Volume 5, No. 8
October 2009

Small Business & The Internet
"100,000 Garages"
By Mike Gould

Employment Issues: "Job Descriptions - Why They Are Important"

Read all about
local business
people and firms


Ann Arbor Area BUSINESS MONTHLY magazine brings the reader the latest business news and information important to the businesspeople in Washtenaw County. Each month articles cover real estate, legal, Internet, employee concerns and the climate of business in the greater Ann Arbor area. There is news about company employees and feature articles on local businesses. We cover business news from Ann Arbor, Chelsea, Dexter, Manchester, Milan, Saline, Whitmore Lake, and Ypsilanti.

Economy Still Challenges
Commercial Property Market

Michigan Stadium

Shown here is a recent photo (August 21, 2009) of the new renovations to the U-M Football Stadium. Joe Parker, Senior Associate Athletic Director for the U-M said that the stadium will be completed by the summer of 2010 and will be ready for use for the upcoming schedule of games for the 2010 season. To date 58 out of 82 boxes have been sold, according to Parker. The total seating capacity will be over 108,000. (Photo by Dale Fisher HELIPHOTO).

By Mark Ziemba

Despite the relative strength of downtown Ann Arbor and some encouraging second quarter trends in the area, the economy may still slow the area commercial property market. Local real estate experts see some challenges ahead, but not much change.

Area Commercial Property Market May Stall

Sentiment about the county commercial property market sug- gests that the market may still struggle, but not necessarily enough to worry.

Regarding the office property market, "I don't see any big clouds on the horizon," says Jeff Harshe, vice president of Ann Arbor-based commercial property investor and development company MAV Development. "I don't envision a huge drop-off; I don't envision a huge pickup. I don't see any big changes." MAV Development manages 600,000 square feet of primarily class "A" office space, mostly located in Ann Arbor.

The vice president of commercial real estate brokerage Colliers International's Ann Arbor office, Jim Chaconas says, "We've already hit the bottom" of the county's overall commercial property market. Still, he thinks that the vacancy rate may continue to rise slightly due to companies that are downsizing. "A lot of our work is people wanting less space," he says.

The president of Phoenix Contractors and the Phoenix Company, a commercial construction contractor and a commercial development firm, both based in Ypsilanti, William Kinley feels that both commercial construction and leasing are slow, without much chance of improvement until next summer. "It's stable for now," he says, but "I don't think it's going to get any better for some period of time." Phoenix Contractors handled about $25 million worth of projects in the past year, and the Phoenix Company manages 625,000 square feet of commercial property in the county.

Ann Arbor commercial property brokerage Bluestone Realty Advisors Principal Newcombe Clark sees some promise. "In the past month or so, things have definitely increased in terms of volume of calls and showings. That's very typical of the third quarter," Clark says. "Because it's a sign of normalcy, it's a surprising tone."

Clark adds a note of caution, however. "You can definitely make the case that the most valuable real estate is still here in town in terms of the state, but I think the days of thinking that Ann Arbor is insulated from the rest of the state...are well over," says Clark. Bluestone handles 2.5 million square feet of property, mostly in Washtenaw County and mainly class "A" office and downtown Ann Arbor retail space.

Second Quarter Showed Vacancy Rate Declines, Projections Suggest Increases

In general, Washtenaw County's commercial property market showed some promising signs in the second quarter of 2009 as vacancy rates dropped, but they may be poised to increase.

In the second quarter demand pushed down office vacancies in the county. The total office property vacancy rate decreased from 12.1 percent in the first quarter to 11.3 percent in the second quarter, according to regional Detroit market reports from Colliers International.

Industrial vacancies in the county also dropped in the second quarter. The total industrial vacancy rate dropped sharply from 20.2 percent to 12.8 percent according to Colliers market reports.

County retail vacancies nudged upward, however, from just below 8 percent in the first quarter to just above 8 percent in the second quarter according to Colliers vacancy rates report data.

Colliers market forecast reports suggest that both county office and industrial vacancy rates will rise slightly at the end of the year, and Chaconas thinks the county retail vacancy rate may climb to 9 percent.

"That may be a little high," says Chaconas of his retail vacancy rate projection, but he still believes the rate will rise. "We're going to see some more holes open up," he says, attributing this to the loss of businesses that are behind on rent, as well as smaller businesses struggling in the shadow of big box stores. "The big boxes are killing all the little guys," he says.

Reading Tea Leaves

To foresee where the commercial market might go, commercial property professionals look at a number of key indicators, among them the performance of the stock market, unemployment, the status of the residential property market and consumer confidence.

