GRAND RAPIDS — The pandemic’s impact on office and industrial real estate markets are spilling into 2022, according to a pair of West Michigan reports.
The takeaways? Corporate growth and a lack of new construction are putting both segments in a tight spot. That’s according to Q2 office and industrial market reports from NAI Wisinski of West Michigan published this month and office and industrial market trend reports published by JLL Grand Rapids in July.
In the West Michigan office segment, vacancy rates, particularly in downtown Grand Rapids, are higher than industrial vacancy rates (but not as severely as in other large cities).
It’s a bit of a shuffling game, with new supply hitting the market just as some companies are right-sizing their office footprint and others are expanding. Meanwhile, the availability of suburban office space is shrinking: If proximity to downtown restaurants and entertainment isn’t as important in the work-from-home era, why not move to the suburbs, where rents are lower, and parking is free?
Meanwhile, demand for industrial space far outpaced supply in Q2, making for one of the tightest markets local brokers have seen in their lifetimes. With off-market deals becoming more common, less well-connected businesses are finding it tough to grow their footprint. Brokers are hopeful more supply will come online in Q3, but much depends on whether supply chain problems abate.
Although each firm’s Q2 reports focus on different factors affecting the market right now, what they have in common is the pandemic’s lingering impacts on commercial real estate.
Jeff Karger, senior vice president of brokerage for JLL Grand Rapids, handles acquisition, sales and leasing of commercial real estate in West Michigan.
He said JLL’s reports are based on quarterly leasing activity and corporate owner-occupied property data.
According to JLL’s calculations, Grand Rapids’ overall office vacancy rate in Q2 was 11.8 percent, down from 12.8 percent in Q1. That compares to 18.7 percent vacancy in Detroit, 19.9 percent in Indianapolis, 22.1 percent in Chicago and 18.9 percent on average in the U.S. in the second quarter.
Total vacancy rates were 14.5 percent for downtown Grand Rapids office real estate versus 9.4 percent in the suburbs.
Year-to-date net absorption in the JLL report — the amount of space occupied — was 265,166 square feet, with 10,781 square feet available in sublease vacancy and 51,000 square feet under construction (none of it downtown). The average direct asking rent was calculated at $21.74 per square foot downtown versus $17.63 per square foot in the suburbs.
Karger thinks Grand Rapids is insulated from higher vacancy because local companies have been slower to reevaluate their space usage in the era of remote and hybrid work, while larger companies have already begun reducing their footprint to match the number of daily in-person workers.
But slowly, it’s beginning: Morgan Stanley this year consolidated a downtown office and a suburban office to a location in southeast Grand Rapids, and Wells Fargo consolidated its downtown location into a suburban location on the northeast side.
Karger said it’s possible Grand Rapids vacancy rates will increase in the next 18-24 months as local right-sizing catches up to national trends, but it’s also possible other growing companies will take over the empty office space.
“It will be an interesting dynamic to monitor as we see some companies grow here locally,” he said. “Will they backfill space that is being vacated by right-sizing larger, corporate-type end users? Let’s face it, Grand Rapids is a tertiary market, so this is a space that they may or may not need to be in.”
Other notable downtown moves include:
Hillary Taatjes Woznick, a partner for office and retail at NAI Wisinski, said there’s a misconception that West Michigan has a higher office real estate supply than larger markets.
“The mentality is that there’s just tons of office space, and everybody’s working from home, and people are giving it away,” she said. “That’s really not true. … We have the biggest inventory crisis that we’ve ever had in West Michigan.”
Woznick said in the introduction to her Q2 report for NAI that COVID-19 caused downtown office leasing to stall for a full year from March 2020 to March 2021, but then it picked right back up.
She said the biggest challenge now is the lack of office buildings available to buy in West Michigan.
“Inventory seems to be at a low point, and certainly well below the current demand we are seeing from buyers in the market,” she wrote in the report. “This problem is a result of so many properties having been sold over the past few years, combined with the lack of new construction due to the pandemic and high construction costs.”
