They're just mad about corned beef in Chicago. And hamburgers. And pizza and frozen yogurt. For the first time in years, as large-format retail development has screeched virtually to a halt, it's the small-store tenants who have come out from the shadows and moved to center stage in the Windy City.
Quickly expanding chain restaurants, many of them franchised fast-food emporiums offering deep-discount value to budget-strapped consumers, have brightened up an otherwise dreary retail landscape in the nation's heartland.
A couple of large projects left over from pre-recession planning — including the 280,000 sq. ft. Block 37 urban mall in the middle of the downtown Loop developed by Joseph Freed and Associates — are poised for completion soon. But they've become a glaring exception in an otherwise becalmed retail marketplace that has seen major big-box chains such as Lowe's, Target and Best Buy bring new construction to a standstill for the first time in nearly two decades.
The Dollar Store and discount grocer Aldi are still building around Chicago, predictably. But their presence rarely carries enough clout to serve as an anchor in new shopping centers of any magnitude.
“New development is very slow right now,” says Andrew Hochberg, managing principal at Next Realty in Northbrook, which bought a three-acre parcel in exurban Antioch a few years ago expecting to put up a strip center in short order. It never happened, and Hochberg is still sitting on the vacant land. “There is no real tenant demand, except on the small store end, where there is still decent leasing activity,” he says.
Gregory Kirsch, a tenant rep for the Chicago office of Newmark Knight Frank, made easy money five years ago and more finding sites for Starbucks and Washington Mutual bank and other big chains. Now he's spending his time looking for smaller sites for Clearwire Wireless and the Pret A Manger sandwich chain from London. “A lot of tenant rep brokers here have washed out of the business because there isn't enough deal flow to make money,” Kirsch says. “National chains in many cases are asking for 50% rent reductions. It's either give them a discount or they'll leave your center.”
Big developers back off
The statistics on the market paint a bleak picture. Retail space at midyear in metro Chicago was 11.6% vacant overall, up from 8.6% a year earlier, according to brokerage CB Richard Ellis. Net asking rents had fallen from $20.49 per sq. ft. a year ago to $18.58 as of June 30. In one hard-hit submarket, the south suburbs — once home to steel mills and factories — the retail vacancy rate has peaked at nearly 18%, the highest anyone can remember in a decade or more.
Big developers have been sent to the sidelines by the falloff in the market. As recently as three years ago Minneapolis-based Ryan Cos. had half a dozen shopping centers under development around Chicago. Now the company is finishing up the leasing of a couple of outlots on its last Target-anchored center and has put all new planning on hold. The company was negotiating to acquire three parcels of 50 acres and more when the recession hit, then backed off the deals.
“I don't spend my days waiting for the old markets to return,” says Mark Schoening, Ryan's vice president of development. He predicts that even when the economy recovers, the heyday of 600,000 sq. ft. power centers is past.
In Tinley Park, a suburb to the south, Ryan Cos.' Brookfield Marketplace was built out at 750,000 sq. ft. “In the future we're likely to see centers closer to 250,000 sq. ft. being built,” says Schoening.
New arrivals flourish
Restaurants are now where the action is for both tenant and landlord reps. Chicago is under siege with chains new to the market. In the delicatessen category, the names include Firehouse Subs of Jacksonville, Fla.; Jason's Deli of Beaumont, Texas; Jersey Mike's Subs of New Jersey and Denver-based Spicy Pickle. The last has stores open in Chicago and suburban Naperville with nine more under development.
In fast-food hamburgers, the new names include Sonic Drive-In, Counter Burger, Five Guys Burgers & Fries, Meatheads and Smashburger. “There is a real run on burger concepts right now,” confirms Scott Maesel, executive managing director at Sperry Van Ness in Chicago. He's marketing a site on Chicago's north side that once housed a Washington Mutual branch. “We've got three or four restaurants vying for that building. They're the ones who are active,” Maesel says.
Why now, and why in Chicago? In addition to banks shrinking their branch networks, chains such as Krispy Kreme, Lone Star Steakhouse and Bennigan's have been closing restaurants. Stock Building Supply Co. closed the last of its 11 Chicago-area stores in mid-summer, leaving gaping parcels of land available in prime locations.
