Principal at Frontline Real Estate Partners and Managing Director at MorrisAnderson

By most measures, the national commercial real estate market is well into its recovery phase. And Chicago, the nation’s third largest metropolitan market, is following this trend. It may not be recovering as quickly as coastal markets such as New York, Los Angeles, San Francisco and Washington, D.C., but all of its vital signs are pointing up. In the second quarter of 2011, industrial leasing activity in Chicago increased by more than 37 percent compared to 2010, according to commercial real estate firm CB Richard Ellis. The city’s retail market posted a 9.7 percent vacancy rate, a 220 basis point decrease from 2010.

However, a closer look at the market reveals a different picture, both for Chicago and for the nation as a whole. Obscured by the positive trends and increased transaction velocity is an important distinction between asset classes. While there are significant signs of improvement in the CRE market, the bulk of that growth is concentrated at the extremes of the asset-class spectrum. This “barbell effect” has left the middle remaining weak, with full recovery a long ways off.

The Two Ends of the Spectrum

Reports of substantial improvement in Chicago’s commercial real estate market have relied heavily on data from Class A and trophy properties. This top tier of the market benefits from long-term, stable income streams generated by creditworthy tenants. For these types of properties, prices are back to peak levels, with demand far exceeding the supply of available assets. Huge sums continue to chase stable core properties in major markets, such as downtown Chicago, especially in the multi-family and retail sectors. An index of non-distressed, trophy properties in six large cities, including Chicago, has risen 26.7 percent since Dec. 2009, according to Moody’s.

The distressed end of the market has seen a parallel renaissance of investor interest, with several large pools of notes recently being snapped up from the market. In June, Chicago bank MB Financial announced that it had agreed to sell a portfolio of 631 loans, the majority of which were non-performing or sub-performing, to Colony Capital. Similar deals have sprung up around the country as investors looking to place capital in the CRE market take advantage of the opportunity to acquire large portfolios at bargain basement prices.

The Hidden Story

While these improvements are grabbing headlines, a different story is unfolding in the middle market of the commercial real estate industry, defined as:

• Class B and C properties, many of which are older properties with functional obsolescence or deferred capital expenditures
• Properties in secondary and tertiary markets, such as the outlying suburbs of the Chicago metro area and the collar counties, where recent commercial development was dependent upon new home developments that are now either stalled or in foreclosure
• Properties under $10 million in size, representing a major segment of the overall CRE landscape
• Properties leased to local, non-credit tenants, such as unanchored shopping centers and industrial properties.

There are a number of factors weighing down the recovery of the CRE middle market.

First, while the recession has officially ended and many larger companies have returned to business as usual, most middle-market companies remain in a recessionary mindset. The National Federation of Independent Businesses’ optimism index is still deep in the trough it hit the bottom of in 2009. In August, only 21 percent of survey respondents said they were planning on making capital outlays in the next three to six months.

Second, it continues to be extremely challenging to finance CRE purchases with conventional debt financing. Total outstanding loan balances tied to Chicago-area properties are now nearly 40 percent lower than they were at their peak in 2008, according to Trepp, LLC. The minimal debt financing that is available for CRE is targeted to the larger, stabilized properties that fall outside of the middle market. Meanwhile, local and regional banks catering to the middle market are still working through challenges with their existing CRE portfolios. These banks had a greater percentage of their money tied up in CRE, so the return to a normalized lending environment will take longer for them.

Finally, there continues to be a lack of investor appetite for middle-market commercial real estate properties. Most available capital is focused on either the stabilized core properties or the enticing opportunities available in the distressed market. Investors are concerned about the fundamentals of buying properties with non-credit tenants, and have little opportunity to leverage their purchases with debt financing.

The Reset Button

Until this year, the “extend and pretend” policies of lenders and special servicers created a dearth of transaction activity in the CRE market. However, a new trend emerged this year with banks more actively disposing of notes and REO properties, initiating foreclosures and appointing receivers. Banks are proactively dealing with properties that have languished over the last several years and now require active management. This is a positive sign for the market; we are dealing with the challenges and have begun the process of hitting the “reset” button.

There is no question that the market has experienced major improvements compared to 2009 and 2010. Certain segments of the market have even returned to pre-recession levels. However, we are still in the early to middle innings of a “reset” of the overall commercial real estate market. The middle market, which was most adversely affected by the great recession, continues its slow road to recovery, and the potholes along that road are on full display in the Chicago area, especially in the outlying suburbs and the collar counties. Until the Chicago economy improves, economic uncertainty diminishes and real estate fundamentals stabilize, Chicago’s commercial real estate market will experience continued challenges.

About the Author

Matthew Darin is a principal at Frontline Real Estate Partners, a real estate consulting and advisory firm, and managing director at MorrisAnderson, a leading financial and operational advisory firm specializing in insolvency services. Darin earned dual bachelor’s degrees in accounting and business administration – management information systems from the University of Illinois – Urbana-Champaign, graduating with honors. He is a Certified Public Accountant and a licensed Real Estate Salesperson in the State of Illinois. Darin can be reached at mdarin@frontlinerepartners.com

Headquartered in Germany, Lenze is a world-wide specialist in drive and automation technology offers products, solutions, systems and services for mechanical and electronic drives as well as complete automation systems from a single source.

Constructed in 1995, 125 Wall Street is a 100,377-square-foot free-standing facility. Located in the High Grove West Business Park in Glendale Heights, the cross-docked building features over 6,000 amps of power, 30’ clear ceiling height, 7 exterior docks, and 1 drive-in door. Significant work has been started on both interior and exterior renovations.

Matt Mulvihill of Grubb and Ellis represented Lenze in this lease transaction.

Executive Vice President – Arthur J. Rogers & Co.

