Economist's Commentary: October 23, 2008
Microcosm Michigan
By Manisha Singh, Research Economist
The U.S. economy is likely going into a recession. Michigan, however, has been in a recession for the past seven years. Though improbable, a deep prolonged national recession may lead to a business cycle like the one Michigan is experiencing.
For the last seven years Michigan has been in the forefront of economic news because of its atypical performance. The national economy, supported by most of the states economies, though short lived, experienced an upswing after the 2001 recession before slipping down again in the last quarter of 2007 owing to the credit crisis. Michigan, however, was not a part of this temporary recuperation.
A lot of responsibility for this uncharacteristic performance is placed on the state's lengthy dependence on the manufacturing sector in general and the Big Three (Chrysler, Ford and GM) in particular, as well as the absence of industrial diversification. The clustering of auto manufacturing and related business brought with them an abundance of jobs and prosperity to the state and especially in the Detroit metropolitan statistical area in the past. However, heavy reliance on these industries has taken a toll on the domestic economy since the 2001 recession. The unemployment rate has recently been the highest for the last several years; the annual rate went from 3.7 percent in 2000 to 8.9 percent as of August 2008.
Besides manufacturing, large portions of the state's service-providing industry (which include professional, administrative and management jobs) are also employed by the Big Three, which explains the loss of 82,000 (21.6 percent of total jobs loss) service sector jobs. Scrutinizing the components of the service sector it is found that 76 percent of these losses are in the retail trade business and 42 percent comes from professional and business services. The multiplier effect of one manufacturing job is sizable. Many restaurants and retail businesses can feel the effect of the shrinking manufacturing sector.
Plant closures, white and blue collared layoff, high unemployment rate, high foreclosure rate and falling income have plagued the economic trend in Michigan, especially the Detroit region, for the last seven years. From August 2001 to August 2008 Michigan lost 379,800 jobs; 56 percent of this is attributed to Detroit. The lackluster performance of the employment situation in Michigan along with the liquidity crisis influences the other major economic indicators like weak real estate market. Business and residents are fleeing the epicenter of economic disaster and moving out of the state for better opportunities, are flooding the market place with vacant commercial and residential properties.
Foreclosure rates and Unemployment rate for State of Michigan from 2000-2008
Data Source: Mortgage Bankers association and Bureau of Labor Statistics.
In Michigan seasonally adjusted total home sales (single family, condos and apartments) decreased by 21.3 percent or 38,000 units from the first to the second quarter of 2008. Michigan's total sales for the year 2007 was 172.4, which was 10,000 units lower than 2006 and 36,200 lower than 2005. New house building permits plummeted steeply over the last five years from 51486 units in 2003 to 18690 in 2007. In August of 2008 permits for new home construction further dropped to 1761 units' year-to-date showing weakening demand for homes. After reaching its peak in 2005 third quarter of dollar 172,100 the median house prices for the Detroit metropolitan statistical area dropped drastically to 133,300 in the fourth quarter of 2007 (which is the most recent data available) to the 1998 levels.
The vacancy rate for multifamily housing in Detroit increased to an average of 7.2 percent per quarter between 2001 fourth quarter and first quarter 2006 from 4.8 percent during the prior period. This increased vacancy coincides with an increase in home sales in Michigan and increased mortgage applications nationally. This indicates an amplified demand for home ownership as people take advantage of low mortgage rates which fluctuated between 5.1 to 7.2 percent during this period, which was much lower than the year 2000 rates of 7.7 percent. Net completion of new multifamily properties remained high through this period at an average of 747,760 square feet per quarter as compared to 543,333 square feet in the first three quarters of 2001 and 490,300 square feet per quarter from 2006 through 2008 second quarter. Rent was contained throughout the last seven years.
On the commercial side, a weak manufacturing sector affects the performance of industrial properties while the service sector weakness influences the retail and office properties. This flux in inventory has put immense downward pressure on prices. Due to data constraints, for analysis purposes, we use Detroit as a proxy for the state of Michigan.
The completion of new office properties in the Detroit market went from a healthy quarterly average of 429,000 square feet in 2000 to the slower pace of 263,400 square feet between 2002 and 2007. The average fell to 132,800 from 2007 through the second quarter of 2008. The vacancy rate almost doubled from first quarter 2001 to second quarter 2008 from 10.9 percent to 20.4 percent. The economic turmoil was also reflected in the Net absorption rate which picked up slightly during 2004 to 2007 period to a total of 2941 thousand square feet and plummeted again by 676 thousand square feet in the first half of 2008. Shadow vacancy would be a good reflection of the depressing state of the office properties as the Big Three auto manufacturers still maintain their office property despite having a low job to office space ratio, while employers like Comerica bank and Pfizer have contributed to the increased supply.
The decrease in market share of domestic auto companies has resulted in multiple plant closing and extended temporary layoff. The effect of these adverse movements in Michigan economy is reflected in the industry property data. From second quarter 2001 to second quarter 2008, the vacancy rate increased by 8.2 percent to a new high of 17.4 percent. The completion of new projects has slowed down significantly especially since the first quarter of 2006. The quarterly average of new completions is 579,300 square feet for the period between 2006 (first quarter) to 2008 (second quarter). The average new completion in the years 2001 and 2002 was 1607,000 square feet per quarter thus showing the accelerated rate at which new construction of industrial properties was seized.
The tightening income, weak employment scene and increased inflation in addition to anxiety about the future and insecurities about the local economy have made the struggle tougher for the middle income families. The retail industry in Michigan has taken a large blow as the adverse economic conditions continue to exist. The trickledown effect of these economic woes has caused a lot of small businesses to shut down, but the larger retailers are not immune to these either. From 2001 through 2006 net absorption of retail shopping center properties was at an averagely rate of 116,000 square feet per quarter and dropped to an quarterly average of -206,000 from first quarter of 2007 to second quarter 2008. The vacancy rate shows a steep increase of 7 percent, from the first quarter of 2006 to 2008 second quarter, to 17.2 percent. Vacancy rate from 2004 through 2007 was the lowest at an average quarterly rate of 12.6 percent. The average vacancy rate for the analysis period is 0.8 percent.
The distress faced by local economies in the Midwest like the state of Michigan and especially Detroit are structural and not expected to follow the trends of rest of the nation. Policies need to be put in place to make the state attractive to business investors and help retain skilled labor market participants and the local population. The bailout stimulus offered to the auto manufacturers on 29th of September is expected to stop it from bleeding more jobs and facilitate plans for expansion. The forecast for the commercial properties in Michigan looks very encouraging as appropriate steps are taken to increase liquidity and augment borrowing. Increased activity is expected from investors and developers who recognize that the value of real estate in this local market can go nowhere but up. In the meantime, the housing stimulus offering incentives to first time home buyers and contained mortgage rates are expected to boost the residential real estate market.
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