“There are a lot of opportunities around Chicago right now, and newer companies have been waiting in the wings ready to pounce on deals as they become available,” says Rick Scardino, president of tenant rep firm Affinity Commercial Real Estate. Most of the new arrivals, he notes, are satisfied with second-generation space left behind by a failed retailer.
Marc Geman, CEO of Spicy Pickle Franchising in Denver, reports that when he first started looking for store sites in Chicago more than two years ago, rents were running $70 to $75 per sq. ft. in urban neighborhoods. Now he is negotiating deals closer to $50 a foot.
“That's more palatable for us,” he says. “Chicago [retail rent] is not cheap, but with nine million people in the metro area we enjoy a market with great density.” The company currently has two 1,800 sq. ft. stores in the area, but Geman predicts that Chicago will eventually support as many as 50 Spicy Pickle outlets.
In the past year, Joe Tortorice, founder and CEO of Jason's Deli in Beaumont, Texas, has opened six stores in metro Chicago, each measuring 5,000 sq. ft. He expects to open another half-dozen or more in the next year. “There is no reason Chicago couldn't support 30 or 40 of our stores eventually,” he says.
He has considered entering New York and Los Angeles, but has resisted the notion and is focusing instead on Chicago and Washington, D.C. “We'll have a Midwest regional office in Chicago eventually and from there we can franchise into places like Minneapolis and Indianapolis,” Tortorice says. “Chicago is a strategic hub for any retailer new to the Midwest.”
Have rents hit bottom?
Of course, some of the costs in Chicago for retailers have taken some tenants by surprise. CiCi's Pizza, based in Dallas, has put up eight locations, each about 4,000 sq. ft., over the past year in the Chicago area. The company has been paying net rents of $16 to $23 per sq. ft., but common-area maintenance (CAM) charges in many strip centers add as much as $10 a foot. That's a lot of extra cost for a low-price pizza chain that promotes all-you-can-eat pizza buffets at $4.99 per person.
“In Las Vegas I'm doing deals with $4 CAMs,” says John Baldwin, CiCi's vice president of real estate. “When I have to pay a $10 CAM in Chicago that means I'm paying for a heck of a lot of snow removal.” Nevertheless, Baldwin remains undeterred. “We hope to build as many stores in Chicago as we can.”
Other retailers are being cautious. Bandana's Bar-B-Q of St. Louis, Mo., which operates a chain of 29 barbecue restaurants, recently opened a branch in Rockford, 70 miles northwest of Chicago. Management is currently looking for sites closer to the city.
“We started looking in Chicago two years ago, and back then real estate was clearly overvalued,” says Rick White, CEO and co-owner of Bandana's. Net leases for his favored locations were often priced at $50 per sq. ft. at one time, he recalls. Now they've sunk below $30. “We're hoping to be able do to deals in the low $20s soon,” White says. “We had one landlord in the suburbs who offered us eight months of free rent on a five-year lease in lieu of money for improvements. I think the market is getting close to bottoming out.”
Then again, maybe prices will fall some more. A new study by PricewaterhouseCoopers predicts that Chicago-area retail real estate values will continue to decline this year and next, bottoming out in 2011 and remaining at depressed levels in 2012, even though the rest of the country is expected to see recovery in retail valuations by then.
Urban versus exurban
Nevertheless, in the best locations in Chicago's center city prices and leases are holding up surprisingly well. William Gomez, the owner of the Halsted Street Deli, which has 21 locations around the metro area, recently paid $101 per sq. ft. on a gross lease basis on a 2,000 sq. ft. store at the intersection of State and Lake in the middle of the Loop. “I think that's the same price I would have paid two or three years ago for that location,” says Gomez.
Wally Wahlfeldt, senior vice president of retail outsourcing services for Jones Lang LaSalle in Chicago, believes that lease rates haven't fallen further because lenders have been slow to declare default on many non-performing real estate loans.
Even some empty spaces left behind by bankrupt retailers still can't be occupied due to legal disputes, he notes. “In many places retailers looking for big rent decreases are finding they haven't happened yet,” he says.
Thomas Jednorowicz, co-founder and owner of the Chicago-based hamburger chain Meatheads Management, which has opened two locations since last year, believes that the Windy City is a complex real estate market that many out-of-state merchants fail to understand.
