CITY HIGHLIGHT, OCTOBER 2006

CHICAGO CITY HIGHLIGHTS
Aaron Kulick, John Jaeger, David Burkards and Richard Lindberg

Chicago Retail Market

The next 12 to 18 months should draw the attention of anyone who follows the Chicago retail real estate market. Retailer expansion is continuing at a significant clip, as everyone from big boxes to banks to small shop tenants seek product to satisfy ambitious growth goals. However, while vacancy has dropped slightly in the past year, worries of an overcrowded development pipeline have some predicting supply will soon outweigh retailer demand.

Although development remains robust in all outlying suburbs, much of this new planned development is proximate to the Interstate 355 extension (scheduled for completion in late 2007). This long-awaited interstate segment will stretch I-355 from its current southern terminus at Interstate 55 south to Interstate 80. When complete, the 12.5-mile extension will have five interchanges at critical east/west arterials resulting in significantly improved access and reduction in traffic congestion in the rapidly expanding south/southwest Illinois suburbs such as Homer Glen, Lockport, and New Lenox.

Of particular interest is the 225-acre power town planned by Forest City Enterprises for the intersection of Route 6 and I-355 in New Lenox. Once completed, the center’s estimated 2 million square feet of retail will feature a mix of big box retailers, smaller specialty retailers and restaurants. This hybrid of power center and lifestyle components will be similar to Jeffrey R. Anderson Real Estate’s Algonquin Commons in northwest suburban Algonquin, Illinois. Projects such as these, which cater to a wide array of consumer needs in one location, are worthy of industry attention moving forward.

Aside from Wal-Mart and Target, which continue to rapidly open new supercenter stores throughout the suburbs of Chicago, other retailers making or continuing their aggressive push into the market include JC Penney and health clubs such as XSport Fitness and LA Fitness. Plano, Texas-based JC Penney has plans to open 50 stores annually nationwide through 2009, and appears to have significant interest in the Chicago market. Recently, the retailer announced plans to occupy a former K-Mart location in Woodridge, Illinois, at 75th Street and Woodward Avenue. XSport Fitness remains hungry for new infill and emerging market opportunities, and plans to open several locations in Chicago in both 2007 and 2008. LA Fitness, which is opening locations in the Illinois suburbs of Evanston, Hanover Park and Tinley Park, is also looking to satisfy major expansion goals and plans to open 35 facilities throughout Chicagoland in the next 5 years. Both XSport and LA Fitness look for spaces of about 40,000 to 50,000 square feet in freestanding and inline locations.

Unfortunately, aggressive growth plans from these and other retailers may not be sufficient to meet the supply of existing and planned retail space moving forward. Vacancy for the market in second quarter 2006 was 7.5 percent, slightly down from 7.52 percent rate in the first quarter of the year. In fact, since first-quarter 2004, when vacancy measured 7.8 percent, the overall vacancy rate has fluctuated only marginally, while average asking lease rates have remained constant at around $20 per square foot. Couple this with an estimated 14 million square feet of planned development for 2007, compared to an typical pipeline of 4 million and 6 million square feet of development per year, and it’s no wonder some are worried that the market may soon fall out of balance.

— Aaron Kulick is an associate with CB Richard Ellis’ retail land team in Oak Brook, Illinois.

Shops on Butterfield Complements Yorktown Center

Long/Pehrson Associates LLC is developing The Shops on Butterfield, a 200,000-square-foot retail center in DuPage County.

 “The east/west corridor in Chicago is probably one of the most affluent markets and the fastest growing region in the Midwest,” says Robert Long, president of Long/Pehrson Associates. “It’s a wonderful market with great highway infrastructure.”

To create The Shops on Butterfield, the company tore down a 240,000-square-foot Montgomery Ward’s store at Yorktown Center. Roughly 20 percent of the development will be part of a new extension of the existing mall, and the rest will be an open-air traditional lifestyle development. The Shops on Butterfield will include a mix of restaurants and retail that are new to the area, and will provide shopping and dining experiences that are particularly suited to the discriminating DuPage County shopper.

“We’re striving to create a better quality, more urban experience here,” says Long.