One of the hot button topics in today’s political environment is jobs. The economic downturn of the past few years came with staggering job losses; and while we have moved toward recovery, the unemployment numbers remain at staggering highs. According to the United States Depart of Labor’s Bureau of Labor Statistics, the national unemployment rate as of July 2011 is 9.2 percent (up from 9.1 percent in May), and in Illinois it’s hovering around 8.9 percent. In other words jobs, and job creation, will be the number one issue of the 2012 presidential election debates.

Regardless of where you fall on the political spectrum, common rhetoric in the jobs debate focuses on the loss of manufacturing positions to other countries, China in particular. It’s a charged course of dialogue that easily elicits fear in many Americans; after all, the thought of losing a significant portion of the country’s livelihood to a growing foreign powerhouse can be quite intimidating. And this isn’t a new phenomenon. Throughout the past decade the United States has focused on reducing our reliance on the manufacturing industry while looking to boost the service industry to create more jobs – particularly in the financial sector. However, as was made clear by the devastating turn of events in the past few years, our economy cannot rest solely on the strength (or lack thereof) of our financial industry.

Case in point, as was noted in an article published June 27^th in the Wall Street Journal entitled, “Is Germany Turning into the Strong, Silent Type” both the United States and the United Kingdom admonished Germany for “clinging to an outdated manufacturing base that couldn’t possibly compete with lower-cost industries in China and Eastern Europe.” The view from outside Germany was that the country should focus on deregulation while seeking more growth in the financial services industry. Sound like a familiar course of action? However, while we Americans are shaking our heads in hindsight, Germany had some foresight.

Today the German economy is the strongest in the West and is well-positioned for many years of increasing exports. So how did they do it? According to the same article in the WSJ, former German economy minister, Michael Glos touts, “We got through the crisis better than almost any other country. It isn’t a miracle, it’s because we stuck to manufacturing whereas other countries deindustrialized.” Germans held to several philosophies in order to make this work, including an aversion to debt and a belief that quality goods do create prosperity. Or as the article said, “…solid public finances, a balance between business flexibility and a strong social safety net, and a belief that well-made goods, not financial wizardry, are the foundation of [Germany’s] prosperity.”

What is the lesson for Chicago, as well as the rest of the nation, in all of this? Quality goods do matter. Rather than being overly concerned about the loss of low-paying manufacturing jobs to China; we should instead focus on what we do well here in America – and what we do well is produce educated, talented and creative engineers, designers and entrepreneurs who in turn create quality products. High-quality goods do pay off, just ask Germany whose “Made in Germany” label has become associated with a quality many find worth paying for – including China. In fact, the same scenario is paying off for many U.S. manufactures today. It’s not just a hypothetical situation – it is actually happening.

According to the U.S. Census Bureau, U.S. exports to China in 2000 totaled around $16 billion while U.S. imports from China totaled about $100 billion – or 6-1/4 times more imports than exports. This is about what you’d expect given our national rhetoric, but the interesting thing to note here is how those numbers look 10 years later. In 2010, U.S. exports to China approached $92 billion and imports came in around $365 billion. The difference in imports this time is only 3.9 times more than that of exports.

While these statistics are due in part to the weak U.S. Dollar, it’s also directly related to the fact that the U.S. produces a quality product – particularly when it comes to machinery – and those products are desirable in the production of other goods. Also contributing to the statistics are an improved U.S. productivity and a drive to move manufacturing closer to where the products are being sold. This, in and of itself, is a huge benefit for the U.S. which boasts the largest consumer market in the world. Additionally, the U.S. is in a position to improve the manufacturing process. We have a vast number of out-of-the-box thinkers and entrepreneurs, all of which put the country in a position of strength when it comes to manufacturing.

Where does this leave us, particularly with such a large industrial and manufacturing base in the Chicago area? In a solid position to export parts and machinery to other nations which then finish the production process; thereby creating a truly global manufacturing industry. It’s an exciting time to be in manufacturing and despite what you may read, consider the following from an article entitled “The Exaggerated Rumor of Manufacturing’s Death” by Mark Henricks and featured on Bnet, The CBS Interactive Business Network, “…the torch as top global manufacturer passed to China. That’s a momentous event, surely, but it’s worth noting that China, though producing slightly more than the U.S., has a population more than four times as large. U.S. manufacturers still produce twice as much as Japan, three times as much as Germany, and 10 times as much as India.”

So what’s the moral of this story? We just need to look to our neighbor to the West for answers. Patience, fiscal responsibility and a reliance on our strengths – education, talent and quality – will serve our manufacturing industry, and ultimately our entire economy well in the long-run. We don’t need to fear China, or bemoan the loss of our low-paying manufacturing jobs. In fact, U.S. manufacturing levels are at the highest levels in seven years, according to the Institute for Supply Management. What we need and what we can have, is access to well-paying, quality jobs. We don’t need jobs for jobs’ sake. We need jobs that will offer the citizens of this country a better living. Likewise, we don’t want to be a low-priced provider of goods. We want to be known for quality. We want “Made in America” to carry behind it the force of our great nation.

Kelley Drye & Warren LLP

Distressed properties have long been a target for investors and the continuing weakness in the property market is luring many new players.  Foreclosure auctions involving lenders are a typical option investors use to acquire distressed properties.  However, many investors are acquiring properties by opting to purchase a foreclosing lender’s note and mortgage at a discount.  This article examines common pitfalls relating to collecting rents when an investor purchases a note and mortgage on distressed commercial properties.

Stepping Into A Lender’s Shoes And Collecting Rents

An investor can purchase a note and mortgage and step into a lender’s shoes at any time before the entry of a foreclosure judgment to acquire a distressed property.  Under the Illinois Mortgage Foreclosure Law (IMFL), purchasing a distressed property’s underlying note and mortgage allows an investor to exercise all the benefits the original lender would have enjoyed, assuming there are no transfer restrictions in the lender’s original documents.  To acquire the property, an investor can negotiate with the defaulting borrower to enter into agreed foreclosure transactions (such as “consent foreclosure” or a “deed in lieu of foreclosure”), and avoid lengthy litigation proceedings by settling claims with the borrower while acquiring the property.  Or, an investor may itself initiate or continue as a “lender” in a foreclosure action, minimizing competing bids at the auction to acquire the property.

