MARKET HIGHLIGHT, OCTOBER 2005

CHICAGO CITY HIGHLIGHTS
Denise J. Dalicandro, Elaine Melonides, Todd Caruso, Jason A. Hernandez

Chicago Industrial Market

As we soon cross the threshold into the fourth quarter of 2005, the Chicago area industrial market arrives on the scene strong, showing an increase in both leasing and sales activity.  

Although rental rates have decreased overall in the Chicagoland market since the late 1990s, they have remained fairly consistent over the last few years.   Landlords continue to offer free rent, reduced annual lease escalations, and most importantly, are creative with lease structures in order to stay competitive in the current leasing climate.  

In general, user sale prices have increased.   Attractive mortgage rates have permitted entrepreneurial users to own their real estate economically.

Furthermore, the low cost of capital has placed a strong demand from investors looking to purchase leased assets.   Real estate, a true bricks-and-mortar investment, has become a relatively safe haven compared to the volatility of the stock market for risk adverse investors.

Current development trends in the greater metro Chicagoland market are speculative construction and value-added redevelopment of older, functionally obsolete properties.   This has become apparent in two of Chicago's submarkets, the Interstate 55 corridor (including Interstate 80) and the O'Hare submarket.

In the I-55 corridor, and more recently the I-80 corridor, construction of speculative big box bulk distribution facilities is widespread and on the rise.   Having nearly doubled in industrial market base during the last 10 years, it is anticipated that an additional 3 million square feet could be added in the next 6 months to 9 months.

Another trend is value-added redevelopment.   Redevelopment has proven to be a success for several developers in the O'Hare market, and many other developers are beginning to jump on the band wagon.   Projects that have been started in the last year are almost fully leased and new projects coming to market are seeing considerable amounts of interest from potential lessees wanting close proximity to the expressway system and an abundant labor pool.

I-55/I-80 Corridor Highlights

The I-55 corridor (Chicago's southwest suburbs/Will County), touted by experts as one of the hottest submarkets in the country, seems to be the birthplace of big box development.   This is largely due to the access to intermodal yards, highway accessibility and relatively economic land.   Once farmland as far as the eye could see, the corridor is now home to more than 100 million square feet of state-of-the-art distribution facilities.   As a comparison, in mid-1990s, this market only had approximately 40 million square feet of industrial properties.   Several large tracts of land remain for development along I-55, stretching as far south as Joliet, with a natural progression along I-80 in towns such as Minooka, Morris, Ottawa and LaSalle/Peru.  

Since the beginning of 2005, more than 3 million square feet of new construction, both speculative and build-to-suit, has been completed in the I-55 and I-80 corridors.   It is anticipated that by year-end several more million square feet of pure speculative construction will be started. In fact, CenterPoint Properties just announced plans to build a total of 3.4 million square feet of space at the CenterPoint Intermodal Center-Elwood for a Wal-Mart distribution center, which is tentatively scheduled for completion next summer.   Additionally, developers such as Duke Realty, First Industrial, Opus and ProLogis/Catellus all have speculative projects under construction (or slated for construction starting in the near future) in the I-55/I-80 corridors.

O'Hare Submarket Highlights

The O'Hare submarket is the core of Chicago's industrial real estate base and home to one of Chicago's largest industrial micro-markets, Elk Grove Village, was built in the 1960s and 1970s.   The mature O'Hare submarket has seen an increase in value-add redevelopment strategies by investors.   Older vintage buildings are no longer able to support the needs of today's users due to their general functional obsolescence, such as lower ceiling heights and lack of exterior truck docks.   Air-cargo and logistics-related firms desire modern facilities with close proximity to O'Hare International Airport, but the product to support their needs is often hard to come by.   Current user demand has caused developers to tear down or acquire functionally obsolete properties for redevelopment.

For example, AMB Property Corporation acquired the former Osram Sylvania building at 800 Devon Avenue in Elk Grove Village. After completely demolishing the building and constructing two new facilities totaling more than 300,000 square feet, AMB has subsequently, less than 6   months after the completion, leased in excess of 80 percent of the development to several air-cargo companies. Also, Seefried Properties has recently acquired 11 acres at North Ellis Street and Devon Avenue in Bensenville, and will shortly redevelop the site. Seefried plans to build two air-cargo type facilities totaling approximately 140,000 square feet.   In addition, CenterPoint Properties and Opus North Corporation both have similar developments on the north side of the airport. These developments have pushed land prices in the O'Hare submarket into the range of $10 to $15 per square foot and generally do not include the cost of demolishing an existing facility on the site.

