By Evan Lyons, Encore Real Estate Investment Services
Call it what you will — Motown, the Motor City, the Comeback City — by any name, the city of Detroit has long been a place of possibilities. A smart student in the school of hard knocks, Detroit has teetered on failure, yet still managed to graduate with high marks.
Best known as the birthplace of the automobile and home to Motown music’s Hitsville USA, Detroit went from being the driver of American capitalism to a city in ruin. It endured population decline in the ’50s, rioting in the ’60s, the collapse of the auto industry in the late ’70s and ’80s, and in 2013, the largest municipal bankruptcy in U.S. history, yet somehow emerged as a hot spot for high rollers and hipsters alike.
Evan Lyons, Encore Real Estate Investment Services
As 2019 winded down, Detroit and the surrounding Southeast Michigan area boasted a healthy economy. The automotive industry, a key driver of the region, posted better than expected sales of cars and trucks in the fourth quarter of 2019, beating projections. Employment was on the uptick both in the city and across the state. Southeast Michigan appeared positioned for growth in 2020. The same held true for the region’s commercial real estate market, including its retail sector.
Then came COVID-19 and, like other major U.S. cities, Detroit faltered. The once upbeat tempo of Motown’s economy hit a flat note in 2020 with the pandemic-fueled recession, which strangled the country and continues to hold the nation in its grip.
Business bankruptcies and closures were already mounting nationally ahead of the pandemic and store closings hit an all-time high of 12,000 in 2020. Detroit and the region saw the impact, particularly in older properties located in areas of recent economic decline. Net absorption fell in the second half of 2020 with a negative net absorption of 527,000 square feet.
Leasing activity also dropped 30 percent below the prior three-year average. The second half of the year normalized however with fourth-quarter volumes in line with prior years, foreshadowing an uptick in leasing activity for 2021. Discounters were among the most active in 2020, according to a retail market report by Costar Group. Dollar Tree signed six leases totaling over 78,000 square feet, while Family Dollar and Dollar General signed three leases each, which totaled about 22,000 and 27,000 square feet, respectively.
Over the years, because of limited new development, vacancy rates in Detroit steadily declined from nearly 11 percent in 2010 to a low of 5.4 percent in the second quarter of 2020. Last year, we saw vacancy rates increase, though not as sharply, due likely to a nationwide moratorium on evictions as well as landlord rent deferment and abatement programs. Vacancy ended the year at 5.6 percent.
While development activity last year was limited, the pipeline is now expanding with 1 million square feet of new construction in the region. Most of it — 6.4 percent of current inventory — is in Detroit’s New Center district. Standalone big-box formats led new retail construction during the past 10 years with deliveries from Walmart, Kroger and Menard’s, the latter of which opened an impressive six new Michigan locations.
More recent market newcomers included BJ’s Wholesale Club, which opened stores in Madison Heights and Taylor. BJ’s was joined by The M Den and Meijer, as well as national apparel retailers H&M and Lululemon, all of which chose downtown Detroit locations. Other notable additions to downtown included Whole Foods, Amazon and tech giants Google and Microsoft.
Innovation persists
Still, COVID-19 and its resulting lockdowns in Michigan left retail operators and investors alike humming refrains of that long-ago Motown hit “Tracks of My Tears.” Early on, Michigan was among states hardest hit by the pandemic, and Michigan Gov. Gretchen Whitmer’s response was equally hard for the retail sector to swallow. In March, to help curb the virus spread, she indefinitely shuttered all bars, restaurants, entertainment facilities, gyms and other retail venues. Subsequent months saw car and truck sales crash, consumer spending drop and employment spiral downward.
Yet even under the dark cloud of COVID-19, there were bright spots on the region’s retail horizon. With work-from-home the “new norm” and few options beyond carryout for dining, consumers cooked their own meals. Grocery stores were suddenly the new hot spot in town and in retail. Nationally grocers saw year-over-year sales increases in 2020 of roughly 10 percent.
Meanwhile, once allowed to reopen with limited operations last spring, restaurants and entertainment — the hardest hit retail category in Detroit and nationally — responded with innovative ideas and new approaches.
With indoor dining prohibited, many created or expanded outdoor spaces, investing in igloos, yurts and heaters to entice diners. Some upscale restaurants experimented with prix fixe or limited menus and added takeout and delivery. SheWolf Mercato, a high-end Italian eatery in downtown Detroit, switched to carryout-only offerings during the shutdown, while Grey Ghost, also in Detroit, provided cook-at-home gourmet burger kits to patrons.