Whichever option an investor chooses to acquire the property, many look for an immediate source of funds from the commercial property’s rents.  This tactic is often more complicated than many investors expect.  First, collection of rents requires possession of the property.  The Illinois Supreme Court ruled in Comerica Bank-Illinois v. Harris Bank Hinsdale, 284 Ill. App. 3d 1030 (1st Cir. 1996) that a lender (and by implication – an investor holding the debt) must have possession of the foreclosed property to collect rents even if the lender’s documents explicitly state that the lender may collect rents after default.  The Court’s ruling rests on a public policy rationale:  A lender may not unilaterally collect rents on a property without also assuming the burdens of possessing that property, such as upkeep and maintenance.  Therefore, even though some lenders continue to include such provisions in their mortgage agreements, an investor may not rely on these provisions to secure an immediate source of funds after acquiring a lender’s note and mortgage.  Second, in Illinois law, a borrower owns the property until after confirmation of the sheriff’s sale.  To the extent an investor receives rents and other income derived from the property during the pendency of the foreclosure, it must apply this amount against the amount of the borrower’s debt.

Receivers And Mortgagees In Possession

Still, depriving a borrower of rents during the foreclosure process can otherwise be advantageous to an investor.  The IMFL provides two mechanisms for removing possession – and rents – from a borrower prior to a foreclosure judgment.   The most common is the appointment of a receiver to manage the property pending a foreclosure.  A receiver is tasked with collecting rents on the property and maintaining the property, among other statutorily delineated powers, under an appointment order of the Court.  However, despite prevailing misconceptions, a court-appointed receiver in foreclosure actions does not act on behalf of a lender or investor.  Rather, an investor may designate the name of a receiver to the Court, who then appoints a receiver to maintain the property as an agent of the Court.  The receiver holds rents and other profits in excess of expenses pending release after the sheriff sale confirmation.

Alternatively, the IMFL permits the appointment of an investor as “mortgagee in possession.”  This allows an investor holding the mortgage to directly collect rents and be responsible for maintaining the property during the foreclosure action.  However, an investor must either segregate these funds or apply the rents to the outstanding balance on the debt as it could be subject to an accounting of the funds collected and expended until the Court’s confirmation of the sheriff’s sale.

Under either scenario, the IMFL favors appointment for commercial properties.  In fact, the Court must make an appointment:  (i) if the investor requests one, (ii) the mortgage agreement states that it permits an appointment, (iii) the lender demonstrates a default on the note, and (iv) the borrower fails to present a “good cause” why such the appointment should not be made.

Setting Expectations

Assuming process of service on the borrower in the foreclosure action, an investor’s request for appointment of a receiver or as mortgagee in possession may be lengthy, perhaps taking as long as six to 10 weeks.  Accordingly, it is recommended that investors file their request with the foreclosure complaint, or as soon as possible after purchasing the note and mortgage, and expect at least a couple months delay after purchasing a distressed property’s note and mortgage before depriving the borrower of rents.

Michael R. Dover is an attorney in the Chicago office of Kelley Drye & Warren LLP.  He represents banks and receivers in commercial litigation relating to secured interest lending and deposit accounts, and assists communications companies in litigation matters involving commercial claims, patents, antitrust and monopolization claims.  He can be reached at mdover@kelleydrye.com.

Executive Vice President – The Alter Group

With the nation’s banks sitting on between $1.2 and $1.3 billion worth of capital, they are nevertheless reluctant to lend on commercial real estate because of the elevated level of risk and current valuations of properties already on their books.  Many banks own portfolios of commercial real estate whose valuations have declined significantly and do not want to increase their exposure.

Currently, banks are under pressure to de-leverage and raise their book capital ratios to assure that they have adequate liquidity to cover losses.  This is critical because they are carrying approximately $1.6 trillion in loan balances on commercial real estate.  This is 14 percent lower than the 2008 peak, which indicates that banks are writing down and selling loans and not lending as much as they did previously.

As long as banks are risk averse, the capital markets will not function at a pace considered to be anywhere near normal.  Typically, banks account for half of all lending; CMBS falls between 25 and 30 percent; and insurance companies, Fannie Mae and Freddie Mac combined contribute just 10 percent.

Extremely limited capital is available at present to finance speculative construction or significant land acquisitions.  If a project has credit-worthy users and attractive lease terms, capital may be available.  Even in these situations, developers might have to submit their proposed plans to upwards of 30 banks before finding a source willing to provide financing.  Interest rates are still attractive, but vary depending on the deal and are likely to be in the 6.5 percent to 7.3 percent range.  A 25-year term with a balloon in five years is typical.  In some instances, developers may be asked for a personal guarantee.  Construction loans are perceived as the riskiest and hardest to attain, experiencing a 60 percent drop in originations since 2008.

Some capital is flowing and is centered on gateway markets like New York City and Washington, D.C.  Both markets are experiencing price inflation and cap rate compression, especially for core assets.

One of the challenges is that appraisals are difficult due to minimal deal activity in the investment markets.  There is a strong focus on cap rates as the leading value indicator. A strong perspective of replacement cost impact is advisable in case the income approach utilizing cap rates is too low.  Loan-to-value ratios of 60 percent are likely to be the norm for the foreseeable future.

The Status of CMBS

Historically, refinancing commercial properties has been accomplished through CMBS.  Because this market currently totals only approximately $40 billion, a significant source of that refinancing has disappeared.  Compare that to 2008, when CMBS transactions totaled $300 billion.  It’s unlikely that CMBS will ever return to the historic high levels it attained between 2000 and 2008.