While no one holds the proverbial crystal ball, the Chicago market will remain in the pink as activity by users, investors and developers remains steady.   Speculative construction and redevelopment will remain the hotspots of Chicago's industrial real estate market, as developers continue to strive to meet the ever-changing demands of their clients.

— Denise J. Dalicandro is a senior associate with Lee & Associates and is based in the firm's Chicago office.

Chicago Office Market

The Chicago office market has been as flat as the Midwest prairie for the past 3 years, and there are no hills or valleys visible on the horizon. Vacancy rates are holding at more than 15 percent downtown and are even higher in the suburbs, giving tenants the upper hand in most lease negotiations.

Jones Lang LaSalle's comprehensive survey of the office market shows vacancy rates in downtown Chicago continuing to creep up, from 14.8 percent in the third quarter of 2004 to 16.1 percent in the second quarter of 2005. Suburban vacancies have shown only a slight improvement during the same period, dropping from 20 percent in the third quarter of 2004 to 19.5 percent in the second quarter of this year.

Average gross rents downtown have held steady since 2002, with Class A space leasing for about $30 per square foot and Class B leasing for about $26 per square foot. Rents have declined slightly in the suburbs, with Class A space today commanding about $26 per square foot, down from about $28 per square foot in 2002. Class B suburban space is leasing for about $23 per square foot on average, down a couple of dollars per square foot compared to 2002.

The forecast in both the city and suburbs is for more of the same. Jones Lang LaSalle's study predicts that rents will remain flat or experience small declines in the next 3 years. Barring unforeseen circumstances, central business district (CBD) vacancies in 2008 will still be at about 15.5 percent, and suburban vacancies will decline only to 16.2 percent.

The current absorption numbers are not overly encouraging for landlords, either. Year-to-date net absorption totaled 246,128 square feet downtown and negative net absorption of 395,221 square feet in the suburbs. At least the suburbs have no new buildings delivered to the market this year; in the Loop, completion of 111 South Wacker added slightly more than 1 million square feet of new space, accounting for the slight rise in vacancy rates over year-end 2004.

The outlook for the second half of 2005 suggests that demand for growth space will remain sluggish. The most likely scenario for a drop in vacancy rates will be if landlords accelerate their plans to convert office space to other uses. In the CBD, some older office buildings are currently being converted to residential condominiums, and development sites once considered ripe for office development are now being built as residential and/or hotel properties. In the suburbs, a 200,000-square-foot office building is being converted to retail space.

Yet, there is still new office development planned and underway. In addition to the 1 million square feet already added to the downtown this year, another 800,000 square feet is scheduled for delivery in the second half of the year and about 480,000 square feet are under construction for delivery in 2006. Moreover, downtown tenants continue to look at new construction alternatives to existing buildings, and it is possible that one or more additional buildings will break ground within the next 2 years.

In a market of healthy absorption year after year, the current level of new development would be necessary just to keep up with demand. In the current market environment, however, it is expected that Chicago landlords will continue to be very aggressive in competing for tenants.

— Elaine Melonides is an executive vice president of tenant representation in Jones Lang LaSalle's Chicago office.

Chicago Retail Market

One word describes the Chicagoland retail market — revitalized. Fueled by rapid housing growth with prices remaining lower than comparative coastal developed sites, the retail market is benefiting from consumer's higher disposable income.

Owners in the Chicago retail market are capitalizing on a mixed-use format. Examples of this include 108 N. State (left), the Rezmar site at Roosevelt and Clark, and Heritage Shops at Millennium Park. Combined, the three projects will account for more than 1 million square feet of retail space alone.

Quick serve casual theme restaurants, banks and drug categories are among the groups leading the charge, which include names such as Potbelly Sandwich Works, Panera Bread, Bank One and Harris Bank. A surprising comeback is apparel users, such as Chico's, Coldwater Creek, Gymboree, White House Black Market, J. Jill and Talbots.

Chicago will see its second IKEA and Bass Pro Shops Outdoor World stores open in Bolingbrook. Competition is fierce with news of a new Cabela's store in nearby Highland, Indiana, and a proposed location in Hoffman Estates.

With a push to find alternative methods for income-producing buildings, owners are looking to capitalize on a mixed-use format, which is quickly becoming the new wave of development, especially in urban infill markets. Examples of this include 108 N. State, the Rezmar site at Roosevelt and Clark, and Heritage Shops at Millennium Park. These three will account for more than 1 million square feet of retail space alone.