“So many cities are spread out today, but Chicago is still a very urban marketplace,” he says. “It's tricky to grasp all the changing ethnic populations from one neighborhood to the next. You can't be haphazard in your development of Chicago. That's one reason why we see retailers fail. They don't take the time to understand where their customers are.”
One thing that retailers do think they've figured out is the new limits to the market. Until two years ago there was a land rush to exurbia as developers competed to put up shopping centers in sparsely populated — though promising — edge towns such as Sugar Grove, Elburn and Richmond.
Residential subdivisions have since gone dead in those places and retailers have fled. “Retailers have changed their minds. They want to be in the center of things where the action is,” says Michael Bell, president of land broker Pentad Realty in Chicago. “Nobody wants to be in a remote shopping center drawing on customers from a 180-degree radius anymore.”
Return to Main Street?
A retail consultant in Los Angeles, Michael Kraus of StoreTouch, believes that Chicago's turn to more activity among smaller tenants is a microcosm of what's unfolding around the rest of the country.
“In the past century we've moved from small mom-and-pop retailers in Main Street locations to mass consumerism in big malls. Now we're moving full circle back to smaller retailers — including restaurants — in Main Street locations again,” Kraus says. “Everything seems to be moving in cycles, and the experience in Chicago reflects that.”
But the cycle could eventually turn again. Andrew Hochberg of Next Realty isn't ready to sell his three acres in Antioch yet. “Growth has slowed in Chicago's outer-ring suburbs,” he concedes. “They'll take a couple of years at least to come back. But they will. It just takes a developer with a long time horizon today to see that and be willing to wait for it to happen.”
What's more, not all new restaurants chains vying for space in metro Chicago will still be around a decade from now, points out Robert Paine, a restaurant consultant with Affinity Solutions in New York. He recalls that the Sambo's chain once had 1,100 restaurants in the U.S., while Howard Johnson peaked at more than 700.
“There is one Sambo's left in Santa Barbara and the last Howard Johnson closed earlier this year,” says Paine. “One thing that is constant about restaurants in cities like Chicago is that they will change. But they're holding up in the current recession for a simple reason: you can postpone a purchase of a car or a washing machine for another year. But you wake up every day hungry and you've got to eat.”
H. Lee Murphy is a Chicago writer.
2. Abbott Laboratories
3. Allstate Corp.
Source: Local estimates
|METRO POPULATION UNEMPLOYMENT RATE:|
|Source: U.S. Census Bureau||Source: Illinois Department of Employment Security|
METRO AREA VITAL SIGNS
11.9% vacancy, 2Q 2009
10.8% vacancy, 2Q 2008
$32.51 rent per sq. ft. 2Q 2009
$32.73 rent per sq. ft. 2Q 2008
Source: CB Richard Ellis
6.6% vacancy 2Q 2009
8.4% vacancy 2Q 2008
$2.32 average rent per sq. ft., 2Q 2009
$2.39 average rent per sq. ft., 2Q 2008
Source: Appraisal Research Counselors
11.6% vacancy, 2Q 2009
8.6% vacancy, 2Q 2008
$15.95 rent per sq. ft., 2009
$23.53 rent per sq. ft., 2008
Source: CB Richard Ellis
11.2% vacancy, 2Q 2009
9.5% vacancy, 2Q 2008
$4.11 rent per sq. ft., 2Q 2009
$4.48 rent per sq. ft., 2Q 2008
Source: CB Richard Ellis
64% occupancy, July 2009
70% occupancy, July 2008
$154.50 average daily rate, July 2009
$192.00 average daily rate, July 2008
Source: Smith Travel Research
Cornerstone: The 650-acre development in northwest suburban Grayslake will include 3 million sq. ft. of office/industrial space and 500,000 sq. ft. of retail, as well as 800 residences that will include condominiums and apartments. The late William Alter, founder of the Alter Group, bought the property more than three decades ago.
Developer: Alter Group Property Developers North America
Cost: $750 million
Former Sears Tower: The owners of the 110-story tower propose a $350 million “green” renovation of the skyscraper, renamed Willis Tower, as well as the addition of a 50-story, 500-room hotel on the site of the building's pedestrian plaza. Financing is not yet in place.
Developer: American Landmark Properties and others
Cost: $350 million for renovations, $225 million for the hotel.