Tue, 06/03/2008 – 10:23 — manystrom

by Michael Nystrom | June 2, 2008I’ve had a minor obsession with Detroit for the past year or so, ever since I learned that one could purchase a single family home there for $5,000 or less. In the world of sky high housing prices in my adopted hometown of Boston, $5,000 wouldn’t be enough for even a down payment on a tiny condo. In my neighborhood, converted duplex units start at $350,000. Apparently there are people willing to pay that much for half a duplex, but I’m not one of them. Needless to say, for countless young people like myself who have been shut out of the inflated housing market, the idea of a home of my own (and several investment properties to boot) for the price of a used car was intriguing.

When I told people of my Detroit obsession, nearly everyone laughed at me. “Why would you want to move there?,” they asked incredulously. I took this as an encouraging sign – after all, any good investor knows that the way to riches is to find value where others simply aren’t looking. Mocking laughter is an especially good sign. So it was with great optimism that when an opportunity for me to visit Detroit arose, I jumped at it. My wife and I were returning from a business trip to Taiwan, and by chance we had a stopover in Detroit.

The first thing that struck me when we got off the plane in Detroit and into our rental car was the price of gas. It was well over $4.00 per gallon – shockingly higher than when we left Boston two weeks prior. Our hotel was in a Detroit suburb called Southfield, which is about 15 miles from Downtown, but jetlagged as we were, we decided to take a peek at the city before doubling back and checking in at the hotel. Speeding down the highway towards the city center, we noticed the miles of sad houses lining the freeway on either side. Many of them – the majority of them – were semi destroyed: Windows broken, roofs collapsed, paint peeling away to expose the bleached gray wood below. Some were just charred skeletons. It was an eerie feeling, zipping down a modern highway that bisected a ghost town.

Digg It!

From my cursory observation, the downtown core was like any booming modern American city, a model of cleanliness. The glass and steel GM Renaissance center rose high above the city, sprouting forth from a gleaming, revitalized river walk park along the Detroit River. The downtown was unique in that the skyline is punctuated by the ornate architecture of well preserved, early 20th century skyscrapers. They just don’t build buildings like those anymore. (Check them out at Forgotten Detroit). This was the Greenzone.

Both the Detroit Lions and Tigers have their sports stadiums downtown, and across the street is the beautifully restored Fox theater. (Beautiful pictures of downtown Detroit here.) The activity gave the downtown a festive, bustling feel – at least on the Tigers game night when we were there. Another bright spot was the Eastern Market – an outdoor meat, produce and local goods market amid brick stalls, old warehouses, antique shops and greasy spoon cafes. On the Saturday morning that we visited, the market was packed and bustling, both with foot traffic and unfortunately, automobile traffic. Parking was a nightmare, with cars idling in the streets and trolling slowly through the market looking for parking.

I suppose I have been spoiled by the excellent public transportation system of Boston. From my home in the leafy suburb of Arlington, I can walk to a subway station in ten minutes, hop the train, read the newspaper for a spell and arrive in the heart of downtown half an hour later. I couldn’t help compare the two cities from a transportation perspective, which in my opinion is fundamental to informing real estate investment decisions in this age of $4 (and likely much higher) gasoline. Unlike Boston, which was settled before cars roamed the streets, Detroit was clearly built for, and centered around the automobile. In contrast to the preponderance of narrow lanes, winding roads, crooked one way streets, and overwhelming congestion that make driving in Boston a nightmare, the streets of Detroit are wide and straight. The main arterial in the city, Woodward Blvd, is a full eight lanes wide – four in either direction. The surprising lack of traffic combined with expertly synced traffic lights made it a pleasure to drive the long, wide open expanses. Stores and restaurants on either side of the wide boulevards were pulled far in to provide ample parking. But this made it daunting for pedestrians. Distances between anywhere on foot – even downtown – were immense, and psychologically exhausting. Simply crossing the street, all eight lanes of it, was an exercise in intimidation.

Between the downtown Green Zone described above, and the cultural center – home to Wayne State University, the public library, and the Detroit Institute of Arts (home of Diego’s fabulous Industry of Detroit as seen in the movie Frida) – was a neighborhood known as Brush Park. It was a distance of perhaps a mile, but seemed so much longer by the lack of anything in between but vacant lots and abandoned houses.

