HEARTLAND SNAPSHOT, JUNE 2008

Chicago Retail Market

Because of the current state of the national and local economy, the unfettered expansion of retailers throughout Chicago has slammed to a halt. Leasing is going to be a challenge and developing will be risky. Many in the industry were taken by surprise, but those veterans among us that have ridden prior waves of volatility know this too shall pass. My own informal polls indicate that times will be better within the next 12 to 18 months. The poll also shows that this is as bad as it’s been in approximately 20 years.

 What occurred in the first quarter can best be stated as the undoing of the third and fourth quarter of the year before. Pipelines of deals cratered in a short time period. Our clocks have been reset and the rebuilding has begun.

Some market segments have suffered more than others, especially in areas where small shop retailers relied on the big draw of power retail to stir customer activity. The sub-prime debacle has slowed development in Chicagoland retail corridors such as Route 59, Route 47, Randall Road and Orchard Road, as retailers pull back to survey the effect on housing starts. This wait-and-see posture will dominate for the near future. Nodes of vibrancy do still thrive, primarily where there is signed big box retail in place or under construction. Standout examples include Yorkville, where Harlem Irving is developing Cannonball Trail Marketplace; the new proposed Wal-Mart Supercenter on Route 34; Lakemoor, which has three large-scale developments underway along Route 120 and Route 12; and New Lenox, where there are multiple projects in the works along Route 30.

The developers’ primary challenge right now is procuring enough small shop retailers of national credit to fill all the outlot positions surrounding the centers currently underway. Big box retailers’ leverage on developers has forced the need for small shop national credit in order to prevent developments from busting. This has resulted in a plethora of vacant small shop space and empty dirt along prime, well-traveled corridors. Developers can’t afford to give away 80 percent of their land for free to the big boxes, and they won’t when the pads and small shop space do not lease.

Developers seem to be shifting to established markets and smaller footprints. There is a plethora of attractive small-scale developments from the same folks that previously ran with The Home Depot, Target and Lowe’s Home Improvement Warehouse. Smaller strip centers on prime corners in established markets will be more common than new power centers for the near future. Many homebuilders-turned-commercial developers have found themselves failing to sell houses, and at the same time have made the mistake of building a shopping center with no tenant in hand.

Take note that many retail developers with long connections and honorable business dealings have recently been burned by some of our most reliable national tenants. This undoing of deals has caused significant strain on some of our best performers. Only time will tell if these concepts understand that this is a relationship business and the interests of all involved — developers, brokers and retailers — are tethered.

New national entrants to the market such as Sonic, Meat Heads, and Five Guys Burgers and Fries have provided an infusion of new blood and energy to the market, and other concepts like Qdoba, El Pollo Loco and Bruegger’s Bagels have resumed their expansions unabated. Despite the poor state of the financial industry, Chase, Fifth Third Bank, Bank of America and even Washington Mutual are on the hunt for that prime pad sites across the market.

Chicago’s core urban markets may be the bright spot in the overall downturn. Rental rate escalation for space on the more fashionable streets has continued in the last 12 months — in some cases, exceeding $400 per square foot net. Prominent European and New York retailers are out kicking tires and exploring their options. Michigan Avenue now hosts two Forever 21 stores, after the retailer’s new location opened in April. Vacancy remains very low considering that some stagnant retailers have finally bowed out of the in-town market, which has long been expected. Leasing activity on State Street is brisk, with 108 North State Street flourishing under Joseph Freed & Associate’s stewardship.

Nationals are pulling back their expansion efforts, which will cause downward pressure on small shop suburban rents for at least the next year. Pads that were once available only for ground lease are now for sale at a discount, and communities may ease restrictions on use to facilitate sales. Local retailers that have been long snubbed have real leverage, and the real estate professionals that respect the stability that a good local operator brings to their development will have fewer vacant and forlorn storefronts. Those same banks occupying the prime pads must soften their credit requirements, lest their own equity position in these large developments drag down their balance sheets.

Some would say that it is not be the greatest time to start a retail brokerage division in the Midwest, but the only way to go from here is up. Chicagoland’s resilient marketplace will adjust and make meaningful strides in this rebuilding year.

— Gregory Kirsch is principal of Newmark Knight Frank’s new retail division in Chicago, which was launched this year.

©2008 France Publications, 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.