Thanks to the fall-out of the CMBS market, there is virtually no permanent mortgage market in place.  Banks are offering a net term of five-to-10-year debt with the condition that they are able to resell it on the CMBS market.  The alternative is hard money lenders who typically are at very low loan-to-value ratios.

It should be noted that CMBS is showing some signs of life and is likely to recover slightly during 2011.  Markets are active; lenders and investors are showing renewed interest; owners are willing to deal to close transactions.  CMBS issuance reached $11.6 billion in 2010 after a scant $3.1 billion in 2009, according to the weekly newsletter Commercial Mortgage Alert.

What About Equity?

Generally speaking, equity is taking a hit because this is where the initial losses occurred.  Transactions with severe equity gaps are not closing.  Upper levels of the capital stack — equity, mezzanine debt or participating debt – are being written down.  The equity gap is what is fostering much of the delay and the willingness to “kick the can down the road” rather than deal with current valuation vs. the original capital stack valuation.

Several billion-dollar deals recently have made commercial real estate developers and owners more optimistic about the investment market.  The FTSE NAREIT (National Association of Real Estate Investment Trusts) reported returns of 27.43 percent in 2009 and 27.58 percent in 2010.  Wall Street’s consensus is that commercial real estate values will grow from five to 15 percent this year.  Minimal demand for space has cut new construction, giving current buildings the opportunity to recoup some of the value they lost.

The Role of Institutional Investors

Institutional investors have cut back severely on their allocations for commercial real estate.  Still, some are aggressively pursuing Class A assets and are able to obtain financing to purchase trophy buildings in top-tier markets.  Risk-tolerance is relatively low for these assets, which makes them all the more popular.

On the other side, non-performing and non-stabilized assets in secondary markets are still considered challenging in terms of liquidity for financing and the risk-return matrix for investors.  As a result, capital avoids those properties.

Richard Gatto spearheads The Alter Group’s business development, corporate services, leasing and build-to-suit activities.  Additionally, he supervises all client contract negotiations and financial structure underwriting for the firm’s portfolio properties.

Senior Vice President-UGL Services Capital Market Services

Expectations for a modest recovery in the Capital Markets in 2011 have been “spot on” as the activity of the second half of 2010 was pivotal and has continued led into the first quarter of 2011. A continuation of the “cleansing” of distress assets has resulted in greater velocity in the debt markets, albeit still rather slow and steady compared to the past. Significant increases in lending activity have been seen with life companies and large commercial banks. Additionally, more CMBS issuances have resulted in revised volume estimates for 2011 ranging now from $30 to $50 billion.

Institutional investors have started to improve their forecasts for the future of commercial real estate and have initiated new allocations for 2011 in commercial real estate investments. Private Equity funds full with capital have started to spend and will continue their spending ways throughout 2011. Many are back or soon will be back “on the street” raising more money for the next generation fund as bid/ask spreads for their prospective acquisitions narrow.

Low interest rates and a continued “soft” prediction from the Fed on future rate hikes through 2012 have speared on a resurgence of investment in all asset classes. Overall, core property values have adjusted within a range of 15-30% from their lows based on region and asset class.

Ok this sounds great so what’s the catch?

Simple, the new world order is described in a few words. The Haves- Assets that are Core, Mission Critical, Having Good Fundamentals and a Stable Sponsor, that are located in Gateway Markets with Positive Cash Flow and Good Long Term Tenancy.

Several billion dollars of investor capital is now chasing investment grade tenanted assets with a minimum lease term of 15 years, where the asset is described as critical to running the tenants’ business (such as the firms headquarters or key manufacturing or research and development facility) and will survive a bankruptcy reorganization filing should one occur. Additionally, the asset should be located in a major metro or secondary market that is a critical driver for the satisfactory performance of tenants existing and future business plans.

Assets of this caliber have been and will continue to fetch high investor interest which will result in greater valuations. Lenders are also hungry for these types of assets and their pricing will reflect that appetite accordingly.

So what happens to the “The Have Nots”?

Specialty type assets such as golf courses, ice rinks, busted development deals; or those non core lower grade types that lack the location or technological improvements or the quality of tenants that usually do not sign long term leases.

One of the biggest challenges over the last 3 years has been dealing with the “pretend to extend” mentality of lenders. Opportunistic buyers have been deeply disappointed with this logic. The biggest fear in the market is that banks will begin to foreclose at a brisk pace which will begin a downward spiral effect on the capital markets.

Unfortunately, this is and will be the case for “the have nots” through the remainder of 2011 and well into the future. This will include many of the legacy CMBS issuances which are maturing through 2015.

Refinancing non core assets will be very difficult without an infusion of additional or new equity from the borrower. Short term “bridge” or “mezzanine” options may have to be considered but those usually will come with a high price tag. Lenders of these types of notes will require double digit rates, usually in the mid teens all in. Given the current CMBS issuance predictions the market is still way behind the $100 billion per year needed to clear the legacy loans.

There is definitely a yield premium available for these types of assets located in secondary and tertiary markets; however, liquidity still remains very challenging. Valuation may also be effected, as well, since most owners of troubled or under water assets do not have the ability to mitigate current or future maintenance or capital issues the asset requires.

So how do we fix this?

The largest seller pool driving the most sale velocity that will take place in the next few years will be lenders, banks and special servicers. Market momentum will help in the future, as more of both groups trade which will enable financing requirements to continue to ease.

The best advice is to begin an early dialogue with the lender and/or special servicer. Hire a professional that can work through the multiple of layers and processes in an effort to start developing alternatives to a workout process.

The goal of GO TO 2040 is to strategically align public policies and investments, and maximize the benefits of scarce resources as the region adds more than 2 million new residents by 2040. The plan reflects more than three years of research and careful deliberation by CMAP, its partners, and stakeholders, and includes feedback from more than 35,000 residents.

