Chicago is basking in the limelight. As hometown to President-elect Barack Obama, who began his election acceptance speech by greeting the city, Chicago is gaining worldwide attention. If regional leaders get their way, the city will raise its international profile even further by winning the 2016 Olympic bid.
All this is good news for the Windy City’s real estate investors. Already attracted to the city’s strong fundamentals, investors say these additional activities only add to the area’s value.
To be sure, much real estate activity is on hold because of uncertainty in the national economy and tight credit markets. But investors say Chicago is a solid pick as a long-term play. In particular, the city’s apartment and office building markets promise healthy performance, while demand for retail space is mixed. Though these sectors may soften in the short-term, the long-term outlook is strong.
“Chicago, from a long-term perspective, has great fundamentals,” said Jason Mattox, chief administrative officer for Behringer Harvard, a privately-owned, national real estate investment trust, or REIT, which has invested heavily in the city. “This sort of economy provides any number of opportunities.”
Investors are attracted to the city because of its excellent fundamentals, which have helped withstand the national financial storm. These fundamentals include: a diversified economy, educated workforce, excellent transportation and vibrant cultural activities. The city’s gross regional product—at $470 billion in 2007—is the third largest in the country, behind New York and Los Angeles, according to Moody’s Economy.com.
Chicago’s diverse economy includes: financial services, real estate, manufacturing, food processing, education and transportation. Thirty Fortune 500 companies and 125 publicly-listed companies are headquartered in Chicago, giving the market breadth. Its nearly 500,000 local businesses, which are less likely to relocate in a downturn, provide market depth, said experts.
The city’s concentration of six universities—including Columbia, Northwestern and the University of Chicago—create a large student market and supply the city’s well-educated workforce. Meanwhile, the city’s many cultural attractions make it a regional magnet for professionals. An extensive light-rail system downtown alleviates the need for cars, while extensive railway and transportation links have turned Chicago into a Midwest hub.
“Chicago is feeling the effects of the financial meltdown, but it’s not feeling it as much as, say, New York,” said Sofia Dermisi, associate professor of real estate at the Walter E. Heller College of Business Administration, Roosevelt University. “The diversity that the market has (in Chicago) has really sheltered the city.”
This economic diversity has sustained the city’s commercial real estate market, particularly downtown. Although the office building subleasing market has grown this year—indicating that businesses are laying off employees or planning for decreased activity—the direct-leasing market has remained tight—indicating business strength, said Dermisi.
Office vacancy rates stand at a low 11 percent, down from 17 percent in 2005. In downtown, all classes of commercial buildings comprise 277 buildings with 123 million square feet, with another five million square feet under construction. For the third quarter, net gross rent downtown dipped to $20.54 per square foot, according to figures provided by Torto Wheaton Research.
Commercial building sales activity picked up in the third quarter 2008, led mostly by national investors. While credit has tightened, “there is more financing out there today for commercial acquisitions…than six months ago,” said David Hanna, president of the Chicago Association of Realtors, or CAR.
The apartment building market has also remained resilient. A large population of students, young professionals and empty nesters fleeing the suburbs continues to boost the downtown area. These groups like living downtown, because of its proximity to amenities. “They’re looking for places to eat and shop nearby and they’re not car-oriented,” said Hanna. “Anywhere you have those kinds of activities, the entire sector benefits.”
The overall retail market is softening because of oversupply, but niche players continue to see demand, said CAR’s Hanna. He noted that several retail centers featuring boutique stores, smaller restaurants and organic groceries in targeted neighborhoods were doing well. “There are some bright spots for niche players,” he said. “You have to look at the demographics.”
However, Chicago is not immune from the national financial crisis. In the downtown area, overbuilding is creating excess supply, said Hanna. But Roosevelt University’s Dermisi said the real danger lies in job layoffs resulting from national trends. Among commercial building tenants, the largest industries represented are legal and investment services. In the suburban areas, commercial buildings have already suffered major losses from real estate industry tenants Countrywide and Ameritech.
The national is also taking its toll, derailing several of Chicago’s high-profile projects. The Spire, designed to be the world’s tallest residential building, has halted construction. The 90-story Shangri-La Hotel is also on hold because of liquidity problems.
Local tax policies are also hurting the commercial real estate market. Chicago property owners on average pay $6.98 per square foot in taxes, or 25 percent of income, making it the nation’s highest, according to a report by the Building Owners and Managers Association of Chicago. Retail sales tax is also the country’s highest—10.25 percent in Cook County—with another 1.25 percent added in the downtown loop. Many retail center anchor tenants—such as Carson Pirie Scott and Lord & Taylor—have fled to outlying counties, where sales taxes are 2 to 3 percent lower.
But experts said that well-financed buyers will find many opportunities in Chicago. “If you have plenty of cash in this environment and can identify assets in this market—maybe an owner who has a debt problem or squeeze—there are plenty of opportunities,” said Mattox of Behringer Harvard.
Mattox noted that investors can enter the Chicago market through several means: stock in publicly-listed REITs, privately-held REITs typically starting at $2,000 per allotment, syndicated loans and direct investments. “This may as good a time as any to take advantage of a near-term dislocation of capital markets,” he said.
Investors also said the city’s Olympic ambitions enhance its long-term value. Under mayor Richard Daley, the city has launched an international marketing campaign, as part of its bid to host the 2016 Olympic Games. The Olympic committee will make its decision by October 2009.
Real estate investors have already started collecting parcels in the city’s southside, where the games would be hosted, said Dermisi. Commercial investors are also positioning themselves for potential growth. “Real estate owners in Chicago are very interested in the Olympics, because of increased commerce in the city,” said Mattox.
If Obama’s approval rating continues to climb, and if Chicago wins the Olympic bid, its torch will be burning very bright, indeed.