MUSKEGON — With developers facing a series of complications in creating a sustainable housing market in downtown Muskegon, city government decided to take the rare move and jump into the business of commercial real estate development.
In the closing days of 2015, Muskegon officials acquired an entire city block bordered by 1st and Jefferson Streets and Western and Clay Avenues that consists of an already under-construction 72-unit apartment building, a vacant former bank building and multiple empty lots.
The properties are located within blocks of ongoing significant institutional investment led by Muskegon Community College and Baker College, as well as near startup breweries, restaurants and coffee shops.
Despite the growth in the immediate area, Muskegon’s downtown contains few, if any, residential units. Developers say that’s created a situation where banks are unlikely to finance their projects because of the perceived risk of being the first entry into the market.
“There’s a catch-22 stopping progress,” said Jon Rooks, principal at Muskegon-based Parkland Properties LLC. “A municipal entity can take on that role because it has a bigger goal than making a profit.”
With private developers at a disadvantage, the city of Muskegon decided it needed to step in and be the market maker and take on the risk, according to City Manager Frank Peterson.
“Our interest is taking our downtown a step further,” Peterson said. “It’s not profit-making. We see the value being our long-term investment.”
The city will most likely redevelop the two existing buildings on the site and leave the vacant parcels to be developed at a later date by private developers, he said.
TIME TO MOVE
The deal came together as Rooks faced escalating construction costs for his long-planned Highpoint Flats apartment project, as bids came in at $9 million, about $2.5 million more than expected. The impending expiration of a key state tax credit also played a role in the decisions for both parties.
Both the cost overruns as well as commitments to other projects led Rooks to determine that the completion of Highpoint Flats was not feasible for him to pull off at this time. However, he remains confident that upon completion, Highpoint Flats and the other parcels of land will go a long way toward creating an urban housing market in the lakeshore city.
“This (project) will definitely be a market maker,” Rooks said of the city’s plans. “Then it will be easier to come in with (new construction) and take advantage of the market.”
After investing about $1.5 million into the developments, Rooks said he sold the two properties — including a vacant former bank building at 880 1st St. — at a loss for a total of $451,000.
While he sold Highpoint Flats for $1, Rooks said he’ll receive significant tax breaks by unloading the building.
Now that the city has committed to completing the project and creating the market for downtown housing, commercial real estate sources, including Rooks, expect the project to move along quite quickly.
“They can pull permits tomorrow,” Rooks said.
While Rooks’ original plan for Highpoint Flats consisted of 72 market-rate apartments, the city aims to include ground-floor retail at the site, and it has similar plans for the building at 880 1st Street.
The city will stick to Rooks’ plan for market-rate apartments, Peterson said, noting that the city doesn’t see demand for any subsidized housing in the immediate downtown area. The city will fund its developments with existing cash reserves and possibly some bank financing, he said.
Prior to the sale of the building, Rooks had contracted Grand Rapids-based Orion Construction Inc. for the project. Orion CEO John Boonstra said that while the company does not yet have a signed contract with the city, he expects Orion will remain the project’s construction manager.
SETTING A PRECEDENT
A state-mandated timeline also contributed to the city determining that its direct involvement in the development of the block was the best option to complete Highpoint Flats and serve as a catalyst for increased private development.
The Michigan Economic Development Corp. (MEDC) previously had awarded the Highpoint Flats project nearly $3.6 million in tax benefits, which expire in 2017.
While the state economic development agency supports the city’s efforts to bolster its urban housing and commercial options, a lack of clarity over the development process does create some concern.
“We appreciate the city of Muskegon’s eagerness to develop residential housing in downtown Muskegon,” Jennifer Nelson, executive vice president, COO and general counsel at the MEDC, said in a statement to MiBiz. “At this point, we are anticipating further clarification of how the development deal will be structured.”
Multiple industry sources indicated there is little by way of precedent for a city taking the charge on commercial real estate development, particularly one supported by tax breaks.
Municipalities have long had a variety of options such as tapping tax increment financing via a Downtown Development Authority to support investment, said Dan Gilmartin, executive director and CEO of the Ann Arbor-based Michigan Municipal League.
Gilmartin also acknowledged it can be difficult for the risk-averse private sector to be the first entry into an urban market.
“In cities like Muskegon, where for whatever reason the private sector has been unwilling or unable to get (projects) done, the city is trying to fill a gap,” Gilmartin said. “I would say that urban development in Michigan is something that requires risk tolerance that many private businesses have been unwilling to take.”
Given the overall lack of downtown rental units, Muskegon city manager Peterson said it’s difficult for a private developer to guess what the market rate for the planned apartments could be, noting that’s what the city intends to find out.
“Downtown rental rates don’t exist,” Peterson said. “We think there’s value in making the market. Once we set the market, other folks can make the decision.”