JCF Real Estate’s Paul Robertson and Steve Chrastka recently spoke with CMAP’s Executive Director Randy Blankenhorn regarding how Kane County and its communities can benefit from implementation of GO TO 2040.

Paul Robertson: What is the GO TO 2040 plan and does it predict what will occur in the Kane County area over the next 10, 20, 30 years in terms of commerce, demographics and other areas of growth?

Randy Blankenhorn: GO TO 2040 doesn’t actually attempt to predict the future. That’s a crystal ball that we don’t have. What we do, rather, is layout policy issues that we think will drive decisions throughout the future. GO TO 2040 is about saying here’s what we need to do to create the kind of business environment where all types of business can be successful.

We talk a lot about what we expect needs to happen in terms of economic development, in terms of demographics, etc. The population is going to be

Steve Chrastka

older and it’s going to have significant minority populations in all parts of our region. So this plan talks about that demographic shift and the importance in planning for it. Additionally, how do we think about that in terms of business and economic development? We look for a region that offers jobs throughout all parts of northeastern Illinois. It’s key that we’re not a one-company town.

Robertson: That’s the industry clusters that are mentioned in the GO TO 2040 plan?

Blankenhorn:Precisely. We must look at where our strengths are, and where we think those strengths are going to be over the next 30 years as we build on those strengths. For example, in regard to green technology and where we go in the new technologies of the future, I think there are significant decisions that this region needs to make about how to get into that kind of business. Everybody wants to be the green economy center of the world. What makes us special is that we already have a solid manufacturing base here. We already have a distribution network. We have a strong workforce, but we need to make sure that it is always adaptable to the evolving needs of our business community.

Robertson: What is the GO TO 2040 plan’s vision for Kane County in terms of residential, retail and commercial aspects?

Blankenhorn: We expect significant growth in Kane County. We’re going to add 2 million people to this region over the next 30 years. That growth needs to be focused in existing communities, including those in Kane County, which has a distinct character that residents want to see preserved.  We need to think about residential patterns, about how to use infrastructure that’s available, and about some of the mixed-use developments like the Corporate Reserve that you’re doing in St. Charles (a 50-acre business park developed by JCF). We need tobring jobs and houses closer together, reduce peoples’ commute time and improve theirquality of life.

Robertson: So what does GO TO 2040recommendin terms of stimulating economic growth in Kane County?

Blankenhorn: I think there are a number of factors that contribute to the economic strength of the region in general and to Kane County in particular. The first is infrastructure. We’ve got aging infrastructure that we need to take care of. To a certain extent the economy of northeastern Illinois exists because of transportation and because of where we’re located in a national and international global network, so we’ve got to take care of what really is

Paul Robertson

our economic advantage, and that is our transportation infrastructure.

The second is we have recommendations about what we need to do for workforce development. We start that discussion with education. We need to do a better job of educating our children. We need to be training for tomorrow’s jobs and not yesterday’s jobs. The workforce development system, while it works well in some parts of the region, doesn’t work well across the board. We need to get business more involved in it. We really need to talk about streamlining it and making it more efficient.

The other part of what makes business work is when we talk about what we call livable communities. We must continue to make our communities strong and economically attractive not only to businesses, but to the workers who want to live there and raise families. We must continue to think about how we deal with making our community the kind of place where people want to stay and be on the cutting edge of innovations. We’ve got to find better ways for government to support our innovation while at the same time staying out of the way when it’s appropriate. Innovation doesn’t happen because the government makes it happen. It happens because private industry makes it happen.  So we need to change the way the government supports private investment and research and how we raise more venture capital to allow businesses to succeed. Our communities aren’t competing against one another these days — St. Charles against Schaumburg, or Joliet. Together we’re competing against Brazil and India and China for businesses and jobs. We need to be on the cutting edge.

Steve Chrastka: Just a follow-up on what you are saying here. Can you give us an example of where you see this community education coming from?

Blankenhorn: I do think it comes a lot from the existing organizations that are out there – economic development organizations or commerce organizations. How government relates to business has to change. That won’t happen just because we wish for it, however. It’s got to be a joint effort between businesses and government. We’ve got great thinkers here in this region. We’ve got the business community that thinks a lot about what

Randy Blankenhorn

tomorrow ought to be, and we need to harness that energy. How do we bring smart people together that are thinking about new technologies to talk about how we move from that idea into making something happen? Chambers can play a huge role in making that happen, but it’s also a role that the government has to be supportive of.

Robertson: Following on that same thought, what kind of industries does the GO TO 2040 plan think will become more and more prominent tenants within areas like Kane County?

Blankenhorn: I think you all are seeing this in what you’re doing out in St. Charles. Business and financial services are going to be a key part of our economy. We also see opportunities in an information age, and not everybody has to be downtown Chicago to make this work. And there is real opportunity for health care, health care issues and health care provision as a key part of job growth in the metro area.

Additionally, we don’t want to give up on manufacturing. Some people may tend to think we don’t have any manufacturing left in metropolitan Chicago, and that’s certainly not true. There are many examples in Kane County of successful manufacturing that’s still happening. How do we turn that into advanced technologies and advanced manufacturing? The bottom line is that we’ve got to create an environment in which all kinds of industries can be successful in northeastern Illinois. We can’t become dependent on a small handful of sectors, but rather we must have a diverse economy that can work across the region.

Robertson: How could GO TO 2040’s land-use recommendation influence development of Kane County?

Blankenhorn:I think there are great examples of the new downtowns, as we talk about in the plan, seen in St. Charles, Geneva, Batavia, and others in Kane County. It’s a place people don’t just pass through, but rather a place where people stay and gather, a place where people live. We think the fact that they are right on the river, with the parks and walking and biking trails make it attractive. So how do we think about that throughout Kane County? How do we think about making a downtown that thrives and not putting our businesses out 5 miles on the highway? Let’s make it easier for people by usingthe infrastructure that we have and not building more than we need.We need more compact development to make transit work better, to make our communities walkable, to make it easy to get around. GO TO 2040 is not saying that everybody has to live in a small home and a small condo or apartment — the nice thing about our communities is the diversity of the land uses. In general if we get more compact we will become more efficient.

