HEARTLAND SNAPSHOT, JUNE 2004

CHICAGO RETAIL MARKET

The outlook for the Chicago retail market remains upbeat as supply and demand fundamentals move toward equilibrium. This year, Chicago’s total employment is forecast to expand by 1.5 percent, or 61,000 jobs. This job creation is expected to support retail sales growth of 3.7 percent.

Vacancies are expected to ease as new construction is slightly outstripped by demand, and rent growth will accelerate toward the end of the year. Retail construction throughout Chicagoland will remain consistent with last year’s pace; approximately 3.6 million square feet of space is expected to come on line. The overall vacancy rate in Chicago will ease this year to 11.5 percent, a 10-basis-point adjustment.

Regardless of geography, the majority of vacant space is located in mid-block or in secondary shopping centers. The well-located corner lots throughout the Chicago metropolitan area continue to perform at near-full occupancy. Rent growth will accelerate slightly this year as stable occupancies and the influx of new construction push the overall average asking rent up by 2 percent, to $17 per square foot.

Chicago retail is firmly placed on investors’ radar screens. Whether from institutions, real estate investment trusts or the wealth of local private capital, strong investor demand has pushed cap rates to historic lows. Single-tenant net-lease properties are trading at 7 percent to 7.5 percent cap rates on average, and well located, newer, unanchored strip centers are commanding cap rates from 8 percent to 8.5 percent. Grocery-anchored centers remain highly competitive, but this sector may be in for some restructuring as evidenced by the recently announced closures of some Dominick’s stores. As a result, the range in cap rates is wide, at 7 percent to 8.5 percent, based on location and credit.

The geographic blindness in valuations is a trend that underscores the insatiable appetite for Chicago retail. While Chicago remains a north/south city in terms of pricing — with the majority of affluence located to the north, northwest and west of the city — the high premiums once commanded by the north have waned. The spread in cap rates when moving from north to south was 100 to 150 basis points a couple of years ago, and is now no more than 25 to 50 basis points, particularly in heavily populated areas like Hyde Park.

One geographic consideration facing retail investors and owners in Chicago, however, is the disparity in property taxes. Cook County taxes are higher than other counties in the region and, in some cases, they are more than double. While the higher taxes have not dampened demand, astute underwriting with heavy consideration regarding the impact of the current tax (and plausible future increases) is warranted.

Downtown Chicago’s retail landscape continues to evolve. A recent study indicated that national retailers, such as Borders Books & Music and Walgreens, occupy nearly 50 percent of downtown’s retail space, while the presence of local retailers has declined from 57 percent in the late 1980s to less than 40 percent today.

Retail development also is evolving in areas other than downtown. For example, the enclosed Brickyard Mall was demolished in favor of an open-air, 573,000-square-foot power center, now called The Brickyard.

In the suburbs, national chains are straining local retailers by driving rents and taxes up. Rents have skyrocketed in some suburban downtowns where successful redevelopment has landed national chains. However, there are questions as to whether developers a who favor high-density downtown redevelopment are turning their streetscapes into large outdoor malls. While investors benefit from the stability of these national credit tenants, the long-term impact may be less favorable. Early accounts suggest that the “malling” of suburban downtown areas has led to increased traffic congestion but not to increased retail foot traffic, which could endanger retail sales growth in the long term.

— Greg Moyer is a managing director for Marcus & Millichap and serves as the regional manager of the firm’s Chicago office. Stephen Rachman is the regional manager of the company’s downtown Chicago office.

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