Economic Update – Seismic Shifts in Auto Industry Have CRE Implications

Monday was an historic day in Detroit, and arguably for the entire U.S. manufacturing sector, even though GM’s formal announcement of bankruptcy, along with President Obama’s promise for more than $30 billionfor a company in which the U.S. Government will soon own a controlling interest, weren’t surprises . A little more surprising (only a little) was the quick approval by Chrysler’s bankruptcy judge of the sale of most of its assets to a group led by Fiat SpA, meaning that the Detroit automaker will continue to exist in one form or another, albeit with Italian bosses. But the fact that both events happened the same day is an unusual coincidence indeed.The federal government probably won’t control GM forever, but in any case the eventual outcome will be a smaller operation (“leaner and meaner” is the cliche) that has less manufacturing capacity and sells fewer cars. The same could probably be said for the automobile industry as a whole. But what about Detroit’s office market, which has for so many years depended directly and indirectly on the fact that the region is a hub of international automaking and R&D? In some ways, the metro Detroit office market is ready for any future shocks caused by auto industry downsizing, because it’s been a tough few years for the market already. According to Southfield, Mich.-based Cresa Partners, the average metro Detroit office market vacancy rate reached 17.5 percent in 1Q09 after steady increases in 2008, and the rate isn’t expected to decline anytime soon. Some submarkets have vacancy rates in the high 20s. At the same time, office ownership is being squeezed by rising cap rates and the prospect of hard-to-refinance loans. On the other hand, there are also winners in the metro Detroit office market–namely tenants with deep pockets and the moxie to drive hard bargains with their landlords. “It hasn’t been this much of a tenants’ market in Detroit for a good many years,” Mark Bowman, managing director of the Bloomfield Hills, Mich., office of tenant rep specialist Howard Ecker + Company, told CPN. It’s so much of a tenants’ market, in fact, that Bowman was recently tapped to open the Bloomfield Hills office to take advantage of it. “Tenants with three or four years left on their leases are already re-negotiating, generally from strong positions if they have the financial wherewithal,” Bowman said. “We’re seeing rent reductions, plus generous tenant improvement allowances we wouldn’t have imagined only a few years ago.” Strangely enough, he added, it isn’t true any more that landlords are the only parties demanding to know if the other side is strong enough to fulfill its lease terms. Increasingly, he said, tenants are demanding evidence of financial strength from landlords. No one wants to ink a lease with a landlord who isn’t, for example, going to be able to follow through on those generous tenant improvement allowances. “It’s an entirely different world now,” said Bowman. Perhaps Detroit-area tenants are making hay while the sun shines. If the economy does begin to turn, even Detroit might not be quite the tenant paradise that it seems to be now. And there are indications that the economy is turning ever so slightly, or at least there were on Monday. U.S. manufacturing is still contracting, but it shrunk less than predicted in May, and the Institute for Supply Management’s factory index rose from 40.1 in April to 42.8 in May, the highest level since September. Americans’ personal incomes, meanwhile, rose 0.5 percent in May, according to the U.S. Commerce Department, and consumer spending dropped–but not as much as expected, a mere 0.1 percent. Americans are saving most of the difference, with the personal savings rate at 5.7 percent. Despite the specter of the GM bankruptcy, Wall Street was in a distinctly bullish mood on Monday because of all this relatively good news, with the Dow Jones Industrial Average ending up 221.11 points. The S&P 500 gained 2.58 percent and the Nasdaq saw a positive gain of 3.06 percent.