Chicagoland thrives on a diverse economy

Because the Windy City is home to a diverse economic base that is larger than some countries, the city has helped foster a strong, stable real estate market.

Simply stated, some of Chicago's strengths are its size, diversity and climate. Well, two out of three isn't bad. Agriculture remains a large component, as does manufacturing, finance, insurance and real estate (FIRE) as well as a growing high-tech sector. The biggest development is the employment growth in FIRE and business services. "Over the past five to six years, that growth has been extraordinary," says Paul O'Connor, executive director for the Chicago Partnership for Economic Development. "The economy is really booming."

Since 1994, Chicago has experienced a 28% growth in FIRE workers - or approximately 160,000 jobs, according to a market report produced by New York-based Reis Reports Inc. Chicago is the dominant metropolitan region in the Midwest and the third economic and population center in the United States, after Los Angeles and New York.

"There are some interesting developments in the technology sphere," notes O'Connor. "The city is experiencing a considerable amount of tech development and redevelopment starting at Goose Island and extending along the north branch of the Chicago River to the West Loop. Part of that activity is due to a city-backed initiative to attract high-tech companies to the outskirts of the CBD. Functionally obsolete buildings are being converted to state-of-the-art space that caters to technology-oriented users," he says.

Another significant trend in the Chicago economy is that the city has become a magnet for young people. Members of Generation Y are now graduating from college and choosing to live in the city, says O'Connor. "That is driving one of the bigger trends - the concentration of technology jobs within the city itself. Companies are opting to locate in and around the city to attract those younger workers."

Active office market "Overall, we are really surprised at the level of leasing activity," says Jeffrey Barrett, a managing director in the Schaumburg, Ill., office of Los Angeles-based CB Richard Ellis. "We looked at our model for the year, and we thought with the amount of new space coming on board, we would see a significant amount of vacancy."

Spec construction deliveries for the year are projected to top 3.8 million sq. ft., up from 3.5 million sq. ft. in 1999, according to CB Richard Ellis.

Currently, 28 new buildings are under way totaling 2.9 million sq. ft. At mid-year 1999 there were 30 projects in progress totaling 3.6 million sq. ft., according to CB Richard Ellis.

"We thought the vacancy trend would increase in excess of 11% by year-end," says Barrett. But despite the new construction, the second-quarter vacancies dropped to 8.3% from the 10% recorded in mid-1999, according to CB Richard Ellis.

The drop in vacancy is proof that the new construction continues to lease well. "What we clearly didn't anticipate was the surge in demand we experienced in the second quarter," says Barrett.

The net amount of space leased during the second quarter was 1.5 million sq. ft., which brings net absorption for the year to 3.1 million sq. ft. "That was clearly more than we anticipated for the entire year," adds Barrett. First-half absorption over the past decade averaged 810,000 sq. ft., according to CB Richard Ellis.

Downtown office Leasing activity in the downtown office market showed no signs of slowing during the second quarter. Net absorption during the three-month period totaled 928,915 sq. ft., according to CB Richard Ellis. Since 1995, the net amount of space leased during the second quarter has averaged 662,972 sq. ft.

Lease-up is almost complete for the first deliveries of spec office space in downtown since 1992. The 332,000 sq. ft. Union Tower in the West Loop and the 115,000 sq. ft. office portion of the North Bridge mixed-use development off Michigan Avenue both came on line in 1999, according to CB Richard Ellis.

Development downtown in recent years has been dominated by properties in the 300,000 to 500,000 sq. ft. range. "Most of the buildings still under construction are of a smaller nature," says Barrett. "That has tested the market, and led to the launch of larger projects."

Five projects totaling more than 3.9 million sq. ft. are currently under construction in the CBD with 754,000 sq. ft. scheduled to open by year-end, according to CB Richard Ellis. "The initial buildings have been very successful, so there has been an increase in new construction starts," notes Barrett.

One new project is the 700,000 sq. ft. Class-A tower at 191 North Wacker Drive. The office building, which will be located at the southeast corner of Wacker and Lake, will begin construction this fall with completion slated for late 2002. Locally based Hines Interests LP is developing the building, and the law firm of Gardner, Carton & Douglas is the tower's main anchor.

"There is clearly demand for downtown office space, but it's still extremely difficult to finance downtown office towers," says Greg Van Schaack, a vice president at Hines Interests. "As a result, much of the new office space that has been built in recent years has involved smaller buildings located on the edge of downtown. The fringe buildings are smaller and easier to finance."

