Chicago Real Estate

Although the storm has been raging for some time and appears to be diminishing, we have not quite reached an end. Values continue to fall and cap rates continue to rise across the broader real estate market. Real Estate Research Corporation just reported that cap rates for multifamily rental product have shown the first small decrease since the recession started – a small ray of light through the storm. Real estate values will continue to be discounted, approaching a flat bottom later in 2010-2011. As the economy recovers, another cloud approaches: $3.2 trillion in maturing commercial real estate debt. Much of the debt was lent at the height of the market in 2005-2007. The ability to refinance much of this debt will be hindered by property fundamentals: vacant space, reduced cash flows and diminished valuations. Extend-and-pretend will end, sooner or later. There will be winners and losers during this period. No storm lasts forever. As distressed assets continue to need recapitalization in the future, opportunities appear to acquire good cash-flowing assets well below their intrinsic values. Now is the time to buy "right" so you can sell "well" in the future.

Chicago Office Market
Jones Lang LaSalle reports that class A multi-tenant office vacancy in the Central Business District has reached 15%. Three new Class A buildings are being delivered which will add over 3 million square feet to the market. In addition, there is 4 million square feet of sub-lease space now available in the downtown market. Supply is increasing; demand is decreasing, so prices are falling. Gross asking rents have declined 5%. Class A net rent is now around $25 to $35 per square foot. Tenant improvement allowances are up in the $65 to $85 per square foot range and free rent can be as much as 6 to 11 months, depending upon length of lease. Total CBD office inventory is about 135 million square feet. 20 million square feet of office space is vacant – a 3 to 4 year supply of inventory in the CBD. The suburban market is seeing greater pains with total vacancy around 25% and net rents down around $18 to $24 per square foot with free rent routinely above 6 months.

Chicago has a solid well-diversified economy and highly-educated work force. As the recovery approaches, job-creation will overtake lay-offs and office vacancies will diminish. The velocity of recovery is uncertain and will be bumpy, but as the long-term economic outlook for the Chicago economy remains strong, long-term real estate values remain solid. Discounted asset purchases today will be rewarded by attractive investment returns tomorrow.

For-Sale Residential Market
Appraisal Research Counselors indicate that, since 1990, over 48,000 new for-sale units were added to the downtown market – an average of 2,400 units per year. Despite large price discounts over 25%, only about 600 units will be absorbed by the market in 2009, mostly in the $300 per square foot product sector. Due to job loss, lack of buyer confidence and scarcity of financing, buyers continue to walk away from contracts and their deposits. With over 4,300 unsold units in inventory and an additional 986 units in the pipeline, Chicago easily has a 3-year supply on hand. Developers are trying many means to rid themselves of excess inventory – price cuts, free parking, free upgrades, special financing for home buyers and conversion to rental. The $8,000 federal tax credit for first-time homebuyers has been extended until June 30, 2010. This will help sales to entry-level market segments. The move-up market will be helped by a new tax credit of up to $6,500 for some buyers. Nonetheless, absorption of excess inventory will remain difficult until job creation fully recovers.

Multi-Family Rental Market
Demand for class A and B apartments continue to increase in the face of an uncertain job market. Overall, total occupancy has reached 94%. Appraisal Research indicates that class A effective rents are at $2.10 per square foot, and class B effective rents are at $1.88 per square foot. Market fundamentals remain attractive which would normally lead to new development in the rental sector. However, financing new construction remains difficult. While Federal capital is available through Fannie and Freddie, equity is shy and costly. In the meantime, rental inventory will increase slightly as the pipeline delivers and unsold condominium units continue to be converted to rental.