Robertson: What advantages and challenges does Kane County pose for companies and developers looking for sites for their businesses and more developments?

Blankenhorn: I think one of the advantages is there still are opportunities to put tracts of land together. It’s harder and harder to put property together, and we’ve got to make that simpler across the region. Also, redevelopment is important. Over the next 30 years almost all of our towns are going to redevelop in some manner; and we’ve got to be willing to make that a priority. I think one of the advantages is how you can put the appropriate pieces of property together for the appropriate businesses.

Now, part of the negative is how do we make sure we have a full workforce, a workforce for all parts of the economy that’s going to happen out there? How do we provide the kind of housing stock that allows our workers to live close to where they work? I think those are challenges.  Too often decision makers think about transportation congestion only on the expressway system and heading into Chicago in the morning and out of Chicago in the afternoon.  It’s also about local congestion on arterials, and we’ve got to do something about that. We must make access to transit better in Kane County, and I think they are trying. They’re talking about things like Bus Rapid Transit (BRT), which I think is a real option. It’s not so much the downtown-to-suburb commutes, it’s the suburb-to-suburb commutes that were not doing very well at, and that ties up our arterial highways. The challenge now for Kane County is how do they incorporate public transit into the planning of new development, and how do they make it so people don’t have to get into their car for every trip that they take.

Robertson: How will CMAP implement its recommendations for economic development?

Blankenhorn: That’s the tough part. CMAP alone cannot implement any of these recommendations. It’s going to be through the work of our business partners, it’s going to be through the work of our local government partners and our civic partners, and as much as anything through the work of our residents and real estate professionals to make this happen. When we talk about the economic development components, it’s crucial that our business community, our local governments and our residents own the GO TO 2040 plan. CMAP can guide them and give them assistance, but they have to believe that it’s the right thing to do.

Robertson: And you had mentioned in the report the coordination of the different levels of government.

Blankenhorn: Yes. We lead the world in the number of units of government here in northeastern Illinois, and it’s a dubious distinction. We’ve got to do a better job of coordinating services, for two reasons.  The first is that it’s simply inefficient, and our taxpayers deserve more efficient government. The second is that it’s not very accountable anymore.  People don’t even know who to call when they have a problem; they get bounced around from agency to agency, and it really hurts people’s faith in government. By delivering those services more efficiently, our governments may be able to avoid slashing services that are important to residents.  That’s really what that part of the plan is about. The federal government’s and the state government’s job is to help us solve our own problems, not try to fit our problems into their solutions. And that’s really where we’re headed with that coordinated government work.

It’s important to note that many of our recommendations don’t lend themselves to overnight fixes. It’s a long-range plan for the next 30 years. If we don’t start to act now, however, if we don’t start making some movement in the right direction now, it just doesn’t happen. We are where we are, good and bad,is because of decisions that were made 30 years ago, and we have to make good decisions today so that we have a better economy and better communities 30 years from now.

Managing Director-Northmarq Capital

Today’s buzz-words are “Cash Flow”, “Income in Place”, and “Lease rollover”.  Virtually all lenders have returned to the market.  Life Insurance Companies, Banks, CMBS (no longer called Conduits) and many public and private Funds are providing capital to real estate, post recession.  This is a clear sign that we bottomed out in 2009-10 and the future is bright.  We are no longer focused on fire sales, double dips or falling prices.

2011 and 2012 will start the momentum of capital flowing into the markets as loan maturities start to ramp up.  The amount of maturing debt doesn’t dramatically increase until 2013-2015, and there is a strong likelihood that the by then, property performance and cash flows will have recovered a great deal from where they were the last few years.

Transactions have picked up over the last six months, as many sellers believe interest rates are going up and this is the time to sell.  Cap rates remain low, with a shortage of properties on the market and a lot of money on the sidelines.  There seem to be new “Funds” forming daily, and where these funds were previously formed as equity providers looking for investment partners, now they are lenders and direct investors, all seeking higher returns on their investments.  With nowhere else to place their money for greater returns, they are lending now too.

What we have learned in this last go-around of lending is that true underwriting standards must be adhered to and there should be consideration given to the exit strategy at loan maturity.   Life Insurance Companies have traditionally lent on lower leveraged, high quality properties, in primary markets with high quality borrowers.  Although they did not escape the downturn totally, their losses were minor and their rates remain very competitive.  Their appetites are still healthy for Class A properties in Class A markets with Class A borrowers.  They continue to prefer loan leverage of no more than 70 percent loan-to-value and 75 percent on apartments (everyone’s preferred property type).

Banks were in disarray.  Thanks to government help, they are re-defining their roles and looking for the best borrowers, long relationships and requiring recourse.  They are still the preferred lenders when looking for flexible terms, low rates and conservative underwriting, if you can stomach the recourse.  They are the only name in town when looking for construction financing.

CMBS will be a player in this recovery.  It didn’t take long for these intelligent Wall Street investment bankers to find their new niche.  They are backed by the largest financial institutions that repeatedly come up with creative ways to compete, therefore garnering their share of the market.  This time, at least for awhile, they are underwriting the deals more realistically.  They are trying to compete for the larger trophy properties in the largest markets, primarily the coasts and Chicago.  These players seem to be willing to win the business and be very aggressive on the low leverage deals.  They are also willing to provide a larger portion of the capital stack in the form of mezzanine, preferred debt or B-pieces, in order to win a deal.  It seems that they are using these high profile deals to seed their securitization pools, so that they can be up and running as quickly as possible.  As they increase the size of their lending box, liquidity will return to the market.

