CITY HIGHLIGHT, FEBRUARY 2008

CHICAGO CITY HIGHLIGHTS
Jason Berngard, Douglas Imber and Mark Baumhart

Chicago Retail Market

The in-town Chicago retail market should continue on the path of smart development and strong growth in 2008. In the established core urban market, where there is strong density, there are still many great projects underway. Things are slowing down a little in the retail industry nationwide, but the impact shouldn’t really be felt in the city.

In the greener markets outside of Chicago — that are not as densely populated as downtown — there may be projects that were scheduled to break ground this year that may be stalled for a time. Retailers aren’t doing as many deals as they did in the past few years. Big box anchors such as The Home Depot and Target are scaling back their expansion plans, and many other tenants are reducing the amount of openings planned for the year. For some gestating developments in suburban Chicago, it will be difficult to get off the ground without the anchor tenant commitments. If the anchors aren’t signed, it will be difficult to attract the junior boxes and small shop tenants that would fill in the center.

However, it is not as though retailers have closed up shop; scaling back does not mean that there will be no expansions. Retailers are expected to concentrate more on quality sites in established markets, instead of exploring newer markets and grade-B locations, to fulfill goals and meet Wall Street’s standards. Dominick’s, a Chicago-based grocer, is focusing its growth on infill locations in established urban markets with great residential densities that can support a new store from the beginning. Growth will continue, but it will be at a more cautious, diligent pace.

In the city, retail activity is in full swing. There are a number of high-profile luxury retailers on the move along Michigan Avenue and the Gold Coast. Some are opening their second Chicago locations in the Gold Coast, along Oak, Rush and Walnut streets. Others, such as Marc Jacobs in Bucktown, are opening in boutique spaces in emerging neighborhoods. Also, Nanette Lepore opened her first Midwest women’s apparel store in 2,099 square feet at 1623 North Damen Avenue.

Barneys New York is preparing to relocate from its Oak Street location and create a new flagship store on Rush Street. An Ugg store opened on Rush in 2007, and has had very high sales so far. Designers Tory Burch and David Yurman also opened retail stores last year on Walton and Oak streets, respectively. Penguin is opening a new store on Rush Street. The clothing retailer is taking over the Johnny Rocket’s space at $250 per square foot. The 60-story Elysian Hotel is going up between State and Rush streets, and its ground-floor shop space is getting a lot of interest from retailers.

Holsten Real Estate Development Corporation is developing Wilson Yard, a mixed-use project located on Broadway in Chicago. The project will feature a 180,000-square-foot Target, an additional 30,000 square feet of retail and 178 residential units.

Prior to the emergence of the Gold Coast as a retail destination, Michigan Avenue was the only home in Chicago for high-end retailers. The difference in rental rates, which can range from $150 to $400 per square foot in the Gold Coast, has lured some tenants off the avenue and onto other streets. The opportunity to relocate or open a second store away from the high rents and hustle and bustle found on The Magnificent Mile has marked an evolution in the city’s retail landscape. Michigan Avenue is changing with the arrival of a crop of strong, but less luxurious, tenants such as Forever 21 and Garmin, as well as interest from national boxes like Best Buy.

State Street is also undergoing a transition, with two major Joseph Freed & Associates’ projects — 108 North State Street and the Sullivan Center — adding extensive retail to the corridor. Retail tenants at 108 North State Street, the former Block 37 site, include Muvico Entertainment, David Barton Gym and Club Monaco. Expect to see some major national tenants coming to State Street in the near future and making a big splash.

Elsewhere in the city, Centrum Properties’ Roosevelt Collection is poised to dramatically alter the retail environment south of Roosevelt Road. Along with the existing Target, The Home Depot and Whole Foods Market stores on Roosevelt, the mixed-use center’s approximately 400,000 square feet of lifestyle retail will provide product to a market that is grossly underserved.

Brinshore Development and Baum Development are bringing 53rd and Harper, a 25,000-square-foot retail and restaurant project to Chicago’s Hyde Park neighborhood.

