CITY HIGHLIGHT, FEBRUARY 2009

CHICAGO CITY HIGHLIGHTS

Chicago Office Market

The previous year was clearly a tale of two cities for the downtown Chicago office market. While the economy slowed in the first three quarters of 2008 from the strong growth seen during the stretch from 2005 to 2007, absorption was still positive at 1.2 million square feet through the third quarter of 2008. Leasing velocity was steady, and a number of developers were competing for large anchor tenants to start new buildings for deliveries in 2011 or beyond. A slowing national economy and availability of debt financing were concerns, but many companies were moving forward with commitments to grow their businesses and lease office space.

With the fallout from the subprime loan defaults, financial service firm failures and stock market slide that took prominence in September, the marketplace truly took a step back to pause and reassess the future. During the fourth quarter of 2008, many businesses delayed their plans to expand or renew leases, developers postponed plans to start new construction, and the lack of financing for new construction or loans to buy or refinance buildings was dramatic. Chicago’s central business district (CBD) office market suffered slight negative absorption of 214,000 square feet in the fourth quarter, with more attrition anticipated to come this year.

Assessing the office sector outlook for this year and beyond, there are still many positives for the Chicago CBD, and a number of favorable factors influencing this market’s ability to respond as the recessionary cycle progresses, and ultimately the national economic picture improves.

Among these positive indicators is the fact that, while 4.5 million square feet of office space is under construction in the CBD currently, those buildings are already 84 percent preleased. With no recent construction starts, and new projects delayed due to the capital markets, it is likely that no additional new buildings will be available until late 2011 at the earliest.

Chicago’s centralized location, 24-hour CBD, access to transportation, educated workforce and diversified business base put the city in a position to recover quickly as the economy stabilizes and improves. As of fourth quarter 2008, vacancy in the CBD was 9.3 percent on a direct basis and 10.5 percent inclusive of sublease space, down from 10 and 11 percent, respectively, from year-end 2007. These vacancy levels reflect well compared against historical vacancy statistics.

The Chicago CBD has also seen a reverse trend of the migration of firms to suburban Chicago that occurred during the 1990s. Firms such as United Airlines, BP and Fifth Third Bank have relocated from suburban Chicago to the CBD in recent years. Chicago has also won new headquarters relocations from other cities, including Boeing and MillerCoors. Its centralized location makes Chicago a preferred destination for many international firms’ U.S. headquarters and for regional offices of major corporations.

Finally, new President Barack Obama has put Chicago and many of its business and political leaders in a position of national influence within Washington, D.C. This also bodes well for Chicago’s chances in competing to win the 2016 Olympics, which will be awarded in October. An Olympic win would bring billions of dollars of new investment, development and infrastructure projects to the city.

The new administration is planning aggressive steps to put the economy back on its feet, with an economic stimulus package and injection of capital into the banking and financial services industries to make funds available to corporations, owners and developers. The lack of liquidity in the system has been a major issue in the industry slowdown, and as capital becomes available, improvement should begin to be seen.

This year, the industry will navigate over a bumpy road, as real estate cycles typically lag economic cycles, and things will get worse before they begin to improve. Despite the recessionary conditions in the national economy today, Chicago is well positioned to ride out the current challenges. Look for improvement to be seen in 2010 and beyond, once the national economy begins to respond to the increased availability of inexpensive capital, and the effect of the stimulus and incentive programs currently being implemented begin to bear fruit.

— Tamara Kos, based in Transwestern’s Chicago office, is an executive vice president specializing in commercial office leasing and investment sales.

Chicago Multifamily Market

The Chicago multifamily market can be characterized as being concerned, but trying to be hopeful and optimistic. Most clients are looking in 2009 to manage and optimize occupancy, as opposed to driving the rent roll up and increasing rental rates. A number of clients that manage larger portfolios have already sent out notices for spring renewals stating that there will be no rent increases. Certainly to the extent that different submarkets can absorb a rent increase, owners will seek to get them, but such increases will be modest. There is a growing concern about how correlated the apartment sector is to employment, and despite very good demographics for the rental market and despite the fact that there is an obvious and substantial reduction in home buying, both of which would benefit the rental market, the unemployment issue seems to be mitigating those gains.

In investment sales, Essex Realty Group is working primarily with three major groups of buyers at this time: first, there are a variety of lenders working to sell foreclosed conversion projects. Most of those properties, if not all, are reverting back to rental. The second group is developers that, in addition to their construction or conversion activities, have purchased income-producing properties to provide some diversification. Now that they need additional working capital to support their struggling development projects, and since it is much more difficult to refinance cash out of these investments, developers are selling rather than refinancing to raise capital. The third group of sellers that we seem to keep running into is the sellers that leave the market for everyday reasons; there are always owners that simply want to dispose of their property. Activity is equally divided among the three groups.

