Chicago's Multifamily Market is Poised for a Strong 2010

The weather seems to be changing in the Windy City. Thanks to subtle indications that the U.S. economy will improve heading into 2010, industry observers say that the demand for Chicago apartments will likely increase in 2010 and 2011.

In late 2009, the nation’s unemployment rate declined to 10 percent and net job losses moderated in November. Government programs and tax incentives, such as the first-time homebuyer tax credit, drove a rise in spending in the third quarter. As the impact of government action abates, however, traditional demand drivers such as job growth and improved consumer sentiment will be needed to sustain an economic recovery. Economists predict that firms should resume hiring in 2010, albeit at a modest rate, and that bodes well for cities such as Chicago, whose economy is driven by mega-industries such as finance, trade and transportation, and food production.

In the ’Burbs

In the Chicago suburbs, where ongoing payroll cuts are affecting renter demand, apartment operating fundamentals remain soft. The overall suburban vacancy rate is forecast to increase to 7.5 percent in 2010, 40 basis points higher than 2009.

Meanwhile, rents are expected to drop as owners widen concessions to compensate for waning occupancies. Asking monthly rents in the suburbs are expected to end 2010 at $927, while effective monthly rents will be $848, year-over-year decreases of 2.9 percent and 3.5 percent, respectively.

On the development side, despite easing construction, the supply/demand imbalance continues with the persistence of competition from foreclosed homes and high levels of deliveries. What’s more, with continued difficulties in obtaining construction loans and weak demand, only 390 units will be delivered in the suburbs in 2010, down from roughly 625 units in 2009.

The largest project slated to come online this year in the suburban submarkets is the 390-unit first phase of the Arboretum Landmark mixed-use development in the Woodridge/Lisle submarket. Scheduled for a second-quarter delivery, the project will increase inventory in the area by nearly3 percent, which should push the submarket’s vacancy rate above 10 percent for the first time in more than 20 years.

Most submarkets are posting higher-than-average vacancy rates, particularly in Class A complexes, as some renters seek more affordable housing options and others opt to double-up or move in with family. Conversely, outlying submarkets will post weakness due to softening local labor conditions and elevated competition from single-family housing.

Heart of the City

Apartment fundamentals in the city submarkets, meanwhile, will soften this year, though at a more modest pace than in the suburbs. Ongoing competition from the shadow market and job losses will push vacancies 20 basis points higher in 2010 to 6.9 percent this year; in 2009, downtown vacancy climbed70 basis points. Asking monthly rents will end the year at $1,154 per month, a year-over-year decline of 1.3 percent; effective monthly rents will fall 1.6 percent annually in that same time period to $1,059 per month.

Starts and deliveries will likely slow by about 40 percent in 2010. Roughly 840 units will come online in the city this year, with 75 percent located in The Loop submarket. The decline in deliveries will likely continue. And the imbalance will be further aggregated by job losses in key renter groups. The size of the 21- to 29-year-old cohort has contracted 2.1 percent this decade, with most of the decrease occurring in the past three years as residents leave the metro or move back home.

Additional pressure on operating conditions will come from an increase in completions this year, as developers are on pace to deliver nearly 640 units in The Loop submarket this year—nearly double the number of new units added to the area in 2009. That activity is highlighted by the 389-unit 215 West complex scheduled for a second-quarter completion. However, the supply situation in The Loop has been made more difficult by condo projects that reverted to rentals during the construction process. In fact, more than 100 condos in the West Loop switched to rentals in recent months. In the meantime, while new space premiums will likely prop up rents in The Loop, owners are expected to enact asking rent reductions in other neighborhoods and submarkets early in the year to sustain occupancy levels.

Distress Blues

Investment activity will be driven by local and out-of-state buyers in 2010. Syndicates consisting of long-term owners who are divesting assets and pooling cash also will continue to emerge and seek out distressed properties in areas with broken condo projects.

In particular, New York and San Francisco investors will focus on well-located, quality product in urban infill areas. Investors from Detroit and southern Michigan are also taking a look at Chicago assets due to the high levels of duress in those markets.

Investors will continue to find opportunities for distressed commercial real estate in Chicagoland next year; however, this trend is expected to fall short of buyer expectations. In 2008 and 2009, delinquencies across all property types steadily increased. Despite this rise, the complexity of the CMBS market will continue to limit foreclosures and distressed asset sales. And that means a tight transactional environment for the Windy City in 2010 and beyond.