Last, but not least, we have to stress the importance of the multifamily GSE lenders in returning the liquidity to the markets.  Freddie Mac and Fannie Mae were there the whole time, for the duration of the recession.  It should be noted that the delinquency rates for the multifamily business for the GSE’s are extremely low, at levels far below 1 percent.  The GSE’s never stopped underwriting realistically, and are jeopardized by the single family parts of their companies.  There is no way of knowing what will happen over the next few years, but there is a good likelihood that the agencies will survive in some form, whether privatized or with a form of government guarantee.  They should be the poster child for what SHOULD be the model going forward.  There are hundreds of millions of dollars of long term loans on the books of these agencies that are good, solid, well underwritten business.

All lender types prefer multifamily loans due to demographics, economics, and stability.  There is tremendous competition by all lenders for the lower leveraged deals, as previously mentioned.  Fannie Mae and Freddie Mac are the best execution, by far, for the full leverage loans – up to 80 percent, with 1.25 debt coverage.  Each of the agencies has its niche in product types and has upgraded their student housing programs and senior housing programs in order to expand their market share of rental housing.  FHA is an alternative, although their resources are stretched to capacity, for max leverage of 83.3 percent and 1.20 debt coverage, but based on their own underwriting, which can end up at the same place as Freddie and Fannie.

It sure feels better in 2011 than it has for the last several years.  We will soon be looking back at the recent recession caused by financial and housing upheavals as another cycle that could have been avoided.  Perhaps the same people that contributed to the last downturn might be more cautious and patient going forward, to insure longevity in this next rally.  The future is brightening, like a low energy light bulb that turns on dimly at first and then gradually gets brighter, and hopefully lasts a much longer time.

Susan Blumberg is Senior Vice President/Managing Director for Northmarq Capital in Chicago. She may be reached at sblumberg@Northmarq.com

Managing Director–Sperry Van Ness/Prism Commercial Real Estate, Inc.

By now you may have heard the words, “New Markets Tax Credits.” Or maybe you haven’t.  If you haven’t, don’t feel too bad. In an informal poll of Midwest real estate developers, less than two out of ten developers had ever heard of the New Markets Tax Credit program. And of those who had, misconceptions abound about the program. Here are some quotes:

“Oh, that program funds only health clinics and community centers.” FALSE

“There’s a $5 Million cap on New Markets Tax Credit deals.” FALSE

“You can’t use New Market Tax Credits on shopping center deals.” FALSE

“Hotel developments don’t qualify.” FALSE

“After your done with legal, accounting and consultant fees, there’s nothing left” ABSOLUTELY FALSE!

How about some facts?

According to Rafael Rios, managing director DRI’s Community Development Resource division, in 2010 alone, New Markets Tax Credits purchasers invested more than $2.253 billion in real estate development deals, funding close to ten million square feet of office space and over four million square feet of retail space.

Interested? Yeah. I thought so, but before you start calling Mr. Rios (DRI’s number can be found at the end of this article) you should know at least the basics. A good start would be to read the New Markets Tax Credit “primer” below.

New Markets Tax Credit Program
•    The New Market Tax Credit (NMTC) Program encourages investment in Low Income Communities (LICs). Generally, LIC’s are:
o    Census tracts with a poverty rate of at least 20%: or
o    Census tracts where the median family income for such a tract does not exceed 80% of the median family income for the state or area.
•    The NMTC program provides federal income tax credits equal to 39% of Qualified Equity Investments (QEIs) in Community Development Entities (CDEs) that serve as intermediary vehicles for the provision of loans, investments, or financial counseling in LICs. By way of example, a $20 million development project within an LIC would generate $7,800,000 in federal tax credits, e.g., 39% of $20 million.  At closing, a simple $20 million leverage loan NMTC structure would take on the form diagramed below:

In the above diagramed structure, the tax credit investor purchases the federal tax credits at a discounted rate of $0.72 on the dollar. Over the last year, the purchase price for NMTC has ranged from $0.68 to $0.72. Note too that the CDE has taken a fee at closing equal to 3 percent of the total QEI or project cost, i.e., $600,000 (3 percent 0f $20 million).

During the seven year life of a NMTC leverage loan structure, the Developer/QALICB makes annual interest payments to the CDE on both the A and B QLICI Loans. The CDE passes the QLICI A Loan interest payment up to the Commercial Lender and pays the QLICI B Loan interest payment to the CDE Managing Member as a management fee. The annual QLICI B Loan interest payment is typically calculated at .5 percent of project QEI, e.g., a $20 million project translates to a $20 million QEI which, in turn, results in a QLICI B Loan interest payment of $100,000 annually. At $100,000 annually, the B Loan interest rate is approximately 1.9 percent, i.e., $100,000 on $5,016,000. During the seven year life of a $20 million NMTC leverage loan structure, annual payments would flow as indicated in the diagram below:

The rate, term and recourse requirements of the QLICI A Loan are a function of developer and project credit worthiness. Terms of the leverage loan are typically set two weeks before closing based on either LIBOR or the weekly average seven year Constant Maturity Treasury for the two weeks prior to the week of the closing plus a spread to be determined by the lender based on the credit quality of the borrower. The loan to value ratio will typically be set at 70 percent of value and, the NMTC equity provided by the investor is typically taken into account in meeting these ratios. Maturity of loan is typically no greater than 8 years from closing. While some lenders require a sinking fund for principal payments, the typical leverage loan is interest only with interest payments made monthly.  Typically, the lender and investor will be affiliated, i.e., the lender will have an affiliate that acts as the investor. As such, while the lender will offer a “below market” rate, it will still earn an above market yield due to the NMTC’s. The lender underwrites the credit quality of the borrower, manages all aspects of the loan to the borrower and earns CRA credit for loans and investments made through the CDE.   QLICI B loans are typically non-recourse to borrower.