When a property goes on the market for leasing, Woznick said she gets calls asking if her client would be willing to sell the property instead of leasing it, leading to off-market deals and lower inventory. NAI West Michigan had its best year ever in terms of office building sales, Woznick said.
The NAI Q2 report showed an overall office vacancy rate of 6.6 percent with 8.1 percent vacancy downtown.
Woznick is currently “out of inventory,” she said — especially in the suburbs. Downtown office real estate is going for $20.21 per square foot, on average, according to NAI’s calculations. Woznick said according to her most recent estimate, parking costs add another $10 PSF for downtown tenants, and it gets more competitive all the time due to lack of supply. With lower rents and free parking, the flight to the suburbs is understandable, she said.
“A lot of companies prior to COVID thought they needed to be downtown to attract talent,” she said. “Then COVID hits, and everybody considers a flexible work schedule, and now all of a sudden, it’s not so important to be downtown because the employees prefer a flexible work schedule over being downtown and walkable to all of the restaurants and entertainment.”
Heading into Q3, Woznick is looking at more inventory coming on the market downtown, but bidding will be competitive. She doesn’t know whether the inventory in the suburbs will increase in Q3.
Office supply might be low, but industrial real estate supply is historically scarce in West Michigan.
That’s according to Bob Horn, executive vice president at JLL Grand Rapids, and Andrew Kapanowski, commercial real estate specialist for NAI Wisinski of West Michigan.
“This is one of the hottest industrial markets that (we’ve) seen in decades,” Kapanowski said.
JLL’s Q2 industrial report said the total vacancy rate in West Michigan is at 3 percent while average rent is at $4.26 PSF. And while it didn’t list the number of available square feet, the report said about 2,512,750 square feet of space is under construction.
According to NAI’s Q2 report, which uses CoStar data, the overall industrial vacancy rate in West Michigan is at 2.2%, the average price per square foot is $5.25, and less than 4 million square feet of space is vacant and available.
Kapanowski said demand for industrial space is high not only because of the e-commerce boom but because local companies are performing well.
Meanwhile, new builds have been slow to come online due to supply chain delays and high materials costs. “I’ve run into situations where ordering a garage door takes four, five, six months sometimes,” he said.
Kapanowski is hoping the market will soften in Q3.
“Honestly, (we’re) almost an unhealthy level of lack of supply, because it’s so hard to find stuff for people,” he said. “It would almost, in a way, be healthy to have a little bit of market contraction — not really a full contraction, but just to soften it up a little bit.”
Kapanowski and Horn both said off-market industrial deals are common right now, and buildings that are still under construction are leased before they’re even completed. Businesses are also signing longer-term leases, Horn said — 10 to 15 years versus the five-year leases that used to be common — and leasing more space than they need to allow room to grow.
That’s hurting smaller companies that need less space, since investors and developers aren’t churning out as many small buildings, and the larger projects they’re developing are being leased off-market by companies with deeper pockets.
JLL cited a few major owner-occupied expansion projects in the West Michigan industrial space in Q2, including LG’s $1.7 billion expansion of its facility in Holland to quintuple its capacity to produce EV battery components, Pfizer putting $120 million into its Kalamazoo facility to expand production of the COVID-19 vaccine, Grand River Aseptic Manufacturing investing $160 million in its facility in Grand Rapids, Coastal Container spending $25 million to expand and JR Automation putting $10 million into its facility.
The DeltaPlex arena, the former home of the Grand Rapids Gold basketball team and concerts and events, sold to Visser Brothers Development for $5.5 million at the end of 2021, and the company said in Q2 it intends to repurpose the 6,000-person capacity venue into warehouse space for an industrial tenant that has not been selected.
“Developers are just trying to get their hands on properties or facilities that they can renovate and re-occupy,” Horn said.
As demand continues to outpace supply, Horn expects to see former agricultural properties throughout Kent, Allegan, Ottawa and Kalamazoo counties being rezoned for industrial uses. But it could take time to develop the rezoned land, as infrastructure like roads, power, water and sewer needs to be added before sites are shovel-ready.
For investors looking to cash out their building assets or lease part of their space, now is a good time to do so, Kapanowski said. Low supply, as ever, is driving up prices.
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