Despite Costs, Developers Pursue Rehab Opportunities for Detroit’s Historic Buildings
By Steven Phillip Siegel
Mies van der Rohe. Yamasaki. Kamper. Boat. Portman. Gyllis. Some of the greatest architects in the world are represented in Detroit. Motown’s extraordinary confluence of architects and designers earned the city the designation of a UNESCO City of Design, the only city in the US to receive the UN Prize for Excellence in Design. From the early 1970s, however, many of the city’s finest architectural works slowly sank beneath a weakening market amid the flight of tenants (and apartment blocks) to the suburbs.
After the Great Recession, developers, led by Dan Gilberts Bedrock, slowly began redeveloping Detroit’s architectural gems. In recent years, massive capital investments have been made in historic buildings such as the David Stott Building in downtown or the Fisher Building in the New Center. However, many city dwellers and tenants find it difficult to understand why the rents for these new projects are so much higher than for the rest of the market. The narrative of Detroit’s architectural gems – and the financial jenga it takes to be successful – tells the story of the city’s modern renaissance.
“It’s a passion project for us,” said Brett Yuhsaz, Bedrock’s construction director who has worked on some of the city’s most notable historical rehabs, including architectural gems like David Stott, Shinola Hotel and Book Tower. “These buildings are iconic for Detroit, especially when you look at some of the amazing architectural talent that existed here in the 20th century, and we want to restore these gems to their original state,” says Yuhsaz.
Remarkable challenges exist in the rehabilitation of historical structures. Older buildings typically use more “natural” materials such as terracotta, limestone, ornate brick, and copper, which are no longer used in modern construction because of the inflated cost. Finding crafts to work on these vintage materials adds significant cost to projects. Nonetheless, Yuhasz says: “The level of craftsmanship in Metro Detroit and in southeast Michigan shows the passion of building contractors. It’s not always about finding the lowest bidder, it’s about finding the right people who are really craftsmen. ”
In addition, retrofitting older structures for modern building codes and tenant requirements is extremely difficult and expensive. Early 20th century floor plans and infrastructure were not designed with modern boilers, water heaters, elevators, and technical AV equipment in mind. “It’s a huge puzzle,” explains Yuhsaz. “We are constantly examining and studying every nook and cranny in these buildings and how to fit into these modern systems to achieve great functionality and modernity.”
In addition to the material and operational challenges, there is the inherent troubled condition of older buildings and their inefficient floor slabs. Detroit-based Kraemer Design Group, an architecture and design firm with expertise in historical rehab, knows these challenges well. “One of the reasons why rents are higher [downtown] That’s because they’re inefficient buildings, ”explains Bob Kraemer, director and founder.
“If you are building a brand new house, your share of the rental space is higher than if you are converting an old building. In a new building it is 85 percent of the total area, in a rehab it is 75 percent. You’re backwards from day one. “
With fewer rentable square feet available for rent, developers have to bill more than projects in the suburbs. Add in the cost of retrofitting real estate for modern utilities, upgrading historic natural materials, and demonstrating crumbling structures, and it creates a picture of the high costs associated with these historic rehabs.
The numbers lock this out. According to Don Selvidge, MAI & Senior Managing Director at Integra Realty Resources, the cost of renovating historic structures has increased dramatically. The total cost of historical rehab can be up to $ 300 per square foot. The hard cost of renovating historic buildings is anywhere from $ 220 to $ 300 per square foot, while the soft cost can be anywhere from $ 40 to $ 80 per square foot. Meanwhile, a typical four-over-one wooden frame base project has a hard cost of $ 150 to $ 175 and a soft cost of $ 20 to $ 40 per square foot. At rough averages (suburban), the base for a 100,000 square foot suburban development would be $ 19 million, while the same size urban project would be $ 30 million.
How to make math work
In order to make development projects financially viable, developers strive for a spread between the exit cap rate and the return on costs, which is typically 150 to 200 basis points. This “developer spread” enables them to achieve risk-adjusted returns that are attractive to equity investors. Exit cap rates in suburban Detroit are similar to those in downtown Detroit. With significantly higher costs in the city center, a basic project will need a higher operating income (NOI) to justify the costs. And that’s the whole point: the only way to get a higher NOI is to ask for higher rents. As such, downtown Detroit and Midtown have the highest rents in the entire metropolitan area.
Even as downtown / midtown class A rents approach $ 2.50 per square foot, the high cost of $ 300 per square foot has made it harder to hit the developer spread of 150 basis points. Without the various incentives on offer to developers, including brownfield TIFs and tax breaks to increase the NOI, historical tax credits, or Michigan Economic Development Corp.’s public / private capital to lower investor equity, historical rehabilitation projects couldn’t work with the Competing Capital That Can Go the suburbs for a higher (and less labor-intensive) rate of return.
As a result, many of these gemstones remained empty, as it did for decades until the demand for downtown housing returned. Kraemer sees the restart of the state program for historical tax credits as crucial for future historical rehab projects. “It’s pretty big credit,” he says. “It makes the banking institutions more excited and it’s almost exactly the same paperwork [as applying through the historic preservation societies]. ”
Despite the considerable financial and physical challenges associated with historic renovations, projects such as the Shinola Hotel and Ford’s Michigan Central Station prove that developers’ appetites remain low and the prospects for Detroit are high. While discussions of cuts, brownfield TIFs, and other public / private incentive programs have recently caught media attention, a bird’s eye view of the numbers shows just how important these programs are in making historical rehabs financially viable for developers.
Even so, many developers in Detroit have been driven beyond purely financial means. Brian Hughes, Vice President of Northern Equities Group, welcomes the opportunity to update the Albert Kahn in a way that will maintain its integrity and give it new life. “At the time of construction, the Fisher Brothers said it was a hands-on demonstration of our continued and growing confidence in the future of Detroit that resonates with me because we’re doing the same thing with this project today.”
Perhaps these developers see in these historic properties that the greatest value in real estate is beauty.
Steven Phillip Siegel is Vice President at Lutz Real Estate Investments and Q10 | Lutz financial services. This article originally appeared in the July 2020 issue of Heartland Real Estate Business magazine.