No new buildings are likely to be announced in the short term due to the vacant space created by tenants relocating to new buildings, as well as some large sublease spaces that have come on line. "The downtown market remains strong, but the added space just creates that much more wariness among lenders," says Van Schaack.

Downtown office rental rates, which leveled off in 1999, are on the rise. Net rents in trophy buildings are averaging $30 per sq. ft. Class-A buildings are seeing $20 to $25 per sq. ft., and Class-B rates are averaging $15 to $20 per sq. ft., according to CB Richard Ellis.

Suburban office Demand for suburban office space has kept pace with the spec construction cycle, which during the second quarter included the opening of eight new office buildings. The properties, which totaled 819,741 sq. ft., opened with a combined preleased level of 79%, according to CB Richard Ellis.

"I think the suburban market for the most part is in a fairly good state of equilibrium," says Barrett. "But we have seen the addition of a significant amount of new construction, so there has been little rent growth."

Leasing among suburban office buildings rose to its highest levels in more than a decade during the second quarter. Activity pushed suburban vacancies down from 10.5% to 9.6%, according to CB Richard Ellis.

The northwest suburban submarket has experienced strong leasing among its new developments. Woodfield Preserve Office Center I in Schaumburg, for example, opened in May at 97% occupancy. "I think it's pretty unusual for that to happen, but we are optimistic that the northwest market will still have some growth to fill up our Phase II building," says Van Schaack.

Construction started in May on Woodfield Preserve Office Center II, a 320,000 sq. ft. office building adjacent to Woodfield I. The Class-A project is a joint development between Hines Interests LP and J.P. Morgan Investment Management Inc. of New York. The building is slated for completion in May 2001.

Schaumburg also was the site of two of the second quarter's largest lease transactions: a 223,000 sq. ft. renewal by GE Financial Assurance Partnership Marketing Group at Woodfield Corporate Center; and a 250,000 sq. ft. new tenant signing at Phase II of Windy Point by Zurich Kemper Life.

Some soft spots in the market are due largely to merger and consolidation activity. "The history of Chicago's supply and demand is often two steps forward and one step back," says Van Schaack. "No matter how good things are, a merger or consolidation will come and create a sizable vacant hole in the market. Zurich Kemper Life, for example, will create a sizable vacancy when it relocates from suburban Long Grove to its new Schaumburg location in summer 2001," he says.

"I think there is definitely greater caution today about starting a new spec development, as opposed to where the market was a year or two ago," says Barrett. "Developers are proceeding cautiously and lenders are scrutinizing plans more closely. From a new construction standpoint, the market could benefit from a little bit of a breather."

Industrial outlook Chicago is home to one of the largest industrial real estate markets in the country with a base of 949 million sq. ft. The demand for space has remained strong in 2000. Vacancy rates declined slightly during the second quarter from 7.1% to 7%. Vacancies in properties 100,000 sq. ft. or greater decreased from 7.5% to 7.3%, according to CB Richard Ellis.

The Chicago industrial market may not be experiencing the same feverish pace that occurred in 1998 and early 1999, but activity is still robust, says Phil Wegele, a director in the industrial/technology services group in the Chicago office of New York-based Cushman & Wakefield.

Industrial sales and lease transactions totaled 6.1 million sq. ft. during the second quarter, boosting gross absorption for the year to 15.1 million sq. ft., according to CB Richard Ellis. The five-year average for first-half absorption is 18.7 million sq. ft.

"I think the market is still strong with a lot of big deals getting done," says Wegele. One major project is a 500,000 sq. ft. build-to-suit for Sears Roebuck & Co. at Crossroads Business Park in Romeoville, Ill. Indianapolis-based Duke-Weeks Realty Corp. is developing the project, which is scheduled for completion this fall. "When you talk about deals like that, it's hard to say the market is slowing," he notes.

Industrial development activity first picked up in 1995, and has since averaged 14.9 million sq. ft. of new construction starts each year. There was 8.1 million sq. ft. of new construction starts during the first half of 2000, compared with 7.9 million sq. ft. over the same period last year. Project starts year-to-date include 5.2 million sq. ft. of spec space, primarily high-cube warehousing, and 2.9 million sq. ft. of build-to-suit, according to CB Richard Ellis.

