Building patience

Posted on June 27, 2012

Local and national developers have been quietly — or in some cases not so quietly — shopping plans around Detroit for new residential developments.

How long before plans become construction projects? That part remains a mystery.

Potential Detroit developers say economics, not demand, has kept projects on the sidelines.

The market forces that drive rental rates show newly constructed projects don’t bring in enough money to support the construction costs. Instead, government subsidies and foundation grants continue to make projects feasible.

That situation makes it a challenge for any developer to get a new project under way, said Richard Baron, co-founder of St. Louis-based McCormack Baron Salazar Development Inc., which has done projects all over the country and is currently close to starting on a $15 million apartment project in Midtown.

The trick is figuring out, down to the penny, what kind of revenue can be generated in Detroit to finance the cost of developing or redeveloping a building.

In the central business district and Midtown, the average residential rental rate is $1.25 per square foot, Barron said.

“And if you can do something and make it work at that rental level, there is strong demand,” he said. “But to have a project that is profitable, you need to be closer to $2, and that isn’t likely in Detroit right now.”

For a 1,000-square-foot apartment, that’s the difference between $1,250 and $2,000 a month.

Filling that gap between rental income and project cost remains the role of subsidies from federal, state and local governments as well as philanthropy.

There are hopes of a virtuous circle: As more projects push up the limits of the rental rate, more development can occur to push the limits higher yet again.

Developers on the lookout

Tony Goldman, the New York developer who has taken on projects in Miami’s South Beach and New York’s SoHo, continues to show interest in Detroit.

Longtime developer Jonathan Holtzman, who has built a national portfolio of apartments from his Farmington Hills-based Village Green Cos., is also looking for a development project in Detroit.

Likewise, Cleveland developer John Ferchill, known for redeveloping the Westin Book Cadillac, has been looking at Detroit projects.

Quicken Loans Inc. founder and Chairman Dan Gilbert has been exploring plans for a 350-unit apartment building on the site just north of the Compuware Building on Woodward Avenue.

Gilbert said that while the current rental rate might be lower than what is needed for development, a true analysis needs to reflect the idea that people will pay more for new product.

“A median rental number combines old product and new,” he said. “You’re going to get a higher rate on a new product, and you’re already seeing things in the $1.60 range.

“The marketplace works, and especially when you’re 98 percent occupied with high demand, prices will go up.”

For example, units in the historic Broderick Tower redevelopment are available for $1.35 per square foot, but the penthouse units are more than $2 per square foot, said Fred Beal, an investor in the project and president of Detroit-based J.C. Beal Construction Inc., the construction manager for the development.

“We expected to be above market, as we well should be,” Beal said. “We’re providing a new product with upscale finishes and a glorious view of downtown.

“We placed the rents a little bit above the market, and they’re gobbling it up.”

With 125 units for rent in the historic building on Grand Circus Park, the project has reservations for 58 units.

More to come

But duplicating the Broderick project will require another complex layering of financial subsidies from foundations and multiple government programs.

It’s a series of hoops that any downtown developer needs to jump through, as any of the speculative projects will need some kind of subsidy.

A range of tax credits is expected to be used for the next round of developments,

such as the Capitol Park project, which will be the next major project to be announced.

Three buildings clustered around the site of Michigan’s first capitol building are being marketed together by a group of public entities, led by the Detroit Economic Growth Corp.

An announcement of the developer was originally to be made at the beginning of the year, but nothing has been released.

The Detroit-based Roxbury Group is close to financing the redevelopment of the David Whitney Building, which would include 108 apartments and a 118-room Aloft Hotel on Grand Circus Park. Construction has not yet started.

Like the Capitol Park buildings, the David Whitney is also expected to have significant levels of subsidy.

The historic Book Tower also has been a project rumored to be coming soon. The building’s Milan, Italy-based owner, Akno Enterprises, reportedly has been meeting with local developers to redevelop the building into residential units.

Akno founder Massimo Nouhi and other executives at Akno have not responded to nearly a dozen emails over the past two years from Crain’s.

Ferchill won’t disclose the location of his next project, telling Crain’s in an email: “There’s nothing to talk about … yet.”

Goldman, who announced in October that he wants to make a splash in Detroit with the development of several projects, has yet to announce the specifics, though he has said he’s close to a project.

He could not be reached for a comment on the latest status.

Making the jump

In many markets, there is a jump in rent between older apartments and new ones, said Holtzman. His Village Green Cos. own 40,000 apartments worth $4.5 billion nationwide.

Village Green is building Ann Arbor City Apartments in Ann Arbor, for example, where rent is just above $2 per square foot, a figure higher than the range of $1.50 to $1.75 for older apartments in the city, Holtzman said.

“My building is state of the art, so there is a jump in price from old units to new product, but it’s not very far,” he said. “But in Detroit, that jump from old product to new product is still very far.”

He said the need for subsidies will evaporate as rental rates increase, more companies invest in the city and more retail development occurs.

“Will it get there?” he asked. “The simple answer is “yes.’ The more difficult question is “how quickly?’ ”

An important component is the involvement of banks to invest, Holtzman said. Minneapolis-based U.S. Bankloaned Village Green money for the acquisition of Trolley Plaza on Washington Boulevard, recently renamed as Detroit City Apartments.

“The banks are an important piece,” he said. “It’s not just that the investors want to invest. You need construction lenders. You need mortgage lenders.”

Holtzman said he is exploring a Detroit development but is not ready to announce a project.

How much farther?

Creating a financial environment that will draw developers without the need for public money isn’t too far off, said Dave Blaszkiewicz, head of the Downtown Detroit Partnership and Invest Detroit.

“We have a goal to be at a point where we no longer need to make investments,” he said.

A study related to transit-oriented development in Detroit — if a light-rail system is built — forecast the growth of rental revenue and density on a five-year plan.

The study was done by the Detroit Economic Growth Corp. and Invest Detroit.

To bring Detroit in line with Philadelphia, it will take an increase in population density from eight to 10 per acre up to the 20 that Philadelphia sees in its University City area or 30 in the core downtown, said Robert Gregory, a senior vice president with the Downtown Detroit Partnership.

Based on that goal, Gregory said, Detroit needs 700 new residential units per year for five years for the greater downtown area, including Midtown. In the core downtown area, the need is 300 units per year.

If that level of construction is met, the rental revenue will catch up with construction costs in five years, he said.

“And from what we’re seeing in the pipeline, that level of development is tracking with the goal,” Gregory said.

More development will occur if a light-rail line is approved.

Gilbert, one of the vocal supporters of the rail line, said nothing will bring residential and retail development faster than the creation of a downtown rail line.

He said his own development plans and those of other developers are based on a solid economic argument.

“I’d like to think that it’s the smart developers that are looking around right now to get on board early,” he said. “We are at the beginning of this right now.”