With retail surging throughout the Chicago area, it is rare to speak with a suburban municipality or city neighborhood that is not planning for some type of retail revival. Many plans are ill-conceived formats, which quickly point to lifestyle retail with the more recognizable names. Before jumping on the bandwagon, officials should ask themselves a few questions: Do we have the appropriate demographics? What is our proximity to the nearest mall? Are we willing to Pro Forma the necessary operating expenses associated with lifestyle centers and can we achieve enough rent after funding exorbitant tenant improvement allowances?

Notable towns meeting the market successfully are LaGrange, Arlington Heights, Palatine, Des Plaines and Naperville. All boast an ambiance that is conducive to shopping, and all have a healthy downtown residential base.

On the capital markets side, TICs, REITs, private and 1031 exchanges lead the investor groups. Each is pouring capital into the market at a voracious pace, and provided we see debt remaining at current low levels, cap rates are anticipated to remain flat or increase slightly in the near term.

Chicago is the largest single retail market in the U.S., with a metropolitan statistical area stretching from northwest Indiana on the south to the Wisconsin border on the north, respectively, and stemming 50 miles west from Lake Michigan. Provided consumer confidence remains strong, our well-diversified retail market has a terrific outlook for the foreseeable future.

— Todd Caruso is senior managing director of CB Richard Ellis Retail Services in Chicago.

Chicago Multifamily Market

The Chicago multifamily market has been greatly affected by increased condominium conversion activity. Driving the pace of conversion, largely to the detriment of the multifamily market, are interest rates and economics that may allow a rental tenant to see its monthly cost of housing decrease as a result of purchasing a unit.

In Chicago, conversion has fueled rampant sales of multifamily properties from three to 500 units, and has driven cap rates to historically low levels that have not been seen or sustained since the 1950s.   Key examples of downtown conversions in 2005 include: Vornado's sale of the 452-unit 400 North LaSalle to condominium converter Draper and Kramer for $126 million; the 52-story, 580-unit Park Millenium, which Archstone Smith sold to Centrum/MCZ; two 1920s vintage multifamily properties; NVG purchased and is converting 2000 Lincoln Park West and RDM Development purchased and is converting 1400 North Lake Shore Drive. These were especially notable as they both have no dedicated parking.

Conversion activity also has been successful in the suburbs. Garden-style conversion activity has been especially brisk along Interstate 90, the Northwest Tollway, stretching out from O'Hare. Within 30 miles of downtown, there is almost no vacant land to develop housing and developers are looking up to 60 miles from downtown for vacant land development sites. In the city of Chicago, developers are finding almost no available land sites, and in turn are planting seeds to redevelop areas like the once-overlooked South Shore.   All over the metropolitan area, of the new housing product built, 95 percent of it is owner-occupied, not rental.

In Chicago during the last several years, multifamily owners have been distressed as tenants have left rental properties to consume owner-occupied housing.   This increased vacancy and has put downward pressure on rental rates.   The most qualified tenants in terms of credit worthiness have been lost to home ownership.  

As interest rates rise, and owner-occupied housing becomes less affordable from a monthly payment perspective, many consumers will again be drawn to renting instead of owning.   With these improving fundamentals, now is an excellent time to buy multifamily.   Cap rates in Chicago should not rise in lockstep with interest rates.

As for the existing inventory of condominiums in Chicago, is there overbuilding, and is there going to be a hangover if the condo-conversion party ends?   What does this mean for multifamily owners?

“Though nobody knows for sure, we don't expect this to happen” says veteran real estate investor William O'Kane, president of Group Fox Property Management, one of Chicago's largest multifamily owners.   “It's like Vegas, every year experts say ‘Vegas is maxed-out, they cannot possibly build more hotels and tourism cannot keep expanding' yet, every year, a new mega-hotel opens and Vegas tourism explodes,” he says.    “Chicago continues to evolve and the trend of people who choose to live downtown, as a lifestyle choice, has gained momentum each year since 1970.   Like Vegas, consumers will continue to absorb condominium units; however, very little new multifamily is getting built.   For this reason, cap rates on acquisitions are low, and I expect them to stay low, even with rising interest rates. They aren't making any more real estate, and Chicago has long been running out of locations and zoning to build additional multifamily.”

— Jason A. Hernandez is a managing director with Chicago-based Keller Williams Commercial Real Estate.

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