CITY HIGHLIGHT, FEBRUARY 2007

SUBURBAN CHICAGO CITY HIGHLIGHTS
Tyler Quast, Greg Moyer, Larry Johnson and John Homsher

Suburban Chicago Retail Market

Last year, retailers in suburban Chicago followed in Wal-Mart’s wake as the retail giant expanded across Chicagoland. This trend will continue in 2007, but now retailers are connecting with the new surge of mixed-use developments that combine retail with office, residential and hotel uses. These mixed-use properties, a trend in both urban and suburban settings, are essentially eliminating any lag time in bringing retail amenities to their new population of office workers or residents.

In 2006, much of the retail development in metro Chicago centered on big-box anchors, particularly Wal-Mart Supercenters. Additionally, Wal-Mart went forward with its first store inside the Chicago city limits after Mayor Richard Daley vetoed the proposed big box living wage ordinance.

Another retailer, JC Penney, has launched a new phase of activity, rolling out a new stand-alone store concept and taking over vacant retail locations across the area. Additionally, a couple of new grocery concepts have made inroads, including Grandmart International and Ultra Foods. Menard’s, Lowe’s Home Improvement Warehouse and The Home Depot remain active, while the expansion of bank branches has slowed significantly.

There are a number of significant new shopping destinations under development in suburban Chicago. The Promenade of Bolingbrook, from Forest City Enterprises, features IKEA, Bass Pro Shops Outdoor World and Macy’s — all significant traffic drivers — and is expected to create a major regional hub along the newly completed Interstate 355 extension.

Several new lifestyle centers also are in the works, including the Arboretum of South Barrington from the Jaffe Cos., the Yorktown Mall expansion/redevelopment and the Burr Ridge Town Center, all currently under construction. Similar projects are proposed in Lindenhurst and Joliet, Illinois, as well as in Highland, Indiana.

The area’s major players in the development market are staying busy with projects throughout the metro.  Rubloff Development Group is working on several power centers, including North Aurora Towne Center, among others in the Chicago suburbs of Romeoville, Machesney Park and Huntley. McVickers Development is developing a number of Wal-Mart Supercenter-anchored projects in Montgomery, New Lenox and McCook, Illinois, among other locations. Mid-America Development Partners is very active, with a host of mixed-use developments in the works throughout the market. Location Finders International has been actively investing in land, and developing small shop space, and bank and pad sites; V-Land Corporation is developing a host of projects — both small and large — across the Chicago metro area, including its exciting Beverly Development located at 95th and Western;  Bradford Real Estate is active with big box, mid-sized box and small-shop development throughout the metro area; Harlem Irving is working on projects ranging from urban mixed-use to suburban power center development; and Joseph Freed & Associates is actively building mixed-use communities and regional shopping destinations in Chicagoland and throughout the Midwest.

In recent years, Chicago has experienced an influx of boutique movie theaters, including Florida-based Muvico, a fast-growing chain of state-of-the-art megaplexes, and one of several new cinema operators that incorporate dining and entertainment into the movie-viewing experience. Kerasotes, a theater chain with a considerable presence in the market, has also expanded aggressively of late.

2006 saw few major leases, but JC Penney and Wal-Mart made a significant impact just for the sheer volume of their deals. In a similar vein, Starbucks recently announced an aggressive expansion plan to add as many as 250 Chicago-area stores during the next 5 years and Dunkin’ Donuts has also announced aggressive expansion plans.

Vacancy rates overall for the suburban Chicago retail sector are running a little under 8 percent. Rental rates range from $20 to $23 on average; however, in a region the size of metropolitan Chicago, individual submarkets vary widely.

With the Sullivan Center opening in late 2007 or early 2008, the area surrounding the I-355 extension from Interstate 55 to Interstate 80 and the State Street retail corridor downtown will continue to be growth areas. Much of the new Wal-Mart Supercenter-anchored development is occurring in the collar counties, reflecting the retailer’s expansion strategy.

