Don’t Count the Midwest Out
- Sep 12, 2008
For years, we’ve heard a steady stream of bad economic news out of the Midwest, typified in most cases by the decline of the manufacturing sector and the struggles of the Detroit automakers. Yet for commercial property investors the Midwest remains a fine place to be in business–and may even prove somewhat of a haven in the current economic downturn. The region offers plenty of bright spots for investors and developers seeking attractive cap rates that are rarely found in the more competitive East and West coast markets. In fact, one of the strongest aspects of the Midwest is its perceived lack of trendiness. Living in the “flyover” states has its advantages, including a reduced susceptibility to real estate booms and busts. According to the Office of Federal Housing Enterprise Oversight, for example, average U.S. housing prices appreciated by 14 percent in 2005, whereas Wisconsin and Illinois homes appreciated by only 10 percent, with Indiana, Michigan and Iowa trailing far behind. While less appreciation might be disappointing during boom times, the subsequent housing downturn has inflicted less price damage on many Midwest markets than on regions to the east and west. That relative price stability has translated into steady commercial property markets as well. In 2007, for example, downtown Manhattan office buildings were selling at cap rates between 4 and 5 percent, whereas comparable properties in Chicago were selling at cap rates around 5.5 percent and in Detroit were selling for around 7 percent. Cap rates in the Midwest, especially in Chicago, were compressed in recent years compared to previous periods, but nonetheless were higher than those in the coastal markets. This differential was not lost on investors from outside the Midwest, some of whom came looking for relative bargains in the region. Even with the advent of offshore outsourcing, the impact of job losses from manufacturing on the Midwest’s urban markets has been less dramatic than perceptions suggest. Of the hundreds of thousands of manufacturing jobs lost during the past decade, 80 percent were outside major metropolitan areas in small or midsize communities with few major employers beyond the manufacturing sector. Undoubtedly, some of these communities continue to struggle, but many of the larger cities have diversified sufficiently to retain stability.For instance, while Chicago consistently ranks at the top of the list nationwide for manufacturing-and-distribution site selection and is a major intermodal distribution and logistics center, it continues to expand its financial, professional and business-service sectors. It is thus the Midwest market of choice for out-of-state and institutional investors. And Will County, to the southwest, continues to be one of the fastest-growing counties in the nation, now ranking eighth in employment growth. Manufacturing and industrial companies are drawn to the southwest suburbs for their railway and transportation connections, including the only place in North America where all six “Class 1” railways meet. Plans are also underway for an expansion of various intermodal hubs that drive related development of business parks and manufacturing, warehousing and shipping facilities, and logistics companies.Meanwhile, the growth of the healthcare market has made healthcare real estate development a big business in Cleveland, Minneapolis, Detroit, Grand Rapids, Chicago, northwest Indiana and elsewhere in the region. This is one reason HSA Commercial has accumulated a $100 million portfolio of healthcare properties in metropolitan Chicago and northwest Indiana. In Chicago, Advocate Health Care is a major health network and a significant real estate user, with more than 200 operating facilities. In Cleveland, university hospitals and the Cleveland Clinic Foundation are major, growing users of medical and conventional office space. Grand Rapids–long known as “Furniture City” because of hometown companies such as Meijer, Steelcase and Knoll–has become a leader in healthcare and bioscience research. Its $200 million, world-class Van Andel Institute has created hundreds of new jobs for medical talent from across the world. In addition, Chicago and more than a few other Midwest cities–including Cincinnati-Dayton, Milwaukee, Grand Rapids, Green Bay and Cleveland–have been adopting “new urbanism” planning concepts to revitalize their downtowns and diversify their local economies. Kansas City, for example, has revived its neglected downtown with new residential developments and the launch of the Power & Light District, a nine-block entertainment district, while retaining its eminence as a major logistics hub. Cincinnati-Dayton has outgrown its dependence on Procter & Gamble and become a thriving center for biotechnology, chemicals, pharmaceuticals, advanced materials, logistics and healthcare, as well as becoming a major distribution center with extensive interstate and rail connections. Even the Midwest’s most depressed major commercial real estate market, Detroit, has created some positive energy. As the Big Three automakers continue to shed jobs and shrink their Midwest footprints, Detroit is making a concerted effort to reshape its economy and rebuild its public identity through its marketing of the “D Brand” and public investment in development-friendly urban revitalization. Many lenders and investors avoid Detroit, yet its dynamic civic spirit may ultimately prevail. As it is, Southeast Michigan undoubtedly offers some attractive opportunities for property investors with patience and temerity. We have experienced success in acquiring or developing properties not only in our hometown of Chicago but across the Great Lakes region and into parts beyond. Approximately 80 percent of our 14 million-square-foot property portfolio is in the Midwest. Most recently, we acquired a 154,000-square-foot industrial facility in Kansas City, Mo., one of the Midwest’s best-kept commercial real estate secrets. Similarly, Ohio may not be the nation’s most exciting real estate market, but the stability of its markets and economy prompted us to acquire nearly 2.6 million square feet of industrial properties in Columbus, Cincinnati, Troy, Brunswick, Fairfield, Groveport and Delaware. In Southeast Wisconsin, we have acquired 2 million square feet of commercial properties and a 90-acre land parcel, where construction has begun on Park 94 at Mt. Pleasant, a seven-building business park that will benefit from the impending convergence of the Milwaukee and Chicago markets. Currently underway at Park 94 is a 321,600-square-foot industrial facility expandable to 708,000 square feet and a 125,000-square-foot industrial facility. We also continue to seek opportunities to add to our Indiana portfolio, which includes both industrial and medical-office properties. Looking forward, we expect a continued interest among international investors to help drive demand–and favorable pricing dynamics–in the near term. International investors have long had a presence in the Chicago market; given the fluctuating value of the U.S. dollar against global currencies and the corresponding fluctuations in the exchange rate, we anticipate those investors will continue to consider the Midwest as they search for the ideal combination of cap rates and currency arbitrage. In our view, should a further influx of foreign capital occur, it would only boost Midwest property markets. Furthermore, we see potential in the evolution of the biofuels industry. While some detractors have recently emerged to question its worthiness as an energy strategy, the ethanol boom has already dramatically increased the value of agricultural land in the nation’s breadbasket, while adding production jobs and economic value. Should it continue, the move to alternative fuels could also boost property investment in the Midwest’s university towns, where increased R&D dollars are being invested in agriculture and energy research. In short, for some time ahead, the Midwest may look more appealing to the property investor than the East and West
coasts. Many Midwest communities have risen above tremendous economic upheaval in the region in the past two decades, creating new futures for themselves. Many Midwest commercial property markets thus continue to thrive and could ultimately outperform more glamorous markets elsewhere. So don’t count the Midwest out just yet. Those of us in the know will be doing business here for years to come. Daniel F. Miranda is president of HSA Commercial Real Estate, based in Chicago.