By Timothy Blum, Pat Gallagher, Robert Habeeb, Bill Montana and Chris Sackley

Chicago Apartment Market


Successful investing in any asset class depends on realistic expectations of return. The Chicago apartment market is no different. Heading into 2012, fresh off a banner year in 2011, it’s never been more evident that that’s the case. Last year was an historic year for multifamily transaction volume in the city of Chicago. Transaction volume in total dollars modestly surpassed the previous high-water mark of $1.3 billion set in 2007, with capitalization rates reaching as low as 3.3 percent. On average, cap rates hovered around 5.2 percent for the year.

By comparison, transaction volume in total dollars in suburban Chicago was approximately $490 million, similar to 2003 levels and well below the $1.2 billion achieved in 2007. Cap rates on suburban apartment properties vary widely by submarket, but on average were 6.4 percent for the year.


While the city modestly surpassed the 2007 dollar volume last year by about $200 million, the suburban market at 18 transactions is well below the peak of 39 transactions of 2007, and slightly below the 15-year annual average of 22 transactions. The scatter plot compares capitalization rates by year built for years 2007 and 2011. One takeaway from the graph is the divergence in rates between newer and older properties in 2011 versus 2007.

Investors catch their breath

Unlike typical years, transaction volume late in the fourth quarter eased in the city, with investors hitting the pause button in many cases to re-evaluate underwriting assumptions and rent growth. Given the exuberance earlier in the year, this only makes sense.

When you consider that rent growth on a percentage basis for apartments in the city has been proven to oscillate around the Chicago Consumer Price Index, you can understand why Chicago rents have reached a point where future increases will be more muted than at the start of 2011. The suburban market, however, ended the year with a flurry with 40 percent of the transaction occurring in the last quarter.

Moreover, economic concerns both abroad and at home have further fueled investor caution. Moody’s Investors Service reported that the metropolitan Chicago economy grew at 0.9 percent in 2011. While Moody’s predicts double that growth rate in 2012, it also predicts an uptick in the metro unemployment rate to 11.4 percent over the next six months, an increase of 0.8 percent from current levels.
It’s far from doom and gloom in the local apartment market, however. With record velocity in 2011, even despite high unemployment and minimal economic growth, there are clearly other factors driving investment decisions. Fannie Mae and Freddie Mac continue to be the lifeblood of the industry, accounting for 90 percent of transaction financing in metro Chicago.

With 10-year Treasury rates hovering just below 2 percent, cap rates of 5 percent still look attractive by comparison. Factoring in leverage, returns in the mid-teens and higher are more than enough to sustain above average momentum in the sector.

Fundamentals remain strong, with occupancy rates averaging 95 percent in the city and 94 percent in the suburbs. While development is indeed ramping up, transaction velocity and cap rates have been, and will continue to be, very much driven by the fact that construction financing remains tight, while debt capital for existing product does not.

Factor in the notion that the psyche of the homebuyer has been dramatically altered during the recession in favor of the mobility provided by apartment living, and it’s no wonder that apartment investors are seizing the opportunity to stay ahead of demand. Furthermore, even with low debt rates provided by the agencies at the individual homebuyer level, lending standards have tightened dramatically. Even if individuals want to buy a home, without good credit scores and a suitable down payment, home buying will remain elusive to many.

A look ahead

Many of the factors that drove the record velocity in 2011 have not changed. Investors will continue their flight to quality by buying core assets. They will continue to look for value-add or value-preservation opportunities to buy and reposition lower-quality, highly occupied properties where rents can be pushed.

What gets left behind in the current market is the product in between, with no story and no ability to create value. These types of properties are typically in locations that cater to more cost-sensitive tenants. As long as investors don’t confuse the current strength of market fundamentals with the income elasticity of demand for housing, metro Chicago will remain an attractive market for apartment investing.

It would behoove investors to revert to historical rent growth in their underwriting. A prudent approach to these mid- to long-run assumptions should take the eventual stabilization of home values into account, which will once again draw qualified renters with the desire to own back into single-family homes.

— Bill Montana and Chris Sackley are directors for multifamily brokerage services at Cushman & Wakefield in Chicago.

Chicago Industrial Market


The confluence of railroads and seven major interstates that meet in the Chicago area assures the city’s position as a focal point for logistics operations. At the end of 2011, the vacancy rate for Chicago-area industrial property fell to below 11 percent for the first time in 3 years, reports Colliers International. Vacancies are at their lowest level since the fourth quarter of 2008 when the rate registered 10.3 percent.