Farther south in the city, the historic 53rd Street Building in Hyde Park is being redeveloped by Brinshore Development and Baum Development into a 25,000-square-foot retail and restaurant destination that is expected to anchor Hyde Park’s reenergized 53rd Street District.

In the Uptown neighborhood, Holsten Real Estate Development Corporation’s Wilson Yard is bringing a 180,000-square-foot Target and 178 residences, as well as 30,000 square feet of additional retail space, to the market in the middle of this year.

There is an estimated 10 million square feet of retail product coming online this year, comparable to the amount delivered in 2007. It will be interesting to see if there will be enough demand from retailers to fill all of that space. Downtown Chicago should not be affected as much; projects in strong, dense markets will continue to flourish.

— Jason Berngard is an associate with Chicago-based Baum Realty Group.

Chicago Industrial Market

The Chicago market is feeling a slow down in tenant movements of late, a sign that the industrial sector is at least marginally impacted by the problems in the economy and capital markets. Vacancies in the Chicago metro area industrial sector ended the third quarter of last year at 8.5 percent, which is a 20 basis point increase from mid-year (fourth quarter numbers were not available at press time). As of third quarter 2007, the absorption rate had risen to more than 7.3 million square feet, but the market was off-pace with the 2006 level of 13.1 million square feet. The reason that absorption levels are down is the significant amount of new speculative space that is constantly coming to the market. With more spec developments expected to come online in the months ahead, expect vacancies to continue to rise, as there is currently more than 15 million square feet of industrial product under construction.

In the O’Hare submarket, the pace of new construction of speculative facilities designed to serve the area’s air freight industry is currently outstripping demand. But that doesn’t mean there is no demand; the O’Hare submarket absorbs approximately 1.2 million square feet of new air-freight specialty product a year, according to Mark Baumhart, CCIM, senior vice president of Chicago-based brokerage firm Arthur J. Rogers & Co. There is currently approximately 3.5 million square feet of newly constructed product suited for the air-freight industry that is under construction and is scheduled to come online soon. Based on past absorption figures, this current inventory may be sufficient for the next 3 years of absorption.  Properties with 30-foot ceiling heights and private, fenced-in truck courtyards have a definitive advantage over other projects.

As the larger firms in the air freight industry have acquired some of the mid-scale companies, consolidation has affected demand. Fewer of the mid-sized companies in the 10,000- to 40,000-square-foot range are actively seeking space. Also, these users have yet to adjust to the rental rates — $7.50 per square foot or higher — attached to newer, speculative product.

Baumhart believes that there is concern with the oversupply of new product. One concern is that the success of many of these new projects is dependant on achieving net rental rates north of $8 per square foot. With some recent land sales in excess of $25 per square foot, the cost per building-square-foot for just the land with 40 percent coverage is $62. Because of these high land costs, total project costs can easily exceed $100 per square foot, thus creating the necessity for a developer to generate $8 net rates.  Although a handful of transactions have been completed in excess of $8 per square foot net, the majority of completed transactions are in the $6.50 to $7.25 per square foot range. The near-term success of many of these new developments will be put to the test in 2008, and hopefully the ability to establish a successful base of new tenants willing to pay these rental rates will be accomplished.

Leasing activity in the O’Hare submarket may have slowed down marginally — the marketing time for vacant space is typically 6 months, but can stretch to more than a year for some properties — but the investment market is performing very well. Sales prices are still strong, according to Baumhart, and there is no evidence that demand from investors will wane any time soon.

The O’Hare Modernization Program has been implemented in order to reconfigure O’Hare International Airport’s current runways to a more efficient design. Nippon Express’ Bensenville distribution center was acquired by the program last year, and Nippon has relocated into a 185,000-square-foot build-to-suit at 401 East Touhy Avenue in Des Plaines. A 131,000-square-foot industrial building is now underway at 1502 North 25th Avenue in Melrose Park.

South of the O’Hare submarket, Will County is leading the way for industrial development in Chicagoland. The completion of the Interstate 355 extension was finished late last year, and the new tollway is expected to reduce travel times and the congestion that have plagued the county. There is extensive new development underway in Will County, including a 1.1 million-square-foot distribution center at the CenterPoint Intermodal Center in Elwood, which is nearing completion, and the 1 million-square-foot AMB Minooka Distribution Center, which was recently completed.

