit) significant renovations or new construction in downtown or the surrounding suburbs for quite some time. Now that there are several, it provides comps for people looking at it, and they can see that it works and that’s why we’re seeing more of it. We’re maturing as a market.

MAXAM: Everything is scaling up, taking longer to get put in the ground and yet that whole missing middle is what we’re not seeing — (projects with) four units, eight units, 12 units. From an urban design point of view, that’s the missing piece right now. It’s unfortunate. You hear more and more complaints about ‘developer modern’ apartment buildings. It doesn’t matter how you lay them out or how you skin them, there’s that many units in them driven by that kind of finance. The formula is the formula. I think that’s the thing people complain about with these ‘developer modern’ big ugly buildings coming, but that’s also the consequence of not having units developed in the neighborhoods.

How do you see the changing world of transportation and mobility impacting commercial real estate development?

KARGER: That’s changing very quickly and it’s changed in a lot of tier one or tier two cities. It’s a blessing and a curse in Grand Rapids that you can get anywhere in 20 minutes by car, and everyone realized that. But the whole idea of mobility changing will be a huge cultural shift in mentality in West Michigan.

MAXAM: I think the city planning department deserves kudos which they may not get enough of. They’ve done an amazing job (with) bike lanes, rethinking how they look at parking and mobility and all that. We’re lucky to have that.

BECKERING: I think city planning by and large is very cooperative and very balanced in their approach. They are pro-responsible development, which is a great position for a planning department in a city like ours to be. As we get to the point we’re at now, there have been a series of pretty clear next steps. If you look back to the arena as an example, it’s one of the first big catalysts. Then there was a lot of the historical department and then there was medical development. All of that, I think, most people saw coming somewhat in advance. All the Grand Action projects were planned out. What are the next big projects in our urban core? There are not a ton of them that have been announced or even in the drawing phases, or not as many as we have seen prior to these last waves.

I don’t know if that’s necessarily a bad thing. Maybe it means there are more mid-sized and smaller projects. Maybe it means that we’re going to see a push outward into more neighborhoods. Maybe it’s a combination of those things, but there are very few glaring deficiencies left in our downtown, especially if you fast forward the clock eighteen months as the projects currently underway are wrapped up.

KARGER: What would be interesting, from my perspective, is to see what the river does. If that project is going, how will activating the river activate downtown and the east and west side, and see what that catalyst may bring. I don’t know what that is yet.

What remaining opportunities do you see coming next around the region?

BECKERING: There’s tremendous opportunity on the South Division corridor with the Silver Line that’s in. They’re doing a master plan revision for that area now and I think that’s an area that will work very well with (qualified allocation plan) applications and would be a good area for additional affordable housing. As we look to what’s next, I think South Division is one area to keep an eye on.

SCHMIDT: The city and state really made a huge investment into the Silver Line and up to this point, we really haven’t seen as much of that development as we hoped along that line. Part of that has been, there have been LIHTC developers that have tried to build, but because of the state priorities, it didn’t align well enough to score for a very competitive process. But I think you will see that more — definitely on Division, and I think it’s a very good thing. The infrastructure is there. We should be taking advantage of it. That will go the same with the Laker Line being built out to GVSU.

KARGER: I think it comes back to the culture of riding a bus. Will people adopt it and (why haven’t) they adopted it yet? The bus stops in front of my house and I don’t take it downtown. It’s just a cultural mindset for West Michigan.

Given the region’s population growth and the ease of getting around, does that mean the region can expect to have urban sprawl in the years ahead?

KARGER: You will see some sprawl. … It’s basic economics. Rates are up downtown, parking rates are up downtown and some people just won’t be downtown. You’ll see some office sprawl out to the suburbs just for companies that don’t take advantage of the culture of being downtown. I hate to say it, but I’ve represented several clients that have made that decision to move out there. Is that enough to move the needle? I don’t know, because people still want that great workplace experience and from a recruiting and retention standpoint. But you may see some areas which sprawl.

BECKERING: I hope that it’ll be a different kind of sprawl than we saw the last iteration of sprawl in the greater Grand Rapids metro area where we see more near-neighborhood infill type of projects, rather than just skipping over that and continuing to go further and further out. … I think it’s a fantastic opportunity to address some of those concerns.

On the retail front, the downtown retail occupancy rate has certainly improved over the last several years, but some big empty spaces remain. Why aren’t those filling up?

BECKERING: City planning. There’s no question that developers wouldn’t be putting in first-floor retail unless they were required to do so, because it’s not filling. So, it’s there because of the planning department.

