HEARTLAND SNAPSHOT, AUGUST 2007

Suburban Chicago Industrial Market

Chicago’s industrial market is expected to remain relatively stable throughout the remainder of 2007. Despite a modest deceleration in employment growth this year, absorption levels are forecast to remain healthy through the end of the year, allowing for only a slight uptick in the overall vacancy rate.

However, it is important to note that overall economic growth slowed in the first quarter, and while inflation appears to be under control for now, it continues to fall outside the Federal Reserve’s comfort zone. There are several opposing economic forces at work. Rising job creation and the realignment of business inventories should lend support to economic growth figures through the second quarter, though inflationary pressure from rising unit labor costs and high energy prices remain present. At this point, the worst may be over for the housing market, though the impact of the unwinding subprime market remains to be seen. Short-term rates have remained relatively stable this year. The Fed funds rate has remained unchanged so far at 5.25 percent, as the economic drag created by the housing market has been offset by inflation concerns.

Growth in the Chicago industrial market has been most pronounced in the southwest Interstate 55 Corridor and West Suburban submarkets, where available land is most prevalent. Leasing activity has failed to keep pace with the significant rise in inventory in the SW/I-55 corridor, however, causing this submarket to post the highest vacancy rate of all the Chicagoland submarkets. The West Suburban submarket has fared better, with vacancy well below the metro average. Market-wide, the distribution/warehouse sector will continue to be the primary driver of the region’s industrial market, as wholesale trade is the leading industrial employment sector. Additionally, Chicago is now the third-largest intermodal container handler in the world after Hong Kong and Singapore. The manufacturing sector continues to show weakness, which has dampened occupancy among manufacturing and R&D/flex facilities.

Chicago is one of the predominant industrial markets in the country. Despite some pockets of temporary weakness, sales volume is strong and investor confidence remains high. Underscoring this confidence is the level of out-of-state buyers entering the Chicago market. Out-of-state investors purchased nearly $700 million of industrial properties in 2006, representing 30 percent of total dollar volume. By comparison, just 4 years ago, sales to this investor group totaled only $220 million, or 22 percent of volume. Cap rates have been a draw for out-of-state capital. In 2005, the average cap rate for all industrial properties was 8.2 percent, but significant investor interest last year dropped the average down in the low-7 percent range. While Chicago cap rates remain the lowest in the Midwest, they are still well above industrial cap rates in coastal markets.

Through the end of the year, employment growth is expected to reach 1 percent, down slightly from 1.1 percent in 2006. New supply in the industrial sector will total 12.5 million square feet by year’s end, a slight decline from 2006 and well below the peak of 18 million square feet recorded in 2005. Completions will also outpace absorption, resulting in a slight increase in vacancy to 11.2 percent, up from 10.8 percent in 2006. Asking rents are expected to rise 2.7 percent to $5.56 per square foot, after posting a gain of 3.6 percent in 2006.

The O’Hare and South submarkets will remain the focus for investors this year. While vacancy is highest in the SW/I-55 corridor, improvement is expected, which should draw investor interest.

— Greg Moyer is the senior vice president and managing director in the Chicago office of Marcus & Millichap.


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