A growing stock market suggests that the economy might be getting better, which would mean more business and increasing interest in commercial property. Although the Dow Jones Industrial average had slid down to 6469.95 in March, it has generally been trending upwards since then. Near the end of September it closed at 9707.44, already higher than it closed in January and steadily approaching its 11168.10 value last year at about the same time.

"Usually the stock market is a pretty good predictor," says Kinley. "Even with the job loss continuing and the slightly increasing unemployment rate, it seems clear that it is stabilizing."

Rising unemployment figures indicate that the workforce is dwindling, meaning less business and a lower interest in commercial property. Michigan's unemployment has been generally climbing since January of 2008 and hit a preliminary seasonally adjusted rate of 15.2 percent in August, the latest figure available from the Bureau of Labor Statistics. This is compared to a seasonally adjusted rate of 8.6 percent unemployment last August.

While Washtenaw County's seasonally unadjusted unemployment rate is lower than the state rate, reaching only 10.3 percent in July, the latest data available from the state, it has grown from 7.1 percent unemployment last July. It is, however, less than June's 10.6 percent unemployment.

"Anytime you lose as many jobs as the region has lost, it creates vacancy," says MAV Development Vice President Jeff Harshe. "If you have fewer jobs, those people aren't going to be sitting in offices."

Unemployment and housing trends are especially worth some attention.

Bluestone Realty Advisors Principal Newcombe Clark says, "The way it typically works is that when jobs turn around, housing turns around, and when housing turns around then commercial turns around."

Growing consumer confidence levels also may point to improved business and interest in commercial property. The Conference Board announced that its Consumer Confidence Index was 54.1 in August (with 1985 serving as the reference of 100), up from 47.4 in July and from an all-time low of 25.0 in February. The Reuters/University of Michigan Consumer Sentiment Index preliminarily stood at 70.2 for September, up from 65.7 in August and 67.5 last August.

Market Faces Challenges

The commercial property market is coping with credit availability, some state tax concerns, less construction and even a looming issue with lower commercial property values.

The availability of credit for commercial property transactions is still tight.

"There's certainly a challenge out there with access to capital," says MAV Development Vice President Jeff Harshe. "The lending markets are difficult to access."

Phoenix Company President Kinley sees the economy as a big challenge right now, citing concerns about "the reluctance of banks to lend for expansion or for new projects."

"Banks are much more wary," he adds. "There's much more oversight of loans on commercial properties."

Kinley says that both commercial leasing and commercial construction has slowed because of the lack of financing.

Colliers Chaconas says, "They're being more cautious," referring to banks. "They're not going to do any spec building," he says.

Chaconas notes that it's difficult to get credit for 1-year or 2-year leases. "You can't finance a short-term lease," says Chaconas. "The risk is too high for the bank."

Bluestone Realty Advisors Principal Newcombe Clark says, "We do have some clients and projects that have definitely had to retrench or re-strategize because of the dry-up of commercial loans or construction loans."

State taxes are a concern for the commercial property market, as well.

Businesses looking to locate in Michigan and look for commercial property may be concerned about the tax rate compared to other states, and possible tax increases.

"There's a bit of an unknown about how the tax structure may change," says MAV Development's Harshe. "Michigan has got budget deficits and they're looking to figure out ways to close those deficits," he says. "The likelihood is that they're not just going to cut spending; they're going to go back down and tax."

In addition, the Michigan Business Tax has drastically increased state taxes on some companies.

"The institution of the Michigan Business Tax has had some unintended consequences," says Kinley of Phoenix. He indicates that he has seen state taxes five times larger than before in certain cases.

Construction has dwindled in the current economy, prompting contractors to seek new kinds of work and compete more for jobs.

Phoenix Contractors has managed to continue to find work by diversifying, says Kinley. "We do industrial work, restorations, renovations, tenant improvements, new freestanding buildings, labs, medical offices."

Kinley says, "Typically at least half of our work volume would be privately financed." Instead, much of it is now university, nonprofit and institutional.

For instance, Phoenix is currently working on the University of Michigan Wrestling Center, a $5.5 million, 18,000 square-foot practice facility on South State Street near UM's Preston Robert Tisch Tennis Building.

The project superintendant for Phoenix on the Wrestling Center, Scott Byers says, "The biggest challenge is finding the work," when asked about how the economy is challenging construction.