KARGER: It’s so demographically driven, and then when you look at retailers — (whether) national retailers or anyone from out of market — the city’s demographics just don’t fall (in line). You end up trying to convince them that you really need to go here because the daytime population is so much different than the nighttime population, versus the weekend population. When they look on a map and they’re doing one store in Grand Rapids, then the demographics (don’t work). They want the least risk.

SCHMIDT: I think we’ve seen a lot of success with small retailers along select corridors. There’s effectively no vacancy along Cherry Street, or very little on Wealthy Street within a certain range and within a certain size. It seems like the under 1,500-square-foot store, we’ve actually seen quite a few (spaces) that popped up. This is not my area of expertise, but we have some retail within mixed-use buildings, and we’ve had success with leasing those smaller suites along certain corridors, (but) I think there are other neighborhoods and businesses where we just haven’t seen that success yet.

BECKERING: The rates that people are getting on Wealthy Street are crazy. Crazy. Like are you kidding me — $30 a foot, triple net?

KARGER: I haven’t seen that yet, but I know they’re higher than I have ever seen them, for sure.

BECKERING: Literally 10 years ago, you could buy buildings on Wealthy Street for $30 a foot without a hassle. Now they’re paying that much a year in rent in that defined area where there’s the foodie district.

MAXAM: It’s interesting. Those were buildings that were built on a smaller scale, in more sort of decentralized developments. It’s not mixed use in terms of the building itself. We’re not trying to jam 20 uses in. It was built one building for one butcher, one clothes store. That’s the kind of development that we’re trying to mimic in a way, but we’re not really building them (in a) small sustainable scale. We’re building megablocks and they go up in a big boom but … those sorts of big-scale projects bust big, too. I don’t know what we can do to encourage more of that smaller-scale development and make that easier. (We could) make the zoning more amenable to it … (open) accessory dwelling units by right, (and make it) easier to do so that you don’t have to have a team of experts in order to start a simple shop.

Has zoning and its impact on development become a widespread issue around the region?

LENNON: Yeah. We’ve experimented with ordinance amendments in larger cities that make more of the site planning review process and special land use approval processes administrative. It’s as much about making the approval process more efficient as it is saving time. It takes so long to get to market when you say, ‘We’ve got this great new project, we’ve got an interest rate locked in,’ and then they say, ‘We’ll put you on the agenda in six months.’ And then you’ve got another meeting, and another meeting after PHOTO: JEFF HAGE comments. That’s one of the barriers that busy, urban areas have to overcome, because they do have a backlog of applications in. Waiting your turn can affect your economics.

BECKERING: The amount of time you spend on many aspects of a development project are the same whether it’s 2,500-square-foot of firstfloor retail and the two apartments up above it, or whether it’s a $100 million mixed-use development. You still have planning approvals, you still have to go through that building permit process, you still have inspections, you still have construction, you still have attorneys, you still have bankers. You have all of these people and it’s harder to make the economics scale in many ways on the smaller project.

SCHMIDT: There’s no doubt. That is entirely accurate, and that’s one of the reasons why we have seen a focus on larger-scale developments. Even to the small scale around the fee that you submit for a special land use application: You submit the exact same fee for a three-unit (project) that you would for a 300-unit (project). I think that the city is looking at ways to improve the zoning code, and there’s a very large community conversation going on about that right now. It was met with some resistance around a fear of who is this benefiting. There’s a lot that the nonprofit housing developers and our neighborhood associations have been working with the city on and trying to come to some consensus around those zoning code improvements. They’re critical.

With the licensing set for medical marijuana and the legalization of recreational adult-use marijuana going before voters this November, how could this new industry affect the region’s commercial real estate industry?

LENNON: You can’t avoid it. That is the front-andcenter new use that is very hard to advise people as to how to deal with it because it’s still illegal from a federal perspective. There’s limited to no financing available. Title insurance companies aren’t really willing to insure ownership for these uses. There’s just a cloud of uncertainty around it with potentially very drastic consequences. That said, there’s a widely held perception that this will all sort itself out over the next year or two years. In the meantime, we get a lot of calls asking about a path forward and we’ve done our best to advise clients, but it’s a very challenging area to navigate right now.

KARGER: And from a landlord perspective, I am not seeing any sophisticated landlord taking that risk.

BECKERING: From a construction standpoint, I think the potential opportunity here is more in the production facilities than in the dispensaries. There’s a limited number of both, but the production facilities are fairly sophisticated buildings that have unique requirements, so I think you’ll see significant renovation to existing buildings to accommodate grow rooms and processing facilities, or new construction.

Read 3016 times Last modified on Sunday, 22 July 2018 16:50

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