It is no secret that the lenders are scrutinizing acquisitions much more carefully. For assets that either have a high vacancy or substantial deferred maintenance, where there is a real need for capital improvement, the lenders are being particularly critical, and are either taking a pass entirely or making very low loan-to-value commitments. On the properties that are stabilized and in reasonably good condition, there are still ample lenders willing to loan at typically the 1.2 debt service coverage ratio, which in real dollars translates into 65 to 70 percent loan-to-value commitment. Most lenders are not giving 80 percent financing anymore; consequently, when you are looking at buying these deals – the third piece of the puzzle – buyers have to put more money down. And, because the loan-to-value ratios are lower and both the perceived and actual risk that buyers are taking on is higher, they expect a better cap rate now than they would have 12 months ago.

Between buyers and sellers, there is still a material spread between bid and ask for a variety of reasons. Over the last 8 to 10 years, as values were going up, sellers were inclined to be more aggressive, so there was a natural spread. They had to push the asking price upward to see where the market would go. Now that we are in a period of price erosion, sellers are slow to lower the prices and instead want to see what the market will conform to.

There has not been as much price erosion in Chicago’s prime locations. Deals in those markets sold 3 years ago at a 5 percent cap rate. Implicit in a low cap rate is lower volatility. When buyers move to secondary and tertiary markets and properties, the values dropped off fairly steeply. Implicit in somebody buying at a 7.5 percent cap rate 2 or 3 years ago was greater volatility and risk, and now those investors are experiencing that volatility.

The velocity of transactions continued to be strong in the fourth quarter of last year. There was a fair amount of business, but a lot of it came from banks or developers. If the economy erodes further, or fails to stabilize, then there will likely be an increase in transaction velocity. If this occurs, several things will follow: First, cash flow from operations are going to suffer because of high vacancy. Whenever that happens, there is an increase in the number of transactions. Second, if the economy continues to erode further, many owners will opt to trade in bricks for cash, because they value or need the liquidity.

The Lincoln Park/Lakeview neighborhoods, as well the core suburban markets, have done well because there is a flight to quality, which often happens in an economic downturn. If an investor has some cash, and wants to place it somewhere safely, those are good areas in which to buy. Additionally, in some of the secondary or tertiary locations, like a Rogers Park, a South Shore or a Des Plaines-type of suburban location, investors can get much better pricing today buying there than they could have any time in the last couple of years. If someone is more opportunistic, those markets have received good interest as well.

— Douglas Imber is president of Chicago-based Essex Realty Group.

Chicago Industrial Market

BRIDGE DEVELOPMENT PARTNERS REMAINS ACTIVE IN ‘09

Bridge Development Partners is has not let the economic challenges facing commercial real estate slow it down in 2009. The Chicago-based industrial and office developer has a number of projects moving forward in various suburban submarkets across Chicagoland.

In partnership with Globe Corporation, Bridge is developing two warehouse/distribution facilities totaling 383,305 square feet in Woodridge, Illinois. Located along the Interstate 55 corridor at the corner of Davey and Lemont roads in the southwest suburb, the 19-acre project will be known as Bridge Point Woodridge. The property will target users seeking facilities between 15,000 to 50,000 square feet. The buildings, totaling 264,183 square feet and 119,122 square feet, respectively,  feature 30-foot ceiling heights and pre-cast concrete with an exterior glass façade. Completion is expected in the first quarter of the year.

In Lincolnshire, Illinois, Bridge and Globe broke ground last fall for 555 Corporate Center, a 162,000-square-foot, four-story speculative office building. When complete in the fourth quarter, the facility will be the only Class A, LEED-certified office building in Lake County, according to Bridge principal Anthony Pricco. The building will be constructed by Premier Design + Build Group, which also is working on Bridge Point Woodridge. It will feature architectural pre-cast and glass, with 40,000-square-foot floorplates. The 555 Corporate Center is located on a 12-acre site at Milwaukee Avenue and Aptakisic Road just north of Bridge’s Aptakisic Creek Corporate Park in Buffalo Grove, Illinois. That 508,000-square-foot industrial park was completed last summer, and features two new buildings totaling 188,215 and 146,850 square feet, as well as a retrofitted 173,000-square-foot building. Aptakisic Creek Corporate Park was developed in partnership with San Francisco-based McMorgan & Co.

West of Chicago, Bridge partnered with Wrightwood Capital in 2007 and 2008 to complete Park Butterfield, which features two 175,000-square-foot spec industrial buildings and 3.5 acres  for retail development.

By locating on or near Chicagoland’s major freight corridors, Bridge has managed to continue building commercial space in the face of serious economic challenges, and can be expected to deliver more space in the near future, despite the conditions.

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