Market watchers should continue to track the new growth, movement and strategy of major anchors such as Wal-Mart, Target, JC Penney, The Home Depot, Lowe’s and Menard’s. Wal-Mart’s expansion within the Chicago city limits will be especially interesting. New expansion areas include the Route 47 corridor northwest of Chicago, the underserved segments of the city’s Southside and the new stretch of I-355. The continued growth of northwest Indiana will also likely benefit retail developers as Chicago’s reach stretches further south and west.

— Tyler Quast is an executive vice president and principal with Zifkin Realty & Development in Chicago.

Suburban Chicago Multifamily Market

Demand for apartment properties in suburban Chicago will continue to increase this year, as local employers are expected to add jobs at a relatively strong rate for the fourth consecutive year. As a result, multifamily investors will pursue Class A, B and C suburban assets, particularly in upscale neighborhoods, throughout 2007.

Looking at rental rate growth, the north suburban submarkets should outperform the rest of the city, as condo converters have drastically depleted competitive stock. Overall, suburban rents are expected to gain 4.1 percent to $986 per month. The greatest improvements are expected in the suburban Downers Grove and Woodridge, Illinois, submarkets, both of which have above-average vacancy.

Projected apartment completions in the Chicago metropolitan statistical area (MSA) are down compared to 2006, and the current rate of supply growth will not replenish stock recently removed for conversion for some time. More than 13,000 apartments have been converted throughout Chicagoland since the beginning of 2004, and the resulting 2.9 percent reduction in inventory has supported significant improvements in vacancy. For the most part, new apartment development has primarily occurred in the cities of Oak Park and Glendale Heights, Illinois.

In terms of condominium conversion activity, the Chicago suburbs are expected to follow the national trend and continue to slow in 2007. Suburban conversions in 2006 totaled an estimated 2,800 units, down from 3,660 units in 2005. In fact, up to 40 percent of the properties converted to condos in 2006 were not sold, as the market continues to soften.

Chicago’s dynamic apartment market presents distinct investment opportunities across property classes. For example, luxury apartments are expected to offer strong opportunities for income growth in the months ahead, due to recent inventory reductions. Suburban Class B and C assets, particularly those in quality neighborhoods, will continue to attract investors due to their stable tenancies and consistent rent growth. The long-term prospects for the Class B and C sectors will remain promising, as high rents in the upper-tier segment of the market and the high cost of for-sale housing continue to expand the renter pool.

Due to positive job growth and sound operating fundamentals, Chicago’s suburban investment sales market is expected to remain very healthy this year. Converters will make up a smaller percentage of the buyer pool this year compared with 2006. While conversion demand will not evaporate altogether, price points will be such that buyers can achieve positive returns as either operators or converters.

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

Suburban Chicago Industrial Market

Metropolitan Chicago houses the nation’s Number 1 industrial market, with an industrial base exceeding more than 1 billion square feet. The massive metro Chicago market surpasses the combined markets of Philadelphia, Minneapolis/St. Paul, Phoenix and Las Vegas. Overall, Chicago’s industrial base outpaces Los Angeles, the nation’s second largest market, by 152 million square feet and surpasses North and Central New Jersey, the nation’s Number 3 market, by 287 million square feet.

Historically known as a manufacturing-driven economy — with more than 5,912 manufacturing buildings totaling 412 million square feet — today, Chicago is the world’s third-largest intermodal container handler after Hong Kong and Singapore. Despite a recent resurgence by many manufacturing firms, logistics-related expansion will fuel industrial growth in 2007, and well into the future. Appropriately, REITs, developers and institutions have adequately positioned their holdings for this dynamic by acquiring strategic locations in metro Chicago, as well as building and acquiring dominant ownership positions of Chicagoland’s 7,039 warehouse/distribution facilities.

