Q1 Office Market Report for Detroit, MI
Heading into the spring, the Detroit office market, like most office markets nationally, remains uncertain about the amount and location of office space that will be utilized in the future. This has resulted in businesses conducting operational assessments to determine what the actual amount of space is that they’ll require going forward, and so far, there’s not a one-size-fits-all answer. Recent examples of businesses repositioning include Meridian Health, which started downsizing its physical footprint in the CBD by marketing roughly 300,000 SF at two properties located within the Campus Martius Park. This was part of Meridian Health’s parent company, Centene’s move to reduce the size of its footprint by about 65% nationwide. But locational recalibration isn’t taking place just downtown. In recent months, Comerica Bank, which has a long history in the Detroit area, announced plans to move out of 1 million SF across four buildings in Livonia and Auburn Hills to a consolidated position within 300,000 SF in two adjacent properties in Farmington Hills. Comerica’s signing of these two leases represents two of the top three leases signed in the Detroit area over the past 12 months. Besides the Central Business District’s sizable 27 million SF of space, the other large clusters of office space are diffused throughout the metro in Troy, Southfield, and the Southern I-275 Corridor. While demand for office space in these clusters remains softened in the aggregate, leasing activity is still being generated by a combination of lease renewals, companies repositioning, and opportunistic hunters seeking space on the cheap in depressed markets. Of the companies that have signed lease renewals over the past 12 months, effective rents averaged about $20.70/SF, coming in below the Detroit area market rent of $21.41/SF, indicating softening on pricing. Meanwhile, the space that’s been subleased over the past year has been on the market for roughly five months and is going for an average asking rent of $22.09/SF. Although the traditional office-using employment sector has performed strongly, recovering and surpassing pre- covid numbers, this still needs to translate into increased office leasing on a scale commensurate with the pre- covid office space utilized for similar office employment figures. This trend could be indicative of businesses rightsizing their physical office footprints. But elevated area vacancies could also be the legacy of the Detroit area office sector being dramatically overbuilt during the 1980s. A rash of speculative office development took place between 1985 and 1988, resulting in just under 12 million SF of space being added to the area’s inventory. This office construction boom has been attributed to economic tailwinds, federal tax incentives, and speculative development to accommodate General Motors’ 1984 acquisition of Electronic Data Systems. This has left a large pool of aging properties in the area that are increasingly less attractive to businesses seeking to attract and retain a talented workforce in an era where enhanced office amenities increasingly serve to entice tenants. One option for seemingly unleasable older office properties in the Detroit area might be repurposing the space for other uses. One recent example is at the Victor Center Building in Southfield, the old Plante and Moran Office, which is being converted into a storage facility. In 2021, Plante and Moran consolidated its two Southfield office locations into roughly 125,000 SF at the Southfield Town Center across 12 floors. Devon Self Storage of Emeryville, California, acquired the Victor Center Building with an eye towards conversion, paying attention to property specs like floor weight limits. In a typical office, the floors are built to sustain between 60 and 90 pounds per SF, whereas self-storage requires approximately 125 pounds per SF. Office demand in the Detroit area has softened over the past 12 months, with roughly 1.7 million SF being returned to the market, while vacancy has remained essentially flat over the past 12 months at 12.2%. Annual rent growth is back in positive territory at 0.4%, with annualized rent growth among 1 & 2 Star properties over the past 12 months slightly higher at 1.1%. The average rent in the Detroit area is at $21/SF as of 23Q1. Meanwhile, the pipeline remains full, totaling 1.4 million SF of additional space, representing only 0.7% of the current inventory. Much of the development activity is highly concentrated. Over half of the new space is underway in the Central Business District, New Center, and Detroit West of Woodward submarkets, areas recently challenged by elevated vacancy and availability rates. Two of the more significant projects underway include Bedrock’s work on the iconic Hudson’s Site on Woodward and Ford’s redevelopment of the Michigan Central Station into its Mobility Innovation District in Corktown. In recent years, the Detroit area has had one of the lower levels of investment activity among Midwest peers, and this trend continued throughout 2022 and into the early months of 2023. Annual sales volume as of 23Q1 is $689 million, with over half of the transactions this year in suburban submarkets, including Troy North, Birmingham, Bloomfield West, the Southern I-275 Corridor, and Troy South.
