CITY HIGHLIGHT, OCTOBER 2004

CHICAGO MARKET SHOWS SIGNS OF IMPROVEMENT
George Kohl, Todd Caruso, George Cibula and Greg Moyer

The Chicago market is seeing slow signs of improvement in all four sectors of real estate this year. New construction has caused vacancy rates in some sectors to slightly increase from 2003 and first quarter 2004, but they are expected to decline by the end of the year. In the office market, tenants are taking advantage of a growing supply of leasable space. The retail sector has been active, with financial service firms and quick casual restaurants leading the way. Sale-leaseback transactions are getting attention in the industrial sector. Buyer demand is creating strong investment activity in the multifamily market.

Office

For several quarters, downtown Chicago’s office vacancy rate has been bouncing below its recent peak, yet it remains far from the record lows seen several years ago.

The second quarter ended with a direct vacancy rate in downtown Chicago of approximately 13.6 percent. Including sublease space, the overall vacancy was 15.4 percent at mid-year.

Most tenants with lease expirations within the next 24 to 36 months are out canvassing the market and exploring alternatives — and if they are not, they should be. The current environment and window of opportunity to lower occupancy costs has been and will continue to be a major driver for leasing activity.

Class A buildings are garnering the most attention as tenants seek to improve their lot whenever possible. Sporadic positive net absorption has been evident in Class A space with continued strong demand for West Loop locations. But competition for tenants among lesser Class A and B buildings is increasing with landlords offering more and more lucrative concessions.

Enthusiasm for a rapid recovery is tempered by the supply and demand factors. Many companies are questioning the current state of the economy despite several quarters of healthy growth. Adding to the uncertainty is the current geopolitical environment and the pending election. As a result, businesses have deferred expansion plans, and many are opting for conservative estimates of their space requirements.

Compounding the uninspired demand is an ever expanding supply of new quality space. Unexpected sublease availabilities, exemplified by Bank One’s merger with JP Morgan Chase, offer alternatives to downtown tenants. Meanwhile, several new buildings slated for completion in 2005, along with a new corporate headquarters for USG Corporation at 550 W. Adams Street, will leave behind sizeable vacancies in other existing Loop buildings.

This backdrop suggests that the downtown market will be in a holding pattern for the next several quarters. The worst may be over, but barring any disruptive global event, the market could improve once the election passes and companies begin acting with more conviction in 2005. For now, however, the recovery does not appear to be a steep one.

— George Kohl is executive vice president – Midwest Region with Trammell Crow Company.

Retail

Leasing continues at a brisk pace in the Chicago retail market. But, after declining steadily for more than a year, the vacancy rate — which tracks a growing inventory of 109.1 million square feet of retail centers with 50,000 square feet or greater — increased from 7.8 percent in the first quarter to 8.1 percent during the second quarter. Nevertheless, the current vacancy rate remains lower than year-end 2003. The far west/southwest suburbs, along with urban infill locations such as the Clybourn Corridor and Roosevelt and Canal streets, are among the areas drawing strong interest from retailers.

Vacancy rates continue to run higher than average in pockets of the southern part of the city. Leasing of Class B and C properties in these submarkets remains challenging.

Developers and large national retailers are expanding in both Chicago and suburban submarkets. At mid-year, there were 34 centers (50,000 square feet or greater) totaling more than 3.8 million square feet, under construction across the Chicago market. One example is Chelsea Property Group’s Premium Chicago Outlets development in Aurora. Other large-scale developments include Continental Development’s planned 500,000-square-foot development at Route 30 and Roberts Road in New Lenox and Ryan Companies’ 578,000-square-foot development in Tinley Park. In the downtown market, Mills Corporation has announced details of its mixed-use development at Block 37 at the intersection of State and Randolph streets.

IKEA selected Bolingbrook as the site of its second Chicagoland location with plans for a 310,000-square-foot store at the junction of Boughton Road and Interstate 355. Construction is expected to begin later this year with a projected store opening in the summer of 2005.