"Although there is a lot of pressure on manufacturing, particularly in the city because of the employment situation, big-box warehouse is still king," says Joyce M. Slone, a director in the industrial/technology services group in the Chicago office of New York-based Cushman & Wakefield. Logistics is another strong area. "There is still a lot of outsourcing occurring by manufacturers due to third-party logistics," she says.

Lack of labor and land Chicago's low unemployment rate, 4.3% as of June, is affecting relocation decisions. Many companies are concerned about the ability to retain their work force, and are wary of moving more than a few miles away from their current labor pool, Slone notes.

Lack of available land also is affecting relocation and expansion decisions. For example, there are currently only about 110 acres of industrial land available for development in Central DuPage County, according to Cushman & Wakefield. Of the approximately 1.5 million sq. ft. of space under construction, more than 500,000 sq. ft. has been preleased. An additional 1.8 million sq. ft. of space is on the drawing board. But due to the strong demand, it is likely that the 110 acres will be absorbed within two years, adds Slone.

The lack of land coupled with manufacturers' reluctance to risk losing workers with a distant relocation has produced extremely low vacancies in Chicago. Mid-year vacancies reached 2.7%, and the tight market is creating more interest in areas that have been historically weak. For example, the 385,000 sq. ft. that has been on the market for more than three years at the Chicago Enterprise Center has recently been leased to Co-Steel, according to Cushman & Wakefield.

Meanwhile, population growth in outlying suburbs has produced stable labor pools in areas such as northern Kane County and McHenry County. Motorola has announced its plans to relocate 500 jobs in its accessories and aftermarket division to a new distribution center in Elgin, which is in Kane County.

Areas once considered too far west to be influenced by Chicago's economy are experiencing the positive effects of the tight real estate market. "We're seeing a lot of activity going west and northwest with a lot of new industrial parks under construction," says Slone.

Not long ago, the farthest area west that brokers were marketing was Aurora. But now brokers are marketing space 20 minutes farther west in areas such as De Kalb County, she adds. A 460-acre, mixed-use real estate park is being developed due west of Chicago in De Kalb. The lure of lower land costs, rail-served sites, interstate access and growing labor pools are attracting distribution companies to these outlying communities, notes Slone.

Retail follows residential growth Chicago has the largest retail market in the country with a base of 160 million sq. ft. and counting. The city has averaged more than 3.2 million sq. ft. of new construction per year the past five years. And in the next five years, Chicago is expected to add 4.4 million sq. ft. per year, beginning with this year's 4 million sq. ft., according to the Reis Observer.

"Chicago is a very dynamic market due to its size and residential growth," says John Bell, director of retail development in the Chicago office of Minneapolis-based Ryan Companies US Inc. "The city has been a big catalyst for retail development."

The 2000 population of the Chicago area is estimated at 8.1 million, which indicates an average annual growth rate of 0.7% the past five years. Construction remains steady due in large part to Chicago's affluent consumer base. The metro area is home to the highest average household incomes in the Midwest at $100,471, which is above the national average of $90,069, according to the Reis Observer.

"From a development standpoint, there seems to be a lot of money out there to develop projects, but opportunities are becoming fewer and farther between due to scarcity of sites and competition," says Bell. "In addition, many retailers are doing their own development, so it makes it tougher than ever to develop shopping centers."

Due to the competition and scarcity of sites, some retailers have lowered their requirements in terms of desirable population densities. "Now they are willing to go to emerging markets more so than in the past," adds Bell. "That has created new development opportunities."

Ryan is just one developer targeting emerging markets for new shopping center development. Last year, Ryan opened Bowl Farm Marketplace in the northwestern suburb of Crystal Lake. Kohl's, Dominick's, Target, Barnes & Noble and Linens' N Things anchor the 365,000 sq. ft. center.

Ryan also opened its 250,000 sq. ft. Long Run Marketplace in the southern suburb of Lemont in August. The center is anchored by retailers such as Target, Kohl's and Office Max. "A lot of these cities used to be farming communities. Now they have an active residential base," says Bell.

One major retail project in the works in downtown Chicago is North Bridge, a mixed-use development near upscale North Michigan Avenue. Project plans call for about 800,000 sq. ft. of retail - including a new Sears and Nordstrom department store. The project, which is expected to span a nine-block area, will also include hotel, apartment and office space in addition to 2,400 parking spaces, according to the Reis Observer.