Dining options that are currently open at The Shops on Butterfield include Claim Jumper, The Capital Grille and Rock Bottom Brewery. Stores still slated to open include Brio Tuscan Grille, White Chocolate Grill out of Scottsdale, Arizona, Adobo Grill and RA Sushi from downtown Chicago, Flat Top Grill, and Boudin Café from San Francisco. Construction has also begun on an 18-story Westin Hotel, a 500-room hotel and convention center projected to open in 2007. A 27,000 square-foot Lucky Strike Lanes will occupy the lower level of the project, which was formerly Montgomery Ward’s first level. The company also has approximately 40,000 square feet of space to devote to women’s apparel.

“We felt it was important to not go after the same retailers you’ll find in a lot of the nationally based lifestyle centers,” Long notes.

Long/Pehrson will deliver space to the majority of tenants in February 2007 with a projected June 2007 opening.

— Susan Fishman

Chicago Multifamily Market

The Chicago apartment market is one of the most dynamic apartment markets in the country. Historically high occupancies have led to steadily increasing rental rates, while demand has been fueled by long-term, positive job growth trends. Supply constraints and condominium conversions have kept net deliveries in check, and supply has been decreasing through the last 5 years.

According to the Bureau of Labor Statistics, the nine-county Chicago metropolitan division has achieved positive job growth during the last 22 consecutive months. Annualizing current growth rates, approximately 51,000 jobs will be created in 2006, followed by 56,000 jobs in 2007 and 57,000 jobs in 2008, resulting in a 1.25 percent job growth forecast. This growth will continue to create demand for apartments in an already tight rental market.

While there are minimal apartment deliveries in suburban Chicago, the biggest story in the rental market is the condominium conversion activity that was either announced in 2005 or is in the pipeline to be announced. According to Appraisal Research Counselors (ARC), suburban Chicago condo conversion activity since 1995 has resulted in 14,138 units converted, approximately 1,200 units per year. The suburban condo conversion market experienced the most active year in 2005, with roughly 3,000 units announced for conversion. Currently, there are 2,256 units proposed for conversion in 2006 but CB Richard Ellis (CBRE) is tracking numerous pending projects that could push the total to approximately 5,000 units announced for conversion this year.

The Park Bloomingdale is a recent suburban conversion announcement in Bloomingdale, Illinois, within a half-mile of the Stratford Square regional mall. The 250-unit project is being converted by Equity Residential Condominiums, a division of Equity Residential REIT. Opening prices range from $119,900 for a one-bedroom/one-bath unit to $224,900 for a two-bedroom/two-bath unit. The Cook County submarket dominates the suburban condominium conversion marketplace with 54 percent market share followed by DuPage County, with a 36 percent market share (Table 1).

After 2005 — the most active year for conversions since the 1970s, with approximately 4,000 units announced for conversion — condominium converters have been quieter so far this year. However, American Invsco recently announced the conversion of Century Tower, located at 182 West Lake Street in the heart of the Chicago Loop. The 293-unit building was a renovation of a historic office building into luxury residences. After a brief stint as rentals, American Invsco gained permission to convert the building to condominiums and began offering units to the public in September. Prices range from $139,900 for a studio unit to $509,900 for a three-bedroom/two-bath unit.

400 North LaSalle is a 452-unit downtown Chicago condo conversion that was announced in July 2005 and is currently more than 50 percent sold. The remaining inventory is priced at more than $425 per square foot and is being marketed by Equity Marketing and Draper & Kramer.

Through the second quarter of the year, there were only five active condo conversion projects in the upper bracket category in downtown Chicago, or those with retail sale prices exceeding $400 per square foot. Absorption has remained healthy for the upper bracket projects this year, with three of the six projects — 10 East Ontario, 90 percent; 474 North Lake Shore Drive, 75 percent; and 222 East Pearson, 65 percent sold — edging toward their close-out phase. Of the five active projects, only 618 unsold units remained available through the second quarter according to ARC, putting the properties at 68 percent occupied. Monthly velocity has averaged approximately 19 units per month, while retail prices averaged $377,000 or $425 per square foot.

New apartment construction activity has slowed considerably in the last few years and has come to a virtual halt in the Chicago suburbs. The lack of construction activity is due to a number of factors, from the limited supply of available land zoned for apartments; the difficulty in re-zoning land for apartments due to municipalities preference for owner-occupied homes; for-sale developers simply outbidding apartment developers for land; and finally, the challenge of ever-increasing construction costs.