And it isn’t all about inbound logistics. Nationally, U.S. exports total $179.3 billion monthly, while imports of goods and services average $223.6 billion per month. Despite the rhetoric about the decline of the manufacturing sector, it is worth pointing out that the U.S. remains the third largest exporter in the world.

The trend of companies wanting to bring some parts of their manufacturing back to the U.S. is good for the Chicago region. What do we make? Machinery and equipment, industrial supplies, non-auto consumer goods, motor vehicles and parts, aircraft and parts, food, feed and beverages.

In 2011, this two-way traffic of goods and materials drove 33.5 million square feet of Chicago-area industrial leasing — a bit more than the 32.8 million square feet leased in 2010.

The Chicago industrial market has 1.1 billion square feet of industrial/distribution space. Of that amount, just over 112 million square feet is available, representing a vacancy rate of 10.6 percent. Net absorption jumped to 9.1 million square feet during the fourth quarter, according to Colliers, the largest amount in 6 years.

The Alter Group recently developed two industrial buildings totaling 256,426 square feet on 31 acres at Lake Center Corporate Park in Mt. Prospect, Illinois. The buildings are currently leased to a single user.

The fourth quarter also marked the second consecutive quarter of net growth, the first back-to-back increase since 2007. Absorption totaled 5 million square feet in the third quarter. Despite rising demand, however, developers are still reluctant to take the plunge without a significant pre-lease in place. Speculative starts amounted to only 140,000 square feet in Chicago in the fourth quarter. This number jumps to 384,944 square feet, if you include Kenosha and Racine counties, according to CBRE.

The Chicago industrial market is absorbing vacant space for several reasons. For one, the existing inventory is getting old and obsolete for modern users. Also, corporations are seeking to take advantage of the low rents in the market and increase their operating efficiencies.

As a result, corporations are consolidating regional distribution centers into larger mega facilities. Additionally, these companies are choosing cities like Chicago because they want to be closer to the manufacturing centers and the consumer markets.

Six major construction projects were completed during the fourth quarter, four of which were build-to-suit projects and two speculative. All told, a total of 1.2 million square feet was delivered, of which just 15 percent is currently available.

Significant build-to-suits included FedEx’s new 214,000-square-foot facility in Grayslake and Home Depot’s 657,600 square feet in Joliet.

Tenants signed several large leases in the fourth quarter. Georgia Pacific took 696,540 square feet in University Park; The Scotts Co. leased 591,748 square feet in Bolingbrook; Uline Inc. leased 394,070 square feet in North Chicago; Office Depot leased 385,344 square feet in west suburban Carol Stream; and restaurant equipment supplier Edward Don & Co. signed a lease for a new 362,500-square-foot headquarters in southwest suburban Woodridge. Lastly, Lawson Products took 306,805 square feet lease at a build-to-suit facility that’s under construction in McCook.

The need for distribution/logistics space in metropolitan Chicago is driven in part by Black Friday and Cyber Monday Christmas sales. Black Friday sales in 2011, which now includes Thanksgiving Day, reached a record $54.2 billion, up 16 percent from $45 billion in 2010, according to the National Retail Federation.

Cyber Monday — online retail’s answer to Black Friday — rose a whopping 22 percent in 2011, setting a record as the biggest online shopping day in U.S. history. Online sales totaled $1.3 billion the Monday after Thanksgiving, a slight increase over the $1 billion on Cyber Monday 2010.

Internet sales will have a big impact in the some industrial markets over the next several years. As much as 30 percent of all retail sales could be completed over the Internet by 2020, roughly double the current level. This migration of shopping to the online world will create new demand for large warehouses by many retailers.

We have already begun to see increased activity by users like, Macy’s, Dick’s Sporting Goods, and others as this seismic shift in retail occurs. Logistics issues such as access to inbound freight, close proximity to ground shippers like FedEx and UPS will loom large for these companies.

The state sales tax policy is another issue. Internet retailers have historically been exempt from sales tax, which makes their pricing more competitive. Watch for this to be a major issue in the future as the federal, state and local governments battle for their share of Internet sales revenue and how to collect it.

Of the top 500 online retailers, almost half have less than $50 million in annual sales. Why is this important? Smaller companies don’t have the resources to operate in-house inventory management. They rely on third-party logistics suppliers to handle their fulfillment and shipping, driving more business for the 3PLs in the future.

Chicago provides seamless connections for moving product from east to west and north to south. It is this access to markets that has helped metro Chicago maintain its standing as one of the top 10 states — and the first in the Midwest — for international trade. As we look ahead, studies suggest that Illinois is well on its way to fulfilling its goal of doubling the state’s exports over the next five years.