One of the most significant trends to note in 2006 has been new construction, specifically build-to-suit versus speculative building. New supply totaling 5.1 million square feet was delivered during the fourth quarter of last year, of which 3 million square feet was build-to-suit and 2.1 million square feet was speculative. In the Chicago metro area, 12.5 million square feet of industrial product was under construction at the end of 2006. Year-to-date construction starts totaled 19 million square feet, of which 4.8 million square feet was build-to-suits and 14.2 million square feet was speculative. This is by far the largest amount of new construction starts seen in the Chicago industrial market in more than 10 years. Speculative construction accounted for 74.6 percent of all construction starts in 2006, which truly demonstrates developers’ confidence in the Chicago industrial market.

The availability rate for the Chicago area rose for the only time in 2006 during the third quarter, coming in at 9.1 percent. The increase was due in large part to significant new construction deliveries, of which more than half of the facilities were vacant. The highest availability rates at year-end were seen in the McHenry County and Kenosha/Racine Counties submarkets, at 14.8 percent and 13.5 percent, respectively. The year ended with an availability rate of 8.8 percent, which proved that demand has been able to keep up with the brisk pace of construction.

After posting more than 2 million square feet of positive net absorption during the first quarter, 6.3 million square feet during the second quarter, 3.7 million square feet during the third quarter, and 6.1 million square feet in the fourth quarter, 2006 ended with more than 18.1 million square feet of positive net absorption in the Chicago area. The Joliet, Illinois, industrial market exhibited the most significant amount of positive net absorption, with 5.2 million square feet absorbed. 

With a population base of approximately 8 million individuals; a workforce of more than 4 million employees; a balanced and diverse economy; strong interstate, rail, air and water infrastructure; powerful financial capabilities; and 50 percent of the nation accessible within a day’s drive, metro Chicago is poised for immense growth opportunities in the coming years. Capitalizing on opportunity — be it the redevelopment of an older inefficient property, repositioning of existing property or development of land into business-friendly commercial parks — will be key to success for the local real estate community.

— Larry Johnson is a first vice president with CB Richard Ellis in Chicago.Suburban

Chicago Office Market

Economic conditions and real estate operating fundamentals in Chicago’s suburban office market continue to improve. Chicagoland’s employment base is expanding at a strong pace: office employment currently accounts for approximately 26 percent of the total jobs in the metro area. Owners and investors are optimistic that fundamentals will soon begin to improve at a faster pace as a result of this strong employment growth. Marketwide vacancy continues to decline, while effective rents are starting to show growth. Suburban assets are generally outperforming properties in the central business district (CBD).

As office market fundamentals continue to improve, developers are increasing construction activity, with several years’ worth of projects already in the pipeline across Chicagoland. An estimated 40 percent of the space under development has not been leased, ensuring negotiating leverage for prospective tenants that will likely moderate rent growth going forward.

Despite the predictions for increases in suburban vacancy rates, strong demand for office space pushed overall vacancy rates down in the Chicago metro area in 2006. The overall vacancy rate plummeted 150 basis points, from 18.7 percent at year-end 2005 to 17.2 percent at the end of 2006. Asking rents in the Chicago metro area rose from $24.81 per square foot in 2005 to $25.49 per square foot at year-end 2006. Effective rents increased 87 cents to $20.88 per square foot between fourth-quarter 2005 and fourth-quarter 2006.

The north suburbs posted a healthy 17 percent vacancy rate at mid-year 2006, a 20 basis point drop from the previous year. Effective rents in this submarket inched up 0.1 percent to $17.47 per square foot at mid-year 2006. Although vacancy remains relatively high in the O’Hare International Airport area, rental rates remain quite high, coming in at nearly $18.50 per square foot.

One particular asset class — healthcare real estate — has made significant gains during the past year and demand for this property type will remain strong in 2007. Developers were expected to bring 800,000 square feet of medical office space online by January, a 1 percent addition to medical office stock. The median sales price for the 12 months trailing the second quarter of 2006 reached $131 per square foot, down 15 percent from one year ago. Investors can take advantage of the downward trend to acquire medical assets that will generate higher rates of return based on the lower relative prices.

