CRE Midwest

Riding the wave

Ned Frank

A short while ago, those in the industrial real estate industry knew there was a light at the end of the tunnel. The real question remained…..was that light at the end of the tunnel the road to recovery or an oncoming train?

By Ned Frank, Senior Associate | Chicago, Colliers International

A short while ago, those in the industrial real estate industry knew there was a light at the end of the tunnel. The real question remained…..was that light at the end of the tunnel the road to recovery or an oncoming train? No one suspected that negative absorption of ten to twenty million square feet and record high vacancy rates year after year would last forever. Right now, every landlord, tenant, and anyone not currently hiding under a rock can see the upward trend in the strengthening real estate market.

A rising tide lifts all boats and no one is happier about this tide than owners of industrial real estate. If you owned a vacant building in 2009 there was a solid chance that building would stay vacant for years unless an owner was willing to compromise in the form of an aggressively low lease rate combined with incentives such as free rent. At that time, institutional landlords were forced to do whatever it took to lease vacant space. Enter today’s market and that former leverage that tenants possessed is now shifting in the landlords’ favor. Gone are the days of cheap deals matched with a month of free rent for every year of the term. For the first time in a long time tenants are hearing the word “no”. Although there is a palpable shift in negotiating power, tenants and buyers are seeing the benefits of this strengthening market in the form of an increasing supply of brand new industrial product.

In the third quarter alone of this year, four new big box construction projects were completed which added 1.8 million square feet to Chicago’s inventory base. For a building to be classified “big box”, it has to be 300,000 square feet or larger, have a warehouse ceiling height of at least 28 feet, and boast precast concrete construction. Big box construction increased by 500,000 square feet in the third quarter compared to the previous quarter. Three of the quarter’s four new big box construction projects were build-to-suits, the largest of which was the 757,100-square-foot Weber-Stephen Products Company facility off of the Elgin/I-90 corridor in Huntley. That is the largest development in that submarket since 1991 when John B. Sanfilippo & Son, Inc. built a 1.4-million-square-foot building.

However, big box buildings are not the only type of industrial real estate that is getting all the love and attention. Since the beginning of the year, Chicago’s industrial market as a whole has been trending in a stronger direction. From small to mega users, Chicago is experiencing a kind of robustness not seen in over a decade. Vacancy has now dipped below eight percent for the first time since the fourth quarter of 2001. That is remarkable considering only four years ago vacancy had reached 12.24 percent, the Chicago area’s highest level in over 25 years. All of this vigor in the industrial market can be attributed to the tremendous demand from the companies that are occupying the warehouses and manufacturing plants.

The more notable companies that inked substantial deals in the market in the third quarter included the aforementioned Weber-Stephen Products Company which signed a 12-year, build-to-suit lease with Duke Realty in Huntley. IKEA – the Swedish furniture retailer – took down 849,691 square feet in ProLogis’ building in Minooka along the I-80/Joliet corridor for three years. Although these big blocks of spaces get all the press, people are not just buying grills and Swedish furniture. Positive absorption occurred all across the board with a total year-to-date net absorption of 12,159,905 square feet. This hefty amount of absorption means that available space is tightening up. Landlords are enjoying this tight market because there has been an uptick in rental rates with the average net rental rate currently at $4.31 per square foot.

Along with the surge in rental rates and leased space, Chicago experienced a significant escalation in sale transactions. There was a huge spike in demand for properties in the 50,000-square-foot to 100,000-square-foot range. There have been forty sale transactions completed in that size range so far in 2014. 22 of those transactions occurred in the third quarter. In other words, big box buildings are certainly not seeing all of the action. This is an important figure to recognize because the vitality of the Chicago industrial market will not only hinge upon small- to mid-sized companies completing transactions, but also small- to mid-sized companies staying in Illinois.

Recently, there have been a large number of high-profile companies such as Amazon, Uline, and Kennall Manufacturing that have opted out of Illinois and have instead chosen to hop across the border to Wisconsin or Indiana . Companies are attracted to the aggressive pro-business style of Wisconsin’s Governor, Scott Walker. Even with the current rise in supply and transaction volume in Illinois, the big question on a lot of minds is if the new government in Illinois can retain the occupancy of key corporations while also attracting new business to the state. It remains to be seen what effects our new government will have on Illinois’ economic woes and if this surge in activity for the Chicago industrial market will continue.