Due to the Burlington Northern Santa Fe Intermodal Center, which is adjacent to the CenterPoint Intermodal Center currently underway in Elwood, Will County is seen as the main location for international container shipments in Chicagoland. The area is experiencing this development boom in tandem with the region’s growing status as a premier inland port for international shipping. Macy’s is planning to relocate its business to a new 861,000-square-foot distribution center in Minooka Ridge Business Park from its current location on Diversey Avenue in Chicago. The retailer’s new facility is expected to open in the spring.

Because of the considerable spec development in the submarket, Will County’s vacancy rate increased to 16.4 percent at the end of the third quarter of last year. Average asking lease rates for warehouse and distribution space decreased slightly to $3.44 per square foot from $3.47 per square foot, while R&D/flex space rates climbed to $8.52 per square foot.

In Cook County, the third building in DP Partner’s LogistiCenter at Sauk Village is nearing completion. The 496,000-square-foot building is located at 21751 Railroad Drive in Sauk Village.

Construction continues unabated in the Chicago metro area, even though construction costs have climbed over the past few years due to rising material and fuel costs. This is thanks to strong tenant demand from large regional, national and global corporations seeking warehouse and distribution facilities near intermodal railways. The challenge for the owners and brokers will be to find industrial users for all of the new product hitting the market over the coming months.

Chicago Multifamily Market

Essex Realty Group recently brokered the sale of a multifamily property located at 454 Winnetka in Winnetka, Illinois, just north of Chicago.

Three major trends are currently driving the Chicago multifamily market, according to Douglas Imber, president of Chicago-based multifamily and commercial real estate investment sales firm Essex Realty Group, Inc.

• The multifamily sector expects to benefit from improvements in net incomes, which have steadily increased over the past 12 months. This improvement has been driven by the condominium and single-family woes hampering potential homebuyers. The tightening of the single-family credit markets, along with positive net job growth, has led to a material increase in multifamily net incomes in 2007; most area property owners are forecasting 3 to 6 percent rent growth in Chicago this year.

• Another development that will greatly impact the multifamily market in the coming year is the shifting nature of the supply and demand dynamics in the Chicago multifamily market. From 2001 to 2006, condominium converters primarily drove the demand for multifamily investment properties. For property owners, this was an “easy sale” — net incomes were declining for owners, but prices were rising rapidly thanks to the converters’ bullish opinion of the city’s residential landscape. However, in 2006, condo converters began to scale back their efforts, leaving a void of multifamily property buyers in the market. Because of that, prices softened in 2007, primarily for apartment buildings that were only secondary and tertiary conversion targets. The A-list properties continued to trade at high prices, because so many quality properties had been removed from the rental pool thanks to the recent condo conversion cycle. By mid-2007, with net incomes growing quickly, apartment investors had reentered the Chicago investment market, filling the void left by the converters the previous year.

Currently, the demand for multifamily properties is steady, even if the players have changed in the past year. On the supply side, things are much more interesting. While the approximately $1.8 billion in multifamily investment sales recorded in the city in 2007 is the largest total value of transactions ever recorded in Chicago in one year, there was a precipitous fall in the number of deals closed: there were approximately 217 multifamily sales of more than $1 million in the Windy City in 2007. Approximately $1 billion of the year’s total volume derived from four blockbuster sales — 540 N. State Street; Presidential Towers; 180 N. Jefferson; and 345 East Ohio. In addition to those four sales, one portfolio encompassing 43 transactions occurred in Hyde Park. It was reported as 43 sales, but was really one portfolio. Without these deals, the numbers are whittled down to approximately 170 transactions. Compared to the number of properties valued over $1 million that were sold in previous years (see chart), transaction velocity is way down. While 2007 was a record year in terms of the volume of sales, there were actually far fewer transactions than previous years. What does that mean for pricing?

Essentially, supply is currently down and demand is up. Therefore, prices should hold well, as there will be a lot of competition between investors for well-located, quality multifamily assets. Now that sales velocity has slowed — even though demand is steady — the prospect of selling a multifamily asset is no longer an easy sale, as it makes more sense to hold a property in a market where incomes are growing and prices are not increasing as quickly as they had been.