Phoenix also built the Humane Society of Huron Valley's new facility in Superior Township on Cherry Hill Road, a roughly 30,000 square-foot space nearly three times the size of the organization's former building. The new building uses even uses alternative energy, featuring a geothermal heating and cooling system.

The company also completed work in September on the Evangelical Homes of Michigan's Memory Support Center at Brecon Village in Saline. This $11.8 million, 38,000 square-foot senior center is devoted to assisting individuals coping with dementia and Alzheimer's disease.

Evangelical Homes of Michigan President and CEO Denise Rabidoux says, "Not-for-profits are still building. We can manage the ebbs and tides."

Competition for construction jobs is increasing, too. Kinley says, "We're seeing a lot more competition in the competitive bid market." Because of the prevalence of universities in the county and the lack of projects elsewhere in the state, Kinley says he is seeing more interest in the county from Detroit-area contractors.

A growing national concern is the impact of a drop in value of commercial property.

"The realization that the value of those assets is gone hasn't yet really happened in the commercial market," says Clark of Bluestone Realty Advisors.

How much has the value of commercial property generally dropped in the nation? "The national trend of the loss of value of commercial assets is on the order of 30 to 40 percent in major metropolitan areas," says Clark.

The significance of this loss can be seen in the MSCI U.S. REIT Index, Morgan Stanley Capital International's index of real-estate investment trusts. Near the end of September its price index was running about 50 percent below a high in February of 1,233.664.

Although Ann Arbor is not a major metropolitan market, some commercial property values here have lost value according to Clark. "We are party to transactions that suggest values much lower than the current accepted value."

A lower commercial property value limits the amount of money that a company can borrow on that property using a commercial mortgage, and that stifles business activity.

In extreme cases, lower commercial property values might put a business that hasn't paid much equity upside-down on its mortgage, with its debt on the property above the value of the property.

Commercial mortgages also typically have 5- or 10-year terms, at the end of which the remaining balance must be paid. A number of commercial mortgages made during a busy period of commercial real estate investment before the recession began in late 2007 will soon be due in the midst of a far less hospitable economic climate.

Businesses may roll over, or refinance, these mortgages, but if this is done based on lower property values, refinanced mortgages will be smaller, constraining business capital.

Under increasing pressure to make better investments, banks are more carefully evaluating loans, so refinancing won't be as easy, either. Banks may impose a lower, more conservative loan-to-value ratio, which may also lessen loan amounts. They may also require a higher debt service coverage ratio, a measure of the ability of a business to pay its debt. In a tough economy, though, businesses may make less money. With a business property that collects rent, a decreasing demand for space can lead to falling rents. Both examples challenge the ability of the business to service its debt and maintain its loan.

Highly leveraged banks, those that may have borrowed much to make investments, may need to "delever," or reduce the amount they are borrowing by paying back debt. To do so, they may require payment on loans. Companies that can't pay the loans may need to sell the property quickly to raise money, otherwise face foreclosure, in which case the bank will need to sell off such assets quickly to generate money. Either way, this will further lower the value of the property. Kinley of Phoenix doesn't think the local commercial property market has that much to worry about, though. Regarding the impact of this issue, Kinley says, "That will increase nationally. I don't think we'll see as much effect locally."

The lack of overbuilding in the area suggests that speculation hasn't been as high. "Historically Ann Arbor hasn't moved into wild, reckless overbuilding," says Kinley. "People are a little more cautious."

The relative strength of the local economy is another factor that may dampen this issue's local impact. "Because of our local economy we're a little more immune to that," says Kinley.

MAV Development's Harshe thinks the impact will be minimal, as well. "There are already properties in this area where the amount of the loan is higher than the value of the building," he notes. "I don't think that it's going to be a factor in our market that has a huge impact on multiple properties, or has a contaminating effect on properties that aren't directly impacted."

Harshe adds, "I don't think that there are as many properties in Ann Arbor that are upside-down as there are in other markets."

"You're hearing that everyone is going to call these loans," says Chaconas of Colliers. "Banks are being flexible because they don't want to own this commercial real estate," he says. "The ones they call the loan on are the people who aren't making payments."

Clark isn't as concerned about deleverage as he is about preparing for it. "I'm not concerned if it rains; I'm concerned if no one leaves without an umbrella," he says. "If we don't start accounting for this inevitable deleverage, and what the implications are," says Clark, "then we're really in big trouble."

"Ann Arbor is not going to collapse," says Clark.

He believes that deleverage is part of the normal cycle of the commercial property market's health and will help increase transparency in the market by tying assets back to their true values.

"We'll definitely emerge stronger because of this," Clark says.

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