— Pat Gallagher is senior vice president of The Alter Group, based in Skokie, Illinois.

Chicago Retail Market

Facing limited retail development opportunities in Chicago, some developers are looking to Wisconsin. HSA Commercial’s The Mayfair Collection is a redevelopment project in the Burleigh Triangle in the Milwaukee suburb of Wauwatosa.

Promotional retailers seeking the most desirable locations at the lowest cost once again dominated the retail landscape in Chicago in 2011. New entrants into the market appeared poised to capitalize on the new value-conscious trend in consumer behavior as well as the rock-bottom rents in backfill real estate opportunities.

Gordman’s, hhgregg and Ross Dress for Less successfully penetrated the Chicago market during the past 2 years by targeting boxes shuttered by bygone brands such as Circuit City, Borders and Linens ’n Things. But as we pivot to 2012, many may wonder what the new year will bring now that many of those obvious opportunities are gone and the retailers remain risk- averse. The answer is that development in the retail sector for 2012 will largely be driven by the same factors: economic uncertainty among retailers and thrifty consumers.

Rethinking their strategy

Following the financial crisis and the rapid fall of the housing market, retailers now are demonstrating a much more conservative outlook than in the past with regard to their expansion strategies. Having suffered losses by chasing illusory growth in housing in many exurban markets, these retailers have instead focused their site selection on dense, well-defined trade areas within infill markets.

In metro Chicago, this new strategy has generated significant redevelopment activity within the I-294 beltway area. Take, for example, the recent expansion by Meijer. The chain entered Chicago in 1999 by growing its store network in the distant suburbs, but its two most notable Chicago-area store openings in recent years were in urban shopping center redevelopments in Berwyn and Melrose Park. Meijer is pursuing a location in the close-in community of Evergreen Park.

Target and Walmart have similarly narrowed their sights on the more dense regions of Chicago and the surrounding areas, launching smaller prototypes to access such infill neighborhoods as the Loop, River North and Lakeview.

As a result of the changes in consumer behavior, traditional full-price retailers have chosen to focus growth on promotional or outlet brands. For example, Saks Inc. recently opened its third Off 5th store at the Village Square of Northbrook. Bloomingdale’s announced the closure of four home furniture stores, including a location at Oakbrook Center. The company also unveiled plans to open five Bloomingdale’s Outlet stores in 2012.

Although brands such as Off 5th and Nordstrom Rack are seeking opportunities to expand their footprints locally, their business model necessitates deal structures that are unjustifiable in a new construction budget. Therefore, to satisfy the demand for growth among these chain stores while still meeting their relatively stringent qualifications for a dense trade area, developers are pursuing less obvious adaptive reuse opportunities in many of the vastly underserved metro Chicago communities.

Older industrial buildings, for example, may have outlived their original purpose, but are structurally sound and well suited to be recycled into retail facilities. In many cases, the cost of repurposing these buildings can be much less than new construction, thereby allowing for an economical rental structure. HSA Commercial’s proposed 250,000-square-foot adaptive reuse of the Burleigh Triangle industrial park in west suburban Milwaukee is a case in point, given the significant retail tenant interest the project has generated.

That does not mean that there will not be any ground-up development in 2012, but that the expansion of mid-box promotional tenants will not likely be the catalyst. Instead, outlet malls have been an abnormally active part of the retail sector because of their low operational and construction costs and value-driven appeal to consumers.

Retailers like Gap, which announced plans last year to close 200 of its full-line stores and to open approximately 50 stores for both its Gap Outlet and Banana Republic Factory Store brands, have recognized the outlet model as the means with which to generate the highest returns in the sluggish economy.

As a result, Chicago developers have proposed outlet malls in Rosemont, New Lenox and Country Club Hills that could begin to make progress in 2012, but are competing aggressively for tenants.

Grocers expand

Chicagoans should also expect to see the development of several grocery-anchored projects led predominantly by Mariano’s Fresh Market, a subsidiary of Milwaukee-based Roundy’s Supermarkets, which has expanded aggressively with suburban stores open in Arlington Heights and Vernon Hills and projects underway in Palatine and Wheaton.

Like Walmart and Target, Mariano’s has been primarily focused on urban development in dense, affluent communities, including locations in Roscoe Village and Lakeshore East as well as proposed sites in the West Loop, Uptown, Ravenswood and Lakeview.

Judging by current trends, retailer expansion in 2012 and beyond appears most likely to occur east of I-294, in Chicago’s mature infill communities. With a jump in suburban new housing starts and retail development unlikely anytime soon, those retailers that are looking for expansion opportunities are likely to find them in these infill locations.