As indicated, the number of apartment deliveries in the Chicago suburban market is at an all-time low with an average of fewer than 350 units per year projected to be delivered from 2004 through 2007, compared to a 13-year average (1995-2007) of 1,200 units per year. Due to a lack of zoned land, deliveries are not expected to total anywhere near the long-term historical levels. There is only one new apartment project under construction in DuPage County, which had been the most active submarket. Regency Place is a 112-unit mid-rise project located in Oakbrook Terrace, Illinois, which broke ground earlier this year. In all, only 202 market-rate apartment units will be delivered in 2006 in the entire suburban Chicago marketplace. Given the long lead times for entitlements, we do not expect any significant delivery activity to occur in the suburbs until 2008 and beyond.

After only 274 new rental units were delivered in 2004, developers delivered three rental projects totaling 909 units in 2005. Those three buildings achieved record-breaking absorption and entered the market with no concessions. Effective rents of $2.10 to $2.45 per square foot were introduced and accepted by the marketplace.

CBRE is currently tracking three deliveries totaling 1,258 units this year and 1,306 units delivering during 2007, based on projects that are under construction at this time. While it is anticipated that The Habitat Company will deliver the entire 421-unit Kingsbury Plaza development in 2007, Magellan will deliver The Tides in late 2007 with a large portion of the building actually coming on line in 2008. Lincoln Properties, along with Equity Residential, is developing a 278-unit high-rise at 1401 South State Street in the South Loop. Given the active development pipeline, the market could see more than 1,300 units delivered in 2007 and possibly 2,000 units in 2008.

The most recent delivery to occur in downtown Chicago during 2006 is The Streeter, a 481-unit high-rise in the burgeoning residential submarket of Streeterville developed by the local firm Golub & Company. The Streeter opened for occupancy first in late July and is experiencing a rapid lease up due to the excellent location, attractive finishes and amenity package.

According to ARC, Class AA and A effective rents have increased approximately 6 percent compared to second-quarter 2005, while Class B effective rents were up more than 8.5 percent on a year-over-year basis. According to the ARC Second Quarter 2006 Benchmark Report, “job growth, depletion of supply due to the 2005 condo conversions and minimal new units coming on line have converged to produce some of the highest net historical gains in the market. Current occupancy levels would suggest that owners have significant room to push rents further.”

Concessions are virtually non-existent and for-rent condos dropped more than 30 percent from second-quarter 2005, while the amount of condos rented during the quarter as up 22.5 percent. This indicates that the shadow rental market is being absorbed and eliminated. Given that occupancies are reaching full capacity, CBRE is forecasting that investors will continue to aggressively increase rents at levels significantly above inflation for at least the next 24 months.

— John Jaeger is a first vice president in the Investment Properties|Multi-Housing Group of CB Richard Ellis|Capital Markets in Chicago.

Chicago Office Market

On the surface, there are a number of signs that show an improving office market in Chicago’s central business district (CBD). There has been more than 1 million square feet of positive absorption in the first half of the year, direct vacancy rates have dropped below 16 percent for the first time since 2004, and the sublease market is at its lowest point since 2000 (just under 3 million square feet). However, when analyzing recent market transaction comparables, it appears that this improvement is concentrated more in the Class A market than it is occurring in the market as a whole.

For the most part, landlords continue to offer low rental rates and generous concession packages in an attempt to retain existing tenants as well as attract new users. This continued trend, along with tenants’ fear of missing an opportunity in this advantageous leasing market, has resulted in a great number of large tenants in the market. Currently, more than 50 companies with space requirements of at least 20,000 square feet are actively evaluating their real estate positions.

One issue facing some of these tenants, many of which are focused on Class A buildings, is the lack of available supply with good views. Currently, there are less than 25 Class A properties with contiguous blocks of at least 20,000 square feet above the 24th floor, and there are only 10 that can offer at least 50,000 square feet of available space.

The newest office developments have been very successful in landing tenants. The CBD’s four newest buildings — Hines’ One South Dearborn, Hyatt’s 71 South Wacker, The John Buck Company’s 111 South Wacker, and Fifield’s 550 West Adams — all average occupancy rates of more than 90 percent. With little space left at these modern marvels, the more classic, second-generation Class A buildings, such as 77 West Wacker, 225 West Wacker, and 181 West Madison, are benefiting from this recovery, with considerably higher lease activity levels now than in recent years.