Despite the construction activity, retail vacancy rates are at its lowest point in a decade with overall shopping center vacancies dipping to 7.3% during the second quarter, according to a CB Richard Ellis survey of properties 50,000 sq. ft. and greater. The vacancy rate, which peaked at 10.3% in mid-1997, was 8% as of the second quarter of 1999. Big-box users, primarily grocers, discounters and home improvement stores are continuing to anchor much of the area's new retail construction.

Multifamily market "I think the multifamily market is presently in a very steady period," says Greg Smith, president of the central division at Equity Residential Properties Trust in Chicago. The company divides Chicago into three distinct markets, which include downtown, the western suburbs of DuPage County and the north and northwest suburbs including Cook County, adds Smith.

The downtown market is exceptionally strong, and there are high barriers to entry because of the lack of suitable land. "You have a very strong condo conversion market and a strong desirability from a lifestyle perspective to be in downtown," says Smith.

Chicago is experiencing high occupancies that average 97%, while rents are growing at a rate of 5% to 7% per year, according to Equity Residential.

The west suburban market is home to the bulk of apartment development activity. Because of the ongoing construction in that sector, occupancies are slightly lower at approximately 94%, notes Smith. Over the last five years, 20 properties have come on line with approximately 6,000 new units. The construction has produced some softening in the market, and concessions have emerged at some of the new properties. New apartments are offering upfront concessions of one-half to one-month free rent during lease-up. The construction also has created a lower rate of rent increases at around 3%.

Construction in the north and northwest suburbs has produced about 1,000 to 1,500 new units each year, which has resulted in 95% occupancy and rental rate increases of 4% to 5% per year, says Smith. Through a joint venture with

Lincoln Property Co., Equity Residential opened a new apartment in the northwest suburb of Lake Zurich earlier this summer. The Landings is a Class-A apartment project with more than 200 units.

"I think the question over the next few years will be the availability of land and the ability to build [multifamily properties] on that land," says Smith. "The rising land costs and zoning issues are two barriers to entry for new apartment construction."

Hotel sector thrives "Based on what we are seeing, the Chicago market remains extremely vibrant," says John Karver, a senior managing director at Insignia/ESG Hotel Partners Group in Chicago. Although a slowdown occurred earlier this year, the market rebounded in the second quarter. Year-to-date occupancies as of June are equal to that of 1999 at 68.2%, according to Hendersonville, Tenn.-based Smith Travel Research. Average daily room rates increased 3.3% over the previous year, to $112.14.

The first-quarter lull reflected a combination of uncertainty in the economy, as well as the fact that the Chicago climate does not attract a high volume of travelers during January and February. Hotel owners also felt the impact of new projects that have opened the past two years. "During Chicago's strong season, there are never enough hotel rooms," says Karver. "But slower periods, such as January and February, are months when owners do feel the decline in occupancy."

As of June, Chicago had 450 hotel properties, compared with 431 in mid-1999, and the supply of hotel rooms increased 4.4% to 78,698, according to Smith Travel Research. New hotels opening in the city included a 225-unit Homewood Suites, a 152-room Holiday Inn & Suites, and a 350-room Hilton Garden Inn.

"Simultaneously, there have been numerous renovations of truly lower, mid-market hotels that are now much better quality and more competitive," says Karver. Earlier this year, the completely redeveloped Park Hyatt reopened with 203 rooms.

"The question will be what impact the projects proposed or under construction will have," notes Karver. There are reportedly 1,700 new units under construction in 2000 with an additional 3,500 rooms that are proposed or speculative. A 415-room Hotel Sofitel is proposed in the North Michigan Avenue corridor, a new 400-room Embassy Suites is slated for the River East area, and a new 125-room Fairfield Inn is planned in the North Michigan Avenue corridor.

One reason for the active development market is Chicago's growing reputation as an international business travel destination. "Chicago is empirically the largest business travel and convention center in the world," says O'Connor. The city hosts 35,000 conventions, trade shows and other meetings each year, attracting more than 4.4 million attendees who spend an estimated $5.3 billion in the the city, according to the Chicago Convention and Tourism Bureau.

Chicago's rank as a growing tourism destination has also sparked demand for hotel rooms. The area's museums, restaurants and an expanded theater district have helped draw visitors. "Over the past five years," says Karver, "Chicago has moved into the upper stratosphere of being an nternational gateway destination."

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