The Chicago market continues to have strong appeal to retailers. One of the newcomers is Costa Mesa, California-based Anna’s Linens, which recently signed leases to open its first Chicagoland stores in Evanston, Northlake and Evergreen Park. Another newcomer to the market is the upscale meals-to-go chain Eatzi’s, which signed a 15,000-square-foot lease at Century Shopping Centre in Chicago’s Lakeview neighborhood.

Financial services firms and quick casual restaurants have been the most active in the retail market this year. Banks continue to compete heavily with each other for sites. Big names like Bank One, Harris Bank, Washington Mutual, Fifth Third and National City are active in the financial service category. In the quick causal restaurant category, players like Qdoba Mexican Grill, Potbelly Sandwich Works, Chipotle and Panera Bread continue to have a strong appetite for well-located pad sites.

Chicago’s investment activity has been robust. Illustrating the continuing appeal of Chicago area retail assets was United Kingdom-based Grosvenor’s acquisition of the 250,000-square-foot Rice Lake Square in Wheaton. A rise in interest rates may at some point affect demand of retail product, but sales have yet to experience a slowdown in Chicago or the Midwest. The rise has appeared to increase the activity on both sides of the transaction.

A total of 3.8 million square feet of new retail space is currently under construction with another 7.7 million square feet planned across the Chicago area. Wal-Mart has been particularly active in the region. In Antioch, a 200,000-square-foot Super Wal-Mart recently broke ground, and additional Wal-Mart locations are soon expected in Mundelein and on Chicago’s west side.

Chicago has no limitation for additional growth geographically. There has been a substantial amount of development both planned and existing in the southwest due to the growth of affordable housing during the last couple years. The fastest growing submarkets currently appear to be Plainsfield and Oswego.

— Todd Caruso is the managing director, national retail services, of CB Richard Ellis’ eastern region.

Industrial

The Chicago industrial real estate market is experiencing tremendous growth. The distribution centers in metropolitan Chicago, which previously served as the distribution hub for Minnesota, Wisconsin, Illinois, Indiana and southern Michigan, now service an area encompassing parts of Ohio, Tennessee, Iowa and Missouri. Chicago is ringed with mega distribution centers, such as the new 750,000-square-foot Michael’s Crafts Warehouse, which was developed by Northern Builders in New Lenox. Target Stores’s new 1 million-square-foot distribution center will be built near the Union Pacific Railroad’s Global III container yard in Rochelle. CenterPoint Properties Trust is building a 1 million-square-foot speculative building at its Elwood Santa Fe Railroad container inter-modal yard. The new facility will neighbor CenterPoint’s already complete 600,000-square-foot PotLatch Paper building and the nearly complete 1 million-square-foot DSC Logistics distribution center.

There are a total of 80 properties in the west and south suburbs alone that have been constructed, are under construction or are planned — with a total area of 43 million square feet in metropolitan Chicago. These buildings range in size from 300,000 to 1.2 million square feet.

While the big box market has experienced an erosion in rents due to overbuilding, the medium to smaller buildings, under 100,000 square feet, have steady or increasing rents. These buildings are also experiencing fairly high sales prices due to the availability of inexpensive money and an upturn in business for the small- to medium-sized companies. There has not been overbuilding in this segment of the market. Some of these small- or medium-sized companies are being attracted either to the city of Chicago or Cook County.

The sale-leaseback market is red hot in metropolitan Chicago. Any entrepreneur or publicly traded company that owns a 40,000-square-foot building or larger, and is willing to sign a lease, will have a host of potential buyers. Among the more active buyers of sale-leaseback properties are AMB, ML Realty Partners, Cohen Financial, VIP Fund, First Industrial Realty Trust and Prologis.

Two emerging submarkets that bear watching are southern Wisconsin and northwest Indiana.