At the conclusion of the seven-year NMTC leverage loan term, the QLICI B Loan promissory note is subject to a put/call agreement allowing the Developer/QALICB to purchase the $5,016,000 QLICI B promissory note for $1,000,e.g., less than $0.0002 on the dollar. The diagram below illustrates close-out of the NMTC leverage loan structure:

Equity Investors in a CDE receive a federal tax credit for 5 percent of the investment amount for each of the first 3 years and 6 percent for each of the next 4 years (39 percent total). This means the NMTC leverage loan structure must stay in place seven years in order for the tax credit investors to avoid a tax recapture.

According to Mr. Rios, there are certain “rules of thumb” upon which developers may rely. First, in your typical real estate deal, you can figure on a NMTC “subsidy” equal to no less than 20 percent of your project cost (all inclusive). Second, don’t assume your community doesn’t qualify for New Markets Tax Credits. By way of example, all of the property east of State Street, west of Michigan Avenue, south of Madison and north of Roosevelt is within New Markets Tax Credit eligible census tracts. Who would have thought? New Markets Tax Credit financing can even be used for mixed-use developments provided that annual residential revenues don’t exceed 80% of total project revenues.

Now, as for that number you can reach Mr. Rios at 312-368-0770. If you want to find out whether your project is in a New Markets Tax Credit eligible area, go to the Novogradic website at novoco.com.

Oh. BTW. We expect a new round of NMTC allocation will be announce next week in the amount of $3.5 BILLION. Happy hunting!

Dan Martin, CCIM, Managing Director, Sperry Van Ness/Prism Commercial Real Estate, Inc. in Arlington Heights, Il.  Martin has now sold, leased or bought over $400 million in primarily retail properties.  Recent deals have brought him face to face with realities of the New Markets Tax Credit Program, so the result is this article (with intellectual help from many).  Dan can be reached as always at his email address, dan.martin@svn.com

Podolsky Northstar CORFAC International

Economists continue to point to a near-term climate that will be void of sweeping, across-the-board gains in employment. Most companies have learned or are learning to use people and technology to improve efficiencies and hold the line on costs.

The commercial real estate industry cannot look to the entire marketplace to be relocating and expanding its operations. Instead, it must look more carefully at specific growth industries/industry segments. Three industries showing great signs of promise include:

• Chemical—2009 and 2010 were very good years for the chemical industry, and 2011 is generally seen to be increasing further over 2010 levels. The strength of this industry is due to the global increase in demand for chemicals and chemical-related products. A strong chemical industry in the United States will help employment and other types of expansion, including the development, leasing and sale of commercial real estate.

• Food/Food Related—This industry shows great promise. Increasingly, retailers are expanding into the food business. As they expand their coverage, or establish new lines, it adds an increased demand for the food supplies and the equipment (freezers and coolers, e.g.) to conduct business. Dollar General, for example, recently announced it would add 625 new stores nationally, with many of them selling food items. This expansion is similar to efforts by Target, Meijer and Walgreens, among others, to capitalize on consumers’ busy lifestyles and efficiency needs.

The increase in sales of/demand for organic foods is another significant development in the food industry. U.S. purchases of organic foods have increased 70 percent over the past four years, with organic meats a significant growth driver. The U.S. is the largest importer of organic foods in the world. Because of the health benefits associated with organic foods, growth trends aren’t likely to subside any time soon.

• Transportation, Shipping & Logistics—More than 90 percent of world trade is done by international shipping—rail, air, ship, etc. —due to advanced globalization and declining trade barriers. The continued growth and expansion of this industry is a direct result of the concerns for congestion, emissions and high fuel costs. A 2010 study found that 75 percent of transportation companies feel upbeat about their industry in 2011 and beyond.

Many companies look to improve efficiencies and reduce costs wherever possible. Those with significant shipping requirements will continue to move closer to intermodal operations that allow them to harness the benefits of transporting efficiencies. Additionally, they will use other means, such as specialized racking and conveyor systems, to enhance operational efficiencies of the buildings they lease, acquire and develop.

Real Estate Implications and Incentives

These three examples represent where significant future growth and focus likely will take place, from both a real estate and economic development/incentive perspective. In spite of the current state of the market—with the vacancy rate more than 12 percent and large blocks of space available in virtually all markets—some of these industries may find inventory in short supply because of highly specialized requirements such as freezer/cooler space or expansive ceiling heights.

This may result in build-to-suit options or substantial renovation programs to create facilities that satisfy the operational needs of some of these specialty companies. Growth potential—jobs, taxes and other income—makes these industries prime candidates for economic support.

Each year, local municipalities as well as county and state governments budget millions of dollars in grants, incentive programs and tax credits to attract and retain jobs. Incentives vary from one jurisdiction to another. For state, county and local governments, the creation and retention of jobs is a key benchmark.

To be most effective in establishing a strategy for securing economic incentives, which may be critical to closing a deal, it is essential to conduct a thorough review of a company’s situation and overall requirements. That review categorizes critical needs and factors that are unique to a company. It also leads to the completion of economic impact calculations, which allow us to demonstrate to governmental authorities the benefit brought about by their potential “investment” in a company.

The typical project will involve potential incentives available from the federal, state, county and municipal governments, as well as special industry development agencies, utilities and private interests. Beneficial incentives typically fall into statutory credits and negotiated incentives.

Available incentives include:

• Grants

• Infrastructure improvements

• Employee training

• Employee recruitment assistance

• Job creation tax credits

• Property tax abatements

• Tax increment financing (TIF)

• Technology credits

• Income tax credits

• Enterprise zone credits

• Historic designation credits

The coupling of skilled real estate and incentive program negotiations with other elements of creative advisory services can make a significant contribution to the resources available to operate a business. These resources—from job training to tax credits and abatements—can help companies create the competitive edge they need to be successful, in any business environment.

Corey B. Chase is a principal with Podolsky Northstar and the 2011 President of AIRE. He is a 25-year industry veteran and has successfully negotiated a variety of economic incentives for numerous businesses.