The next large-scale project of more than 1 million square feet is not expected until 2009, when Hines delivers its next downtown Chicago project at 300 North LaSalle. When that project comes on line, it will be interesting to see if these second-generation, Class A buildings continue to trend toward higher rental rates and decreasing concessions, forcing some of the view-conscious tenants to forego aesthetic criteria in favor of a more economical real estate choice.

— David G. Burkards is an assistant vice president with Chicago-based MB Real Estate | Corporate Services.

Chicago Industrial Market

Fith substantial positive absorption and single digit vacancy rates, Chicago’s industrial submarkets are thriving. There is a high level of demand for vacant land among developers and users, although rental rates for existing properties have remained flat. With approximately 8 million square feet of space absorbed through the end of the second quarter, the overall vacancy rate is down 10 basis points to 8.4 percent, the lowest level since 2001. Demand for rail-served, large cube distribution centers in the outlying counties and the proximity of large intermodal sites in central Will County — including the Elwood Hub at the old Joliet Arsenal and along the Interstate 55 corridor located 40 miles southwest of the city limits — have driven up the cost of land, with good infill sites at a premium. This has pushed developers to the outer edges of the Illinois/Indiana border and west through the Interstate 39 Corridor into LaSalle, Peru, and DeKalb County, Illinois, where taxes are generally lower than in Cook County. 

Recent market activity in northeast Illinois continues this pattern of exurban warehouse/distribution migration, with close-in locations becoming less of a requirement as multiple states are often being served by the new big-box centers. A 202,000-square-foot build-to-suit logistics center for St. Paul, Minnesota-based 3M Corporation recently opened in the Peace Corporate Center in DeKalb east of Interstate 39 and 50 miles west of Chicago. Wal-Mart has launched operations this summer in its 3.4-million square-foot distribution facility in the CenterPoint Intermodal Center (CIC). And in the largest industrial transaction of the year Kimberly-Clark leased the 806,000-square-foot warehouse/distribution Park 55 Building 3 in Romeoville from Duke Realty Corporation.   

Finding affordable land is the big issue. In the village of Minooka, Illinois, located in southwest Grundy County, an acre of land that sold for $20,000 10 years ago is typically going for $75,000 to $80,000 today. Similarly, inner-market land values are rising incrementally in the O’Hare International Airport area as a consequence of the Airport Modernization project and runway addition. This year, land prices reached $19 to $20 per square foot in Bensenville, Illinois, an adjoining airport submarket, although the average submarket price measures $15 to $16 per square foot. Investor interest in O’Hare properties runs high in this traditional owner-occupied market. The airport expansion has set in motion a spate of build-to-suits for firms relocating from the 141 acres of land ear-marked for the new runway on the airport’s north side. The burgeoning logistics market requires that the new, high-end facilities feature 30-clear ceiling heights, trailer storage and exterior dock ratios of one dock per 3,000 square feet of building. However, much of the existing O’Hare market lacks the inventory to satisfy demand, hence growing speculative construction in a market where land values have appreciated 60 percent on average during the past 4 years.     

Logistics firms and retailers that need to be in Chicago face the option of rehabbing or razing older second-generation space. At the same time, the city of Chicago has experienced a net decline in industrial construction. Soaring costs of energy and building materials is a big area of concern locally. Five planned manufacturing districts (PMDs) — a special zoning designation aimed at encouraging investment, restoring the city’s historic manufacturing base, and providing for stable and predictable industrial environments by curtailing residential and retail development in select areas — were created within Chicago’s 22 recognized industrial corridors. However, despite the hopeful mandate, residential condominium conversion typically secures higher prices for land, and older industrial properties inside the city limits continue to be demolished to make way for condo and retail development, forcing industrial users to migrate south and northwest.

Chicago is home to one of the top five largest container ports in the world. Overall the region’s industrial base, with more than 1 billion square feet of space, is flourishing despite rising construction and land costs, and an aging rail infrastructure system that has created choke points and contributed to gridlock. Relief may come in the form of an industry/governmental partnership called CREATE that will earmark $1.5 billion into long over-due infrastructure updates.   

— Richard Lindberg is the senior business writer and marketing manager for the Chicago offices of Grubb & Ellis.

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