Duerson Foods has located a processing plant in southern Wisconsin. Volkswagen of America and Yamaha Motors of America have located their national parts facilities in Pleasant Prairie, Wisconsin. The Kenosha/southern Wisconsin area offers these companies an alternative to the higher priced land and taxes in northern Illinois, as well as good rail and interstate access to Milwaukee, Chicago and the upper Midwest.

The northwest Indiana submarket is experiencing a vigorous rebirth after its reputation as the center of the “Rust Belt” in the 1980s. Becknell LLC has been very active in developing build-to-suits in Munster, Indiana, such as projects for Dawn Foods, Whole Foods, Staley General (food distribution) and Rockwell Automation. The company recently broke ground on Northwind Crossings, a 75-acre rail-served development in Hobart, Indiana, which is adjacent to Interstate 65 and in proximity to Interstate 80/94. South Bend, Indiana-based Holladay Corporation has been successful in developing its Ameriplex Industrial Park in Portage, Indiana, adjacent to Interstate 94. Within the park, Chrysler Corporation has a parts distribution facility operated by Excel Logistics, and Walgreens has established a major return center. In addition, Delaware Investments, a division of Lincoln National Life, has constructed a 517,000-square-foot speculative building.

Finally, the O’Hare Airport submarket bears some watching. Developers and users are starting to replace some of the buildings from the 1960s and early ‘70s with more modern, efficient facilities. For example, Atlanta-based Seefried Properties purchased the Sola Electric warehouse on Busse Road in Elk Grove Village. The company razed the 1970s structure and is constructing an airfreight/high velocity warehouse for Eagle Airfreight. Duke Realty has done a similar project in Northlake, which is southwest of the O’Hare Airport, and Opus has plans for similar project on Belmont Avenue in Franklin Park, which is immediately south of O’Hare Airport.

— George Cibula is the president of Darwin Realty & Development Corporation.

Multifamily

Investment activity in Chicago will be robust through 2004 as sellers capitalize on lower cap rates in the face of strong buyer demand. Investment opportunities might exist outside the Loop in Cook County, where appreciation has remained muted, but vacancies and rental rates have been firm. Prices will continue to rise as buyer demand for assets in strong locations remains high.

The western submarkets have remained stable throughout the negative economic events of the past several years. Central DuPage County, Elmhurst and Lombard have performed well despite manufacturing layoffs and record-low interest rates, which have allowed many renters to purchase single-family housing. Vacancy rates often are below 5 percent in these areas, and rental rates have continued to climb throughout times of uncertainty.

Apartment construction will slow in 2004 as developers take a brief respite due to near cyclical-high vacancies. Currently, 1,300 units are expected to come online by year end.

Regionwide, the vacancy rate is forecast to decline slightly toward the end of 2004, falling 30 basis points to 7 percent. The Lincoln Park, Lakeview and Wrigleyville areas north of downtown will register slight improvement in 2004, while uptown should register noteworthy gains as condominium conversions have pulled a significant amount of rental stock from the market and the remaining units are offered at below-average rents.

While declining rent rolls in some areas will continue through 2004, the overall average asking rent will rise slightly by year end, to $950 per month. The affordably priced O’Hare submarket is expected to achieve the strongest rent growth with rates climbing to $899 per unit as a low rental stock and a strong centralized location keep vacancies low.

Sales prices will continue to rise in 2004. The median price per unit in 2003 was $67,500 and in 2004 is at $70,000 through September. Transaction velocity is accelerating this year as investors are being lured to the Chicago market by significant price appreciation. The greatest appreciation is in the city, where anxious condominium converters are bidding up prices for apartments. Conversion specialists aggressively bid up prices because they can pay substantially more than what a complex is worth as a rental property. They do not care about cap rates because they expect to flip the individual units after a short period of rehabilitation or redevelopment. It is estimated that 12,500 condominium units are underway in the Chicago metropolitan statistical area, with an additional 11,500 units in the planning phase of development.

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

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