Over the past few years, the total annual net absorption ended up negative, with annual net absorption at roughly -951,000 SF as of 23Q1. While there was an uptick in tenant demand for office space earlier last year during 22Q2, leasing has primarily been softening since then. There’s not yet a definitive answer, as some businesses continue to adopt a wait-and-see approach, debate the best return-to-work policies, and implement hybrid and remote workforce strategies. But General Motors’ recent announcement calling for employees to be in the office three days a week by the end of January could provide a much-needed momentum shift in the downtown area. The struggle to fill space continues as companies that have extended work from home policies seek ways to reduce their office footprint. Weakness is concentrated in Troy, Southfield, and some of the urban submarkets of Detroit. The Troy South Submarket has the highest vacancy rate at 25%, Detroit West of Woodward is at an 18.5% vacancy rate, and Southfield has 18.1% vacancy. Still, the central business district has improved somewhat in recent months, with vacancy compressing down to 8.1% while absorbing about 320,000 SF this year, leading the Detroit area for the most significant amount of demand over the past 12 months. But the level of demand is still falling well short of pre-pandemic numbers. The Downtown Detroit Partnership cites that the average number of workers in the downtown area on a daily basis during September 2019 was at roughly 54,000. As of December 2022, that figure was at 21,140 workers downtown daily. Suburban areas surrounding Detroit saw a modest increase in leasing activity. The submarkets of Dearborn, Macomb East, and Bloomfield all clocked in with around 100,000 SF of net absorption over the past 12 months. Conversely, the Southfield and Auburn Hills submarkets have experienced the largest amount of space given back to the market since the start of the year. Firms are increasingly vacating space ahead of lease expirations, and sublease space is now sitting near an eight-year high of more than 2 million SF. CoStar’s Base Case forecast has vacancy gradually elevating through the end of the forecast period in 2027. This largest lease signed over the past 12 months occurred in September, when Comerica Bank signed a lease for 153,910 SF at 36455 Corporate Dr. in the Farmington/Farmington Hills Submarket. The expected move-in date will be September 2023. This location will be one of two buildings in Farmington Hills that Comerica is relocating to from its current location in Livonia.
Detroit falls in the middle of the pack when assessing affordability compared to other Midwest markets, with average asking rents of $21/SF as of 23Q1. Within Michigan, Detroit trails Ann Arbor but comes in ahead of Grand Rapids and Lansing. Rents for higher rated 4 & 5 Star properties average $23/SF, roughly 9% above the market average. This year started slowly, with a handful of Detroit’s submarkets still experiencing negative rent growth, and as of 23Q1, year-over-year rent growth for the Detroit area was at 0.5%. Over the past year, price-sensitive tenants have sought out space in lower-cost submarkets, driving higher rent growth in these areas. The submarkets of Livingston County, at 1.05%, and Downriver South, at 1.03%, have experienced the most significant annualized growth in rent over the past 12 months. Meanwhile, rent growth in higher-rent submarkets has moved back into positive territory. Suburban areas with higher rents, like Birmingham, Bloomfield West, and the Central I-96 Corridor, have moved into positive rent growth territory in recent months. Weakened demand trends, coupled with elevated levels of sublease space, could continue to weigh on rent growth over coming quarters. In CoStar’s Base Case forecast, rent growth should start returning to healthier levels late in 2024 and continue gradually climbing into 2026. In a severe downside scenario, rent growth remains negative through late 2024.
