Industrial Midwest

Market activity very strong at mid-year, high demand for product raises concerns

MidYearReview-Bridge-Northlake-Dominicks-Rendering-2
Former Dominicks distribution site in Northlake, Illinois, acquired by Bridge Development in 2014.

There's no doubt that this year’s market has been an active one across major industry sectors. Market reports continue to show strong activity, and now that it's past the halfway mark in 2015, market experts weigh in on why CRE is looking good.

There's no doubt that this year’s market has been an active one across major industry sectors. Market reports continue to show strong activity, and now that it's past the halfway mark in 2015, market experts weigh in on why CRE is looking good.

For one, investment sales are as strong as they’ve ever been, according to Steve Groetsema, director of development and leasing at Bridge Development Partners. Chicago is seeing record low CAP rates and near record per square foot prices for top-of-the-line product— infill locations, O’Hare, I-55, northern DuPage County, and Class A construction.

John Coleman, executive vice president at Transwestern, agrees. He said that user and investment purchases remain strong, especially in DuPage County, and in both 40,000 square feet to 100,000 square feet user sales and 200,000-plus square feet investor purchases.

Coleman is also seeing that with leasing it’s been getting difficult for investor-buyers to obtain good quality, stabilized, core real estate because so much of it has already traded in the last two years. The investment market is turning toward Class B industrial product, but he is seeing some weakness in CAP rates— rental rates for Class B haven’t grown and buyers aren’t as willing to pay up for modest rates as they were a year and a half ago. And this isn’t expected to change anytime soon.

Industry experts believe the market has an additional 12 to 18 months with CAP rates remaining relatively put, while net rates, especially in core product and new construction, are suspected to continue rising for that same amount of time.

Groetsema said portfolios are well occupied and the larger landlords are holding rents. Looking ahead, there aren’t concerns of overbuilding since there isn’t excessive supply coming online in a specific submarket.

Today, the two most robust sectors in the market continue to be multifamily and industrial. While there’s been more trading pound for pound in these sectors than anything else, Coleman said there are a few exceptions, including downtown, central business district, Class A, and office buildings, which are selling for record prices.

“Industrial, conversely, is seeing good activity in almost all product types and regions,” he added. “The market corrected itself by launching millions of square feet in spec and build-­to-­suit industrial projects and while the spec projects still have some vacancy connected with them, the demand for space continues to be pretty solid. I do think that is certainly a strength of the market place.”

New construction is asking high lease rates, and spec warehouses are hoping to get above $7 per square foot above net, which Coleman said is high, but it’s also for new, state of the art buildings in great locations.

He’s also seeing a good amount of construction and projects that offer critical mass and favorable prices for multifamily.

And while rental rates are going up, Coleman doesn’t see that as an issue. He sees it as more good than it is bad.

“Obviously it adds cost to the occupier when rental rates go up, but rental rates were pretty historically low in most product sectors, so occupiers can absorb some modest rent increase and still not have it impair its cost of doing business,” he said.

An increase in rental rates generally raises the tide on the value of all property. Coleman said a stronger value overall equals a stronger market.

Groetsema said the real strength is in the capital markets and the flight to quality that has been and is occurring there.

“There is so much money looking to be placed,” he said. “We are hearing anywhere from $6 to $11 looking to be placed for every dollar of available Class A product. Investors’ greatest fear is the inability to get money out rather than something looming on the horizon.”

Groetsema said that despite there being that much demand for product, investors are fairly disciplined in pricing quality and location. He added that there’s a real gap between pricing on infill locations and Greenfield locations, and that’s something that wasn’t always the case in previous strong markets.

One thing that surprises Coleman about the current market is that the spec industrial that’s been built over the last couple of years hasn’t absorbed quite as quickly as the market had hoped.

“I’m also a little surprised that we haven’t seen a rise yet in interest rates,” he said. “We all expected it, but it’s more of a pleasant surprise than anything.”

Ultimately, there are still some concerns in today’s market. Coleman said it’s starting to get to the point where developers are questioning just how long demand will continue with all this product going on.

“There is a belief that demand will continue through 2016,” Coleman said. “I don’t know if they agree that it will go into 2017, but certainly 2016.”

All of this demand has been increasing in locations with better access to the city, most notably the west Cook County submarket, or the eastern I-55/McCormick submarket.

According to Colliers International, the five largest building developments in the Chicago submarket since August 2014 include:

  • Amazon’s Class A, 1,100,000-square-foot industrial warehouse on 158 acres located at 3501 120th Avenue in Kenosha, Wisconsin.
  • Weber-Stephen Products LLC’s 757,120-square-foot industrial building on 72.3 acres located at 14100 Weber Drive in Huntley, Illinois.
  • Bob’s Discount Furniture's 751,966 industrial development on 52 acres located at 21215 SW. Frontage Road in Shorewood, Illinois.
  • Pinnacle Business Center’s 672,080-square-foot industrial property on 39 acres in Romeville.
  • Midwest Warehouse & Distribution System, Inc.'s 626,848-square-foot industrial property on 31.2 acres in Waukegan, Illinois.

Groetsema explained that tenants seem to be more concerned than ever with the employee experience, and in the previous year, firms have won and lost deals based on travel times to and from the city.

“In addition to that, we have seen a fair amount of creative design with the office spaces in these industrial buildings— open offices, loft designs, even lounge-type break rooms,” he said. “With everything happening in the city across product types, especially with apartments and moving downtown, we believe this trend will continue to increase.”

Coleman shared that another area that has shown improvement over the last year is suburban office. Even though it may be the least active, it’s certainly better than it was two years ago.

And although retail seems to be holding steady, Coleman said it has a unique way of being able to reinvent itself with its large community centers, regional malls, and lifestyle centers.

“What we’re waiting on in the retail segment is to see what great, needle moving impact e-commerce will have on the traditional model,” he said.

He believes future industry changes will be in some of the infrastructure of real estate, like in e-commerce, a decentralizing of the product model.

“We will start to increase what’s called ‘the last mile,’ Coleman added. “That’s the most-expensive transportation.”

Meanwhile, Groetsema isn’t expecting major changes over the next few months. He said the new product coming online is well located and has heard that it’s seeing very strong tenant activity. The capital markets, he said, will remain where they are but may even push up toward the end of the year as institutions try to place money before the New Year.