People told me, and it does look like, the area is reviving. We spotted several new developments, and many classic older buildings being converted back into upscale condos. These can be had for a song. But the question that must be considered for an investor is whether real estate purchased today will appreciate or depreciate in the future. While the Downtown core was vibrant, and the cultural center area appeared pleasant, the outskirts of the city was the epitome of depression. Driving northwest out of the city on Grand River Blvd, another empty eight lane arterial, gave me the feeling that I was Will Smith in I Am Legend. Block after block, mile after mile the scenery was the same: empty, abandoned, dilapidated, boarded up, burned out, decaying storefronts and vacant lots. Most of the functioning businesses were streetfront churches or missions. Here and there were sad down-and-outers loitering on the corner, old men wandering in the vacant lots, poor souls in tattered clothes out in the middle of the street, trying to make the crossing from noplace to nowhere. It gave me such a deeply disturbing feeling that I am at a loss to describe. Here stands one of America’s once great cities, a gilded age paradise, home of the automobile manufacturing giants and the dictum that what is good for GM is good for America and of course good for Detroit. Today, the prosperity that once built the sturdy, now vacant high quality brick homes and buildings has evaporated away with America’s manufacturing economy.

A Tale of Two Depots
The greatest feeling of shock and despair came when, driving aimlessly and half lost though downtown, we rounded a corner to find towering before us the abandoned ghost tower of the Michigan Central Depot. Prior to my trip I had heard of this building, had even seen pictures of it on the internet, but nothing prepared me for the feeling I had when this ghostly building suddenly and unexpectedly materialized before our eyes like a pirate ship from the mist. It was sickening, shocking and profoundly disturbing. The building cost $15 million when it was constructed in 1913, designed by the same architects of New York’s Grand Central Terminal.

As New York’s Grand Central bustles, its unfortunate twin, rots away behind a hastily thrown up chain link fence, every single window broken, every facade defaced by graffiti, towering over the nearby and also abandoned old Tiger Stadium like a menacing spirit of prosperity past.

Wikipedia says that the station was built before there was much concern about competition from the automobile. It wasn’t built in the center of the city, but on the outskirts – so most people arrived at the station not by foot, not by car, not by bus, but by street car or by the interurban. Interurban? What the heck is that? Even the vocabulary of the pre-automobile world is being lost to us. The reason that you likely don’t know that word is because you’ve never seen one, and for that you can thank – guess who – General Motors.

In 1921, GM lost $65 million, leading [GM President Alfred P.] Sloan to conclude that the auto market was saturated, that those who desired cars already owned them, and that the only way to increase GM’s sales and restore its profitability was by eliminating its principal rival: electric railways. At the time, 90 percent of all trips were by rail, chiefly electric rail; only one in 10 Americans owned an automobile. There were 1,200 separate electric street and interurban railways, a thriving and profitable industry with 44,000 miles of track, 300,000 employees, 15 billion annual passengers, and $1 billion in income. Virtually every city and town in America of more than 2,500 people had its own electric rail system. Source

Subsequently, according to Wikipedia:

General Motors, Firestone Tire, Standard Oil of California and Phillips Petroleum formed the National City Lines (NCL) holding company, which acquired most streetcar systems throughout the United States, dismantled them, and replaced them with buses in the mid 20th century. After all was said and done, and all the streetcar systems gone, GM was convicted of violating the Sherman Antitrust Act, fined a whopping $5,000. Each executive was ordered to pay a fine of $1 for a conspiracy to force the streetcar systems to buy GM buses instead of other buses (but not for dismantling the streetcar systems, which were also being dismantled by non-NCL owned systems). Source

Still think that what’s good for GM is good for America?

Detroit’s abandoned train station symbolizes the ultimate failure of the automobile, the effects of globalization, America’s throwaway culture, all wrapped up in the second great depression. The recent financial crisis and credit bust has memories of the great depression floating once again through the financial news with regularity. “Worst crisis since the great depression,” we are told. It may or may not seem that way, depending on your vantage point. But ask the millions of residents of the once great industrial cities like Detroit, Cleveland or Pittsburgh, or any of the countless smaller industrial mill and textile towns that time has forgotten (cities like Lawrence, Fitchburg or Lowell in my neighborhood). For many in these cities, the second great depression has long ago settled in and is making itself quite comfortable.