In the first half of the year, expect to see an increased number of potential condo conversions that have gone through foreclosure and come back onto the market. We’ll have to wait and see what kind of impact those properties have on the investment scene. Will these properties be converted, or be returned to the rental pool?

• The changing dynamics in the capital markets are also being closely watched for any potential impact on the Chicago multifamily sector. There is a real difference in financing for institutional deals and financing for mid-market deals. The conduits have been dislocated, and it has forced institutional deals to rely either on all cash or agency (Fannie Mae or Freddie Mac) financing. So how are the mid-market deals — deals from $1 million to $10 million — getting financed? The banks have been active — having always financed those types of deals — and have not slowed up at all. While the institutional deals have been disrupted, the smaller deals continue to receive attractive bank financing. There has not yet been a liquidity problem in those deals.

While the index rates — the treasuries and LIBOR — have remained low, spreads have increased. This has led to borrowing rates that are slightly higher than the previous year, but by historic measures, overall rates to the borrower are extremely attractive. The question is how long banks will be able to provide liquidity without a fluid secondary market.

— Douglas Imber is president of Chicago-based Essex Realty Group, a firm that focuses on the sale of investment real estate throughout the Chicago metro area, with a strong focus on multifamily sales.

Chicago Office Market

Chicago’s central business district office market has performed well over the past year, with approximately 2.8 million square feet of positive absorption in 2007, which makes it nine quarters in a row with positive absorption. All of the CBD submarkets posted positive absorption in the fourth quarter.

The changes in the capital markets have not yet materially affected tenant decisions, but some investment sales transactions have been held up due to the problems in the financial market. Buyers are having to adjust to longer lead times when obtaining loans. While before, lenders would finance highly leveraged deals with 90 to 100 percent financing, buyers are now having to produce 20 to 30 precent of the equity to secure financing.

Despite the slowdown, investors are still actively acquiring office product in the CBD. While fewer properties were traded in 2007 than in 2008, year-to-year sales volume through the third quarter of 2007 increased dramatically to $7.9 billion from $6.9 billion in 2006, according to Grubb & Ellis.

Rental rates are up thanks to strong tenant demand and increased deal velocity through much of 2007. Average gross asking rates have increase more than $2 over the past year for Class A space, and Class B properties have had rates increase by almost $2, as well.

Hines is preparing to develop Chicago’s newest office skyscraper, 200 North Riverside Plaza in the West Loop submarket. William Blair & Co. has signed a letter of intent to anchor the 50-story, 1.1 million-square-foot tower.

Aside from the office component of 108 North State Street, nearly all of the office buildings currently under construction will be complete by mid-2009, which will pose a challenge for the market when the anchor tenants vacate their current space for the new buildings. It will be interesting to see what kind of tenants fill the backspace in the older properties. Large tenant movements have happend before, and the market has been able to absorb the available square footage.

The fact that very little space will be delivered before mid-2009 will help keep the market fairly strong over the next 12 to 18 months, but expect rent growth to slow down when all of the new space comes online next year.

Baum Development is building the Green Exchange at 2545 West Diversey Avenue in Chicago. It will be the largest sustainable business community, and be occupied by more than 100 eco-friendly businesses.

One unique development currently underway is Baum Development’s Green Exchange. The 250,000-square foot property is being built on Diversey Avenue in Chicago’s Logan Square neighborhood. The goal of the building is to bring the green movement from the niche to the mainstream. The building is conceived as a co-op community where eco-friendly and green businesses can flourish. It is expected to open by mid-year.

The story in the suburban market is not as good as CBD. Demand is much higher downtown, and the Northwest and other suburban submarkets have felt the impact of the subprime mortgage problems through the loss of several mortage companies and financial services tenants.

For 2007, the suburban market posted a negative net absoption of 489,274 square feet. However, as of the third quarter of last year, landlords still had the upper hand across the northern submarkets, especially along Lake Cook Road. Rents have risen over the past few quarters and landlords are less likely to offer as much in tenant concessions.

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