Chicago offers investors interested in all types of office product access to a world-class business community, but with higher cap rates and lower prices than other major markets. These characteristics will drive sales activity, as institutional capital moves from overheated East and West coast cities into the Chicagoland market, where higher cap rates can more efficiently absorb increased borrowing costs. With a considerable amount of new office inventory coming online during the next several years, assets with leases that are set to expire will feel pressure to minimize rent increases in order to compete with new construction and retain tenants.

Currently, the median office investment sales price for office properties in the Chicago MSA is $152 per square foot. However, with revenue drivers showing improvement for consecutive quarters, buyers are gaining confidence in the market and are willing to pay more for Chicagoland office assets. Additional price increases are expected this year, as both the suburbs and the CBD offer greater opportunity for sustainable cash flow than comparable coastal cities, where prices are significantly higher.

Moving into 2007, the Chicago suburban office markets are poised for additional growth. New supply in the planning stages will not impact the market next year, but could push vacancies upward in the next 2 or 3 years. Even though some higher-profile downtown office transactions grabbed headlines in 2006, well-located suburban assets, particularly under 50,000 square feet, will remain in demand among both investors and office users.

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

Chicago Office Development On the Rise

The suburban office market continued to show signs of strengthening in 2006 with overall vacancy rates declining and speculative office construction returning to the market. Real estate developers are increasing their land holdings and beginning to market proposed office buildings in the major suburban submarkets with several speculative office buildings currently under construction. 

The big news in suburban office construction in 2006 was the variety and amount of small office buildings being built in the 7,000 to 50,000-square-foot range. Many of these projects are being developed as single-story office condominiums, with anywhere from one to eight buildings per site on average. The office condos are typically divisible to 2,000-square-foot units and can sell from $150 to $250 per square foot. These developments are taking place in non-traditional office markets such as Frankfort, Mokena, Bolingbrook, Mount Prospect and Crystal Lake, Illinois.

Hamilton Partners captured HSBC as the sole tenant of Phase II of Woodland Falls in Mettawa, Illinois. This six-story, 445,000-square-foot building should be complete late this year. Across Interstate 294 in Lake Forest, Duke Realty Corporation has announced its 120,000-square-foot spec building, Cadence at Conway Park located at 300 N. Field Drive. Prior to breaking ground, Duke secured Hospria as the sole tenant and increased the building size to 138,000 square feet.

Also in Lake Forest, Opus North is currently constructing its second building at Opus Landmark of Lake Forest. The 160,000-square-foot building should be complete in the third quarter, with net asking rents of $18.50 to $19 per square foot.

In the East-West Tollway Corridor, Calamos is constructing City Gate Centre I, a 213,000-square-foot office complex adjacent to its corporate headquarters in Naperville. Opus North has also broken ground on its last site within Highland Landmarks in Downers Grove, Illinois. Highland Landmark V is a 250,000-square-foot office building that will feature net asking rents of approximately $19.50 per square foot. The Alter Group is also marketing its Corridors Four office building, a 225,000-square-foot office complex that has not yet broken ground.

In the O’Hare market the only new construction in 2006 was Duke’s 71,000-square-foot build-to-suit in Rosemont for the U.S. Customs Department. Due to the scarcity of land for office development around the airport, developers are becoming creative in identifying land parcels for future office development.

Duke recently purchased a vacant industrial distribution building at I-294 and Balmoral in Rosemont. The company has demolished the building leaving a 16-acre site fronting on I-294 where it plans to develop a three-building office complex totaling 550,000 square feet.

Just north of O’Hare Airport, Development Resources acquired a high-rise and low-rise hotel site. The company has plans to redevelop the high-rise and rebrand it as a Holiday Inn Express hotel. The low-rise portion was demolished and cleared, which leaves a 23-acre site for redevelopment. Marketed as O’Hare Corporate Campus, the site can accommodate five buildings totaling approximately 700,000 square feet with visibility from Interstate 90.  The company is presently marketing its first six-story office building containing 231,000 square feet. 

With suburban office markets continuing to experience positive space absorption, declining vacancy rates and continued job growth, the prospects look good for additional office development in 2007.

— John R. Homsher is principal of Podolsky Northstar CORFAC International, based in Riverwoods, Illinois.



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