Over the past 12 months, there’s been roughly 236,000 SF of construction starts. This number may remain lower throughout the next 12 months, as the initiation of new activity has been decelerating recently. Approximately 1.4 million SF of space is underway, with the majority, at 1.2 million SF, comprising 4 & 5 Star properties. The total amount underway represents less than 1% of the market’s inventory, so there should be little supply-side pressure on rents amid all the macro uncertainty. Meanwhile, work continues on two of the larger high- profile buildings underway. In the Detroit West of Woodward Submarket, the 471,970-SF Michigan Central Station is slated for completion early this year. This location will serve as the central focus point for Ford’s Corktown Campus. Another prominent development underway is at 1208 Woodward on the former site of the demolished iconic J.L. Hudson’s flagship location, which was the world’s tallest department store at one point. Bedrock Management is developing the 1.4 million-SF mixed-use property, of which 432,600 SF will be office space. The building, which broke ground in 2017 and has a projected completion date in 2023, will have retail, residential, a hotel, a 1,250-person event space, and a street-level market. The Edition Hotel, a luxury hotel, will be part of the tenant list at the Hudson’s site. Over the past 12 months, net deliveries have totaled about 620,000 SF, with 4 & 5 Star properties accounting for over 80%. This past August, the 422,440-SF Huntington Tower was delivered. This 4 Star, 20-story property is located across from Comerica Park and has roughly half the floors allocated to parking, with the office spaces occupying the top floors. Last year, the 310,000- SF expansion on the north side of One Campus Martius was the most significant delivery, with Rocket Mortgage occupying 11 floors of the 4 Star office space. Rocket Mortgage is the former Quicken Loans, with the company officially changing its name on July 31, 2021, aligning more closely with company branding. This recent expansion added to the existing 985,000 SF of the 15- story landmark office tower, centrally located at the confluence of Gratiot, Woodward, and Michigan avenues. Other notable tenants include Meridian Health Plan, Compuware Corporation, Calexico, and Texas de Brazil.
After somewhat muted investment activity in 2020, sales transactions in 2021 more closely resembled historical trends, with an increase in total volume equating to over $614 million in sales. The pandemic weighed on investment activity in Detroit during 2020, with a 23% decline in total volume year over year. The drop-off in activity was sharpest in the second and third quarters, and while it picked back up in 20Q4, it remained below pre-pandemic levels. Investment activity in 2021 started gaining some momentum, with 21Q4 seeing just under $152 million in assets changing hands. In the early months of 2023, sales volume reached $736 million in sales from 480 recorded transactions over the past 12 months, with sales of 4 & 5 Star properties accounting for the largest share with $324 million in sales as of 23Q1. The top submarkets for total sales volume include Troy North with $105 million, Birmingham with $102 million, Bloomfield West with $80 million and Troy South with $67 million in sales. Other areas that experienced concentrated activity include suburbs surrounding the urban core, like the Southern I-275 Corridor, Farmington/Farmington Hills, and Southfield submarkets. Over the past 12 months, one of the more significant sales occurred in July 2022, when Big Sky Medical of Dallas, Texas, purchased the Beaumont Medical Center in West Bloomfield for $64.5 million ($432.89/SF) from Seavest, LLC, of White Plains, New York. This 4 Star, 149,000-SF medical office was built in 1985, renovated in 2015, and was 81.2% leased at the time of the sale. The second-largest sale occurred in January 2022, when Versa Development of Royal Oak, Michigan, purchased a 4 Star office building at 325 North Old Woodward in Birmingham for $46.75 million ($371.04/SF) from Intercontinental Real Estate Corporation of Boston, Massachusetts. This mixed-use property was fully leased at the time of the sale and included first-floor retail space tenants like Flemings Steakhouse, while office tenants on the second and third floors include UBS Financial Services and Raymond James Financial. Pricing has remained flat since last year, at $127/SF during 23Q1, while the market cap rate has compressed slightly to 9.2%, right in line with the five-year average.