Back on Highway 10 driving out to the suburbs, the dilapidated, burned out, crumbling and abandoned houses stretched on for miles. We exited the freeway to drive though a random neighborhood. It was surprising clean, like any you’d find in your home town. Big trees lined the streets, unique and majestic craftsman brick homes sat back from the curbs, most of them tragically abandoned, boarded up and falling apart, inspiring a feeling of loss and emptiness so deep. After a few miles of this, the suburbs once again grow “prosperous,” which is to say that people can be seen again and the characteristic brick homes give way to nondescript square buildings so typical of suburban America. And in the distance, from the tangle of streetlights and strip malls, sprouting from the flatness of the suburban nowhere, rises a huge tower of glass and steel, the windows tinted gold in the style of the GM renaissance center. Surrounding this behemoth of a building far too large and out of proportion for its surroundings (the headquarters of the struggling Fifth Third Bank), a generic micro economy has sprung up to serve it. A steel and glass hotel where we were staying, strip malls with chain donut and sandwich shops, overpriced cookie-cutter townhouses that looked for the most part empty, a five story parking garage and acres of parking all tossed together in a riot of suburban sprawl.

I could not help but wonder when I saw it – would this gleaming modern office tower one day share the same fate as the Michigan Central Rail Depot? Its placement made no sense. In an era of $4.00 gasoline, with no public transportation, and out in the middle of nowhere, I wouldn’t bet against it. After seeing the that majestic, beautiful rail station abandoned, I wouldn’t bet against permanence of any kind.

But back to the question at hand. Is real estate in Detroit a good investment? The answer to that question is inextricably tied with Detroit’s chances of revival. In order for property values to return, people must flow back to the city in droves. For this to happen, it must be an attractive place to live in work, and this requires a solid foundation of good, well paying jobs. But the Detroit economy remains heavily dependent on the auto industry, and the US auto industry isn’t doing well. On the plane ride over, I read in the WSJ that the auto industry was a bubble. This is what the Detroit FP headline was on the day we arrived. And here is an excellent article from Portfolio magazine about how to revive the Big 3. Unfortunately, it is all about downsizing, cutting more workers, and cutting production. None of this is good for the D. Jobs in this country are disappearing from manufacturing as quickly as jobs disappeared from agriculture during the first great depression. The city must transform its economy.

Second, the lack of public transportation is a huge minus for the city. Without a car, it is nearly impossible to get around and the city is simply huge. There is a tiny tram that serves the downtown core – the “People Mover,” but it doesn’t serve the suburbs, and I didn’t see many buses.

A third strike against the city, and Michigan in general, is the high prison population. According to this article, Michigan’s prison system costs $5 million per day, or $2 billion per year and rising. This is another tragedy and a serious drag on the economy. The opportunity cost of a $2billion prison system is tremendous, especially considering that the state spends more on incarceration than on higher education. If the prison industry is the best growth industry a state can muster, then I’m afraid investors must consider other locations, if only from a moral standpoint.

My conclusion, at least for now, is that as attractive as the prices in Detroit are, there are good reasons why they are low. But please do not consider this as investment advice – I was only in the city for a day and a half, and there is certainly plenty about the city that I do not know. In my online travels, I found this potentially positive development:

Gov. Jennifer Granholm on Monday signed into law a package of incentives that supporters say makes Michigan the most financially attractive state in the nation for movie production. Michigan’s film industry generated about $4 million in economic activity last year. When states such as Louisiana and New Mexico passed incentives similar to those signed Monday, their state film industries grew into $100 million industries.

Perhaps this is the beginning of a revival. Detroit has been on a 50 year downslope. A weaker dollar may allow the city to rise as a manufacturing hub once again. If GM would release the stranglehold on the city, it should build a streetcar system right down Woodward Ave. The street is wide enough that it could accommodate an interurban and still have 6 lanes for traffic. Construction would revitalize the city, and stops along the new tram could become popular destinations.

Detroit still does have great potential, in my opinion – one of the reasons for my minor obsession. One of its great advantages its proximity to fresh water. While the recent boomtowns have sprung up in the sunbelt, one day the residents of Phoenix, Las Vegas, Atlanta and other southern towns may find the climate is both too hot and too dry (as in the taps run dry) to be comfortable. In such an event, Detroit has a large, cheap housing supply, and plenty of fresh water. But for now, the city remains mired in a long, second great depression.

I am deeply interested in any comments or insights readers may have on Detroit, and other rustbelt and sunbelt cities. Please post your comments here. In the future, I will have more reports on my adopted hometown of Boston which I increasingly appreciate is expensive for a reason. If you’d like to be notified, please sign up to my low volume email announcement list.