Partly Sunny: The state—and states—of the Midwest real estate market

William Bubniak

William Bubniak

By William Bubniak, Executive Vice President, Farbman Group

While tougher times may be on the horizon for certain property segments, and there are certainly differences between specific products and individual markets, the good news is that today the Midwest commercial real estate market is generally quite healthy. The recessionary stresses of 2008 and 2009 are well in the rearview mirror, and some Midwest markets have done more than just recover—they have made some exciting leaps forward.

That said, Michigan, like Ohio, tends to experience turbulence before other states, and we are seeing some concerning signs in those bellwether states. Perhaps the most significant indicator is what has been going on in the Commercial Mortgage Backed Securities (CMBS) market. There are a disproportionately high number of maturities coming up on 10-year notes in 2017, and the general sense across the industry is that this will be a key contributing factor to the next downturn. Our own firm has been engaged in more property management issues, and has been asked to perform a larger number of evaluations of struggling properties on behalf of lenders. We currently expect to be assisting lenders with more workouts and asset repositioning into the latter part of 2016, and we expect to be doing even more of that work in 2017.

Whatever the coming slowdown looks like—and some property segments will have more problems than others—there is little reason to think it will be anywhere near as bad as the 2008-2009 recession. It is no secret in the retail market that the closure of 100 more Macy’s stores will ratchet up additional pressure on B Malls across the region (and the nation for that matter). The Sports Authority and Office Max struggles are not helping, and continuing pressure from online competition will also play a role. Neighborhood centers will likely tend to be more resilient, but malls and, to some degree, power centers are going to face some challenges.

While there will almost certainly be some bumps in the road around the corner, the highway is smooth today. In Michigan (and really across the Midwest) the industrial market is particularly strong. The industrial landscape in Cleveland, Columbus and Cincinnati in Ohio are all quite strong at the moment, as well. We have not seen a great deal of new construction in Michigan, which is a good thing, because there is little concern about being overbuilt. The automotive industry is doing very well, and has taken a more cautious approach to expansion, decreasing the likelihood of becoming overextended in leaner times. Anyone looking for 100,000 square feet of industrial space in Detroit or Chicago right now would be hard pressed to do so, as quality space of that size is tough to come by.

Office in Ohio, Michigan and Wisconsin has always been the toughest segment of the market—and while that is still the case today, we are seeing some signs of progress. Here again, the securities issue is a looming concern: office would likely be one of the first segments to be impacted if the anticipated down-cycle materializes.

To some degree, Illinois is its own animal. Urban markets are seeing strong growth, with urban infill ramping up in response to the continuing trend of residential and office moving back into downtowns across the region. In some cities, competition for quality space in the urban core has been fierce: we are seeing pre-recession pricing in downtown Chicago on most property types. If there is a note of caution to be struck in Chicago, it would be the fact that there are large pension deficits and other structural fiscal issues looming, which will likely lead to strong pressure to increase property taxes in the not-too-distant future. Illinois is very different than some other Midwest states in the sense that your property tax gets reassessed every three years, and is not capped like it is in Michigan, for example. That issue could be a potentially dangerous wild card for Illinois. As far as the Chicago suburbs go, some markets are definitely better than others. Cities like Evanston, Rosemont and Deerfield which are on the train lines and Northbrook and Skokie which are suburban infill sites continue to thrive.  However, others are somewhat flattening out and may be in for still leaner times ahead if the economic situation unfolds like we think it might.

In terms of investment, some parts of the Midwest, most notably Ohio and Michigan, are seeing more coastal buyers active in the marketplace: investors who recognize the potential for better returns at a time when major coastal markets are saturated and prices are spiking. We are also fairly bullish on Milwaukee, a town with some strong fundamentals that often gets overlooked. From an investment standpoint, that combination translates to opportunity. Detroit proper is another exciting market right now. The Dan Gilbert approach of bringing companies into Detroit seems to be sustaining momentum, and others are contributing—with some noteworthy investments from automotive companies. As that energy, activity and optimism gets recognized, it looks to be building on itself and contributing to a long-term positive trend for the Motor City.

As for specific trends to look for in 2017, residential will likely remain strong—especially in urban areas. If we do start to see turbulence on the troubled loan side, new lending will potentially slow down, especially in secondary or B markets, and lenders becoming more selective could impact pricing downstream. If the anticipated slowdown materializes, I suspect industrial will weather the storm well, while office and retail will likely be hit the hardest. Presidential election year uncertainty and hints that interest rates could increase are both wild cards that need to be watched carefully: reminders that in a complex and evolving Midwest marketplace, there is always more to consider.

William Bubniak is the executive vice president of Farbman Group.

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