Detroit’s economy experienced a generational downturn since the coronavirus pandemic, like many other cities throughout the country and even the world. Self- isolation, lockdowns, social distancing, and state- mandated business closures all contributed to Michigan suffering from the worst unemployment rate in over half a century, with 22.7% of the labor force out of work at its peak. Before the pandemic, the worst unemployment number tracked in the past 45 years was 16.2%, in 1982. Catastrophic unemployment like this has a domino effect. Because unemployed workers were out of money, they were unable to purchase items that had been keeping productivity numbers stable. The cycle continued, as those making the previously in-demand products often lost their jobs. Fortunately, federal stimulus packages, totaling over $10 billion in the form of direct stimulus checks, advanced child tax credits, rent forbearance, and additional federal unemployment insurance payments, have softened some of the damage. Michigan’s government established a staged economic reopening, called the MI Safe Start Plan, which began in spring 2021 and is being implemented through a phased approach across various regions and workplaces. Detroit’s economic recovery has gained strength and momentum this year, with improved vaccination rates and easing of restrictions. With another 152,400 jobs added in June, the year-over-year job growth rate for the Detroit area was 8.6%, outpacing the national rate of 5.8%. Many employees have been allowed to return to the workplace, with significant operational changes relating to vaccination status, social distancing, and occupancy standards. Since the pandemic began, there’s been a seismic shift in attitudes and preferences regarding where and how to work with those who can work from home expressing a 70% preference to do just that. This could have a lasting impact on how businesses operate in Michigan, with office workers making up the largest grouping of Michigan’s labor force by workplace, at 29%. With continued uncertainty surrounding new COVID-19 variant cases, the timeline horizon for workers physically returning to the office may have been lengthened. One of the largest employers in the Detroit area, General Motors, announced its cultural shift, called “work appropriately.” Under this new directive, employees are empowered to work at whatever location they can work the most efficiently and productively. The next two largest segments of the labor force are industrial at 19% and healthcare at 13%. Most major sectors within healthcare, including hospital, nursing homes, assisted- living facilities, and outpatient settings, are operating but are under continued COVID-19 workplace safety rules. The industrial workforce, while back on the job, has been hamstrung by persistent side effects of the pandemic, like logistical challenges, supply-chain issues, and raw material shortages. The ISM July Manufacturing PMI was 59.5%, down slightly from June, but still an expansion of the overall economy for the 14th consecutive month. Easing of supply bottlenecks is expected as consumer spending rotates from goods to services. Two of the areas hardest hit during the pandemic, restaurants and lodging, together employing roughly 12% of the state’s workforce, continue grappling with challenges of finding workers to fill empty positions. In December 2019, approximately 416,900 leisure and hospitality positions existed in Michigan. Exactly a year later, that number was down to 217,900. While the Detroit area is still known as the auto capital of the world, Michigan has been ranked fourth nationwide for high-tech employment. Michigan has organized the state into 20 economic Smart Zones, five of which are in the metro Detroit region. The Smart Zones technology clusters promote resource collaboration between universities, governmental and community-based groups, research organizations, and industries. Economic recovery across southeastern Michigan has been concentrated in suburban areas, which have outperformed core urban areas across multiple real estate class types. Even though urban areas have suffered from recent underperformance, many positive key economic drivers remain, which should aid in the recovery. One example is Ford Motor Company’s 30- acre development centered on the Michigan Central Station, west of Downtown Detroit. Ford’s Mobility Innovation District, known as the Corktown Campus, will create a centralized location for startups, innovators, and entrepreneurs to create, experiment, and launch innovative mobility solutions on real-world streets. A total of 5,000 new jobs will be created within the Corktown Campus, with 2,500 from Ford and 2,500 from business partners. Foreign direct investment (FDI)-related job growth in Michigan has ranked No. 1 in the U.S. for the past five years. Of the 313,000 workers employed in Michigan from FDI, 64% of the jobs created are in the manufacturing sector, with the majority being in the metro Detroit area. One of the larger recent additions was Fiat Chrysler Automobiles’ new Detroit Assembly Complex, which along with the Jefferson North Assembly Plant will create approximately 4,950 new jobs.