In both Detroit and its suburbs, delivery and curbside pickup soon permeated retail. From mom-and-pop strip center tenants like The Clothing Cove in Milford, which hosted fashion shows for at-home shoppers via Zoom, to major regional mall tenants like Macy’s and Dick’s Sporting Goods, retailers began offering consumers a contact-free, curbside or ship-to-home experience.
Consumers quickly became enamored with the convenience of BOPIS (buy online pick up in store) and retail operators embraced BOSFS (buy online ship from store) to help drive sales. Many also touted special hours for elderly or immune-compromised customers to limit their exposure to the virus and entice them to shop.
Landlord participation
Key landlords in Detroit’s commercial real estate landscape also lent support to small businesses during the pandemic. Programs such as Bedrock’s Detroit Relaunch offered tenants three months of free rent at the height of the lockdown and, when the virus persisted, gave them the option to pay 7 percent of gross sales in lieu of set rents through the end of 2020. With its more recent Decked Out Detroit promotion, Bedrock installed heated, pergola-like structures at participating eateries throughout downtown to promote safe and comfortable outdoor dining. The plan also provides free parking in Bedrock-owned Detroit lots and a $10 discount on Lyft rides to and from the city.
Such lifelines, coupled with metro-Detroit retailers’ ability to pivot and adjust their operations, provide good reason for optimism. The vaccine rollout and a let-up of restrictions further boost hope. In February, Gov. Whitmer allowed Michigan restaurants to resume indoor dining at 25 percent capacity, enabling them to welcome back patrons, albeit on a limited scale.
Consumers ready to spend
Though questions about the future of retail and the pandemic’s long-term impact on Detroit’s retail real estate loom and uncertainties about market conditions persist, one thing seems certain. Michigan consumers, propelled by lockdown lethargy, are eager to get out. This is good news for Detroit as one of the few cities in America with four professional sports teams within its city limits.
There is pent-up demand for shopping, dining and entertainment, and despite the recession, consumers have money to spend. The Wall Street Journal reported that Americans saved $1.4 trillion in the first three quarters of 2020 — about twice as much as in the same period in 2019 — according to analysis by Berenberg Economics. President Biden’s push for a new $1.9 trillion stimulus package, if approved, will further fill wallets.
Cash-flush consumers, coupled with rapid rebound in the auto industry and improvements in the state’s employment numbers — both of which are already occurring — will help fuel the Motor City. In the meantime, Detroit real estate investors and operators can capitalize on the opportunities current market conditions present.
Retail operators can take advantage as property owners exhibit greater flexibility in rent rates and terms. Owing to negative absorption and slowed leasing activity in 2020, rents as of early 2021 were down 1.5 percent below pre-pandemic levels. Such rent rate declines and business closures offer retailers with less-deep pockets the chance to move into a market that pre-COVID may have been beyond their financial reach. Similarly, existing operators in the market can use the opportunity to expand or upgrade space at lower costs.
Retail rents in the region stand in the middle of the Midwest pack — about 14 percent below Chicago, but above rents in Cleveland by 17 percent. Detroit is currently averaging $16.10 per square foot with average annual rental growth of about 3 percent after 2015. Forecast models by Costar Group show rental rate growth returning to 3 percent annually likely as early as the fourth quarter of this year. The highest rents in the region are found in Birmingham, Troy and Bloomfield.
The fact is, even during a world-wide pandemic that upended global economies, metro Detroit remains a place of potential and possibility. As COVID-19 numbers improve with accelerated vaccination rollout and the governor further dials back state restrictions, the region’s recovery will continue to gain ground. We are seeing this now in Detroit’s job growth numbers, which outpace those nationally. A projected year-over-year increase in automotive sales by Detroit’s Big Three in 2021 to 6.6 million units from 5.8 million last year provides an added sign of recovery.
Indeed, according to a recent report in the Detroit Free Press, Michigan business owners and economists are optimistic about the state’s recovery and expect to see it bounce back in 2021. When that happens, retail investors, operators and residents alike will all be “Dancing in the Streets.”
Evan Lyons serves as senior director with Encore Real Estate Investment Services. This article originally appeared in the February 2021 issue of Heartland Real Estate Business magazine.