CRE Midwest

The suburban market is down, but long-term outlook is positive

| markt

With high vacancy rates, a large stock of outdated product, and transportation issues, it may seem like an odd time to make a case for real estate in the Chicago suburbs, but armed with demographic projections, a panel of commercial real estate executives attempted to do just that at a ULI forum.

With high vacancy rates, a large stock of outdated product, and transportation issues, it may seem like an odd time to make a case for real estate in the Chicago suburbs, but armed with demographic projections, a panel of commercial real estate experts attempted to do just that at a recent ULI forum.

There is no dispute that real estate fundamentals are currently stronger in the downtown market as the suburbs continue to struggle with absorption of office space, reflected in an overall vacancy rate above 20 percent.

Yet while the downtown market may have the current momentum in an otherwise weak market, the suburbs do have one thing going for them: population.

David Galowich, president of Madison Realty Group, Inc., cited numbers from CMAP that projected that the suburbs will add two million people by 2040, while Chicago will add only 400,000 in that same time period. With that growth will come 221,000 new jobs in the city of Chicago and 950,000 new jobs in the suburbs.

One of the main reasons for this population growth is that young families still tend to migrate to the suburbs from Chicago; the only difference now is that they are taking a much longer time to do it.

“In the 1970s people were married at 22,” said Gregory Mutz, chairman and CEO of AMLI Residential Partners, LLC. “Now, the average age is 28. People live downtown longer. Eventually, though, they start families and move to the suburbs for the schools and security.”

The downtown market has captured some buzz with firms such as United leaving the suburbs for a location in the CBD. Employees want access to mass transit and companies want to court the young, talented workers who are living in the city.

Richard Spinell, principal at Mid-America Asset Management Inc., has seen this first-hand at his firm.

“We are headquartered in Oak Brook, but we are opening a satellite office in Chicago to tap into the young workforce,” said Spinell. “It’s hard to get young workers to commute to the suburbs.”

Mutz does not see a large discrepancy between the suburbs and Chicago when it comes to competitiveness, but he does believe that if Chicago ever solves its public school and budget issues, it would see a huge influx of population and business growth.

Office

Ron Lunt, founding partner at Hamilton Partners, said that core office product in the suburbs is doing fine, but older B and C class product is suffering.

“If you look at Schaumburg the vacancy rate may be 27 percent overall, but class A space is probably less than 10 percent,” he said. “It will be difficult to fill some of the outdated product above 70 percent. Some of it should be torn down.”

Cap rates on core product are coming back in line with what they were pre-recession, but effective rents are not up, he said.

What defines core has also changed. It used to be location and building quality, but now it is often defined by lease terms. Buildings with large, long-term leases provide a safe haven for investors.

Lunt says that there will not be any new construction in the suburbs for a considerable amount of time. Typically, the development barriers in the suburbs are greater and very few of them are willing to create TIF districts.

Surprisingly, some suburbs he is currently working with are considering rezoning office and commercial land to support rental housing.

“In the suburbs it was always difficult to do apartments,” said Lunt. “There was a NIMBY attitude toward it. I’m working with three suburbs now who are considering zoning changes to allow new apartments.”

Apartments

All of the attention that has turned to apartments has been good for AMLI’s Mutz.

Rents are consistently rising and although many developers are attempting to get new apartment towers out of the ground, there are no new units on the market right now, making it a great time to be an owner.

“I’ve been in this business for 30 years and this is the best it has ever been,” said Mutz.

His firm has committed to building a 214-unit luxury apartment complex at the corner of Chicago Ave. and Kedzie Street in Evanston. Despite this venture, Mutz says that the majority of his firms construction will be in the city of Chicago in the next 10 years as the costs for developing in the city and suburbs are very comparable.

Neighborhoods like River North in Chicago will provide ample opportunities for growth in the near future. Currently, his firm has only one development in Chicago at 900 South Clark St. in the South Loop.

Retail

The retail sector has staged a decent recovery in both the suburbs and the city.

“Retailers are following population density, but the performance of the city and suburbs is not as far apart as some think,” said Spinell.

He noted that retail vacancy rate in Chicago is around 6 percent and the suburbs it is hovering around 8 percent.

Deal velocity has picked up in the suburbs and many of the big box spaces that were left vacant after a few high-profile bankruptcies have been filled. The biggest difference now is construction activity, or, lack thereof.

“The Chicago area used to average 4-5 million square feet of new construction a year,” said Spinell. “This has stopped. I think it will take 4-5 years for construction to work back up to the historic trend. Developments will be more traditional in concept, with a focus on pharmacy and grocery-centered developments. Power Centers may see a resurgence, but it will probably be a decade or more until someone tries a lifestyle center again. They were the hardest hit. “