Retailers willing to adapt their formats for densely developed city blocks will find that many underserved urban neighborhoods still offer room for growth and would welcome new shopping opportunities.

— Timothy Blum is executive vice president and managing director of the retail division of Chicago-based HSA Commercial Real Estate.

Chicago Hotel Market


After an extended period of turbulence and uncertainty, the Chicago hotel market is steadily, albeit tentatively, beginning to make up some of the ground that was lost over the course of a challenging few years. The test for analysts (not to mention industry professionals with a stake in the Chicago marketplace) is to determine to what extent this momentum is the beginning of a robust and sustainable recovery.

Chicago faces some distinctive local and regional challenges that make forecasting the next 12 to 24 months more of an art than a science. While it is certainly true that a rising tide lifts all boats, and that a broader national uptick in the economy has begun to have a positive ripple effect in terms of higher occupancy numbers and higher average daily rates in urban centers around the country, Chicago also feels the tug and sway of its own marketplace dynamics. While the outlook for the Windy City is generally positive, significant questions remain.

The city’s hotel market is showing clear signs of recovery, but it is not yet recovering as rapidly as much of the rest of the nation. What is interesting is that this lag is evident despite the fact that current demand clearly justifies more growth. The more important question is why this is the case.

To some extent, this is the result of a self-inflicted wound that is still healing. Throughout this recessionary

period, the drop in average daily rates in the Chicago market has been dramatic and illogical, and hotel owners and operators are still trying to make up the ground that was lost due to that overreaction.

The bottom line is that many of the decision-makers who were responsible for those rate decisions exhibited poor judgment, playing a counterproductive game of follow the leader in a rate race to the bottom, instead of holding their position and waiting for those early outliers to fall back in line.

Government’s role

Another factor that must be accounted for is the Illinois financial crisis — the impact of a recessionary economy compounded by years of mismanagement at the state level coming home to roost. Unfunded pension liabilities and ongoing budget problems have led to some dramatic and unwelcome actions (such as doubling the corporate income tax) that have left some asking questions about the state’s business climate.

On the flip side, Mayor Rahm Emanuel has received fairly high marks from the business community. Meanwhile, strong new leadership in the Cook County Executive Office and the City’s Tourism and Convention Bureau has been a welcome change. Perhaps another positive change is an evolving marketplace that, after shifting from a predominance of corporate travel/business to more of a leisure focus in the depths of the recession, is now showing signs of moving back and recapturing that business travel and convention traffic.

For all the uncertainty, the structural fundamentals continue to improve, and the city is already seeing some substantial advance convention bookings — a sign that bodes well for 2012.

The development momentum that essentially came to a halt when the market crashed is beginning to show some signs of life. Demand has not yet risen to the point where it is enough to overcome some of the lingering economic uncertainties, but there are some exciting new projects in the pipeline for the first time in years.

Examples include Virgin Hotels’ purchase of the historic Wabash building, with plans to open a 250-room hotel in 2013, and the recently announced plans to convert the former Crain’s Communications building to a hotel.

These projects, together with high-profile redevelopments of a handful of existing hotels, herald some dynamism in a development market that has been in suspended animation in recent years. It is also encouraging that property values have been fairly stable, and several large properties have changed hands at a good value.

The central business district of downtown Chicago continues to be the prime target for new development, and while we are seeing some recovery in the luxury segment and with high-end hotels, the select-service sector continues to lead the pack in terms of current performance and potential.

Lenders still cautious

In terms of the financing market, there have been some marginal improvement for hotel owners and developers, but the lending climate remains lean. There is still enough uncertainty in the macroeconomic picture that a lack of available credit remains an issue. While some hotel owners are overleveraged, and maturing debt is a concern, so far lenders have been doing a fairly good job of renewing debt and not pushing the envelope.

What it boils down to is a split between those who view the steady progress and positive signs as an indication that the recovery is officially on its way, and those who see city, state, county and nation economic landscapes that are still a vulnerably fragile hostage to big-picture events.

My sense of it is that a year from now we will all be speaking in much more glowing and definitive terms about Chicago’s prospects for 2013 and beyond. The presidential election will be behind us, and barring a global catastrophe or other unforeseen event, the laws of supply and demand seem likely to continue to move in the right direction, and the overall economic portrait should be stronger.

For now, 2012 will probably continue the slow but steady improvement in the hotel marketplace. For hotel owners and operators who have experienced a tough few years, that is plenty of reason for optimism.

— Robert Habeeb is president and COO of First Hospitality Group Inc. based in Rosemont, Ill.

©2012 France Media, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.

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