Experts: Chicago Is The Biggest Obstacle To Continuing The Development Cycle

Conventional wisdom dictates the multifamily construction boom in Chicago will not last forever. So do the numbers: over 12,000 new apartments are being added to downtown Chicago's inventory through 2019, but rents rose a modest 1.3% last year. Combined with rising construction costs, a tighter labor pool and constantly changing affordable housing requirements from the city, a tipping point may be near in this development cycle.

Fifield Cos. CEO Steve Fifield compared the growing confluence of factors to the apartment boom of the 1970s and '80s. Developers believed that boom period would go on forever, but then the Cook County Assessor reclassified apartment complexes as commercial properties, which sent real estate tax bills skyrocketing 2.5 times overnight. 

"We're taking for granted that this period will continue," Fifield said.

The changes to the city's affordable requirements ordinance two years ago have had a similar effect on real estate taxes and effective costs for projects with affordable housing set-asides. Fifield said real estate taxes on affordable housing units increased by $100K/unit since the changes took effect. The new neighborhood-specific affordable requirements along the Milwaukee Avenue Corridor, North Branch Industrial Corridor, Near West Side and West Town will result in tighter balance sheets.

Fifield met last week with Planning Commissioner David Reifman, who suggested developers keep raising rents to absorb the costs. The problem is that those rent increases get passed down to tenants, who are already struggling to pay their monthly notes.

Another indicator that a reckoning is coming is in the percentage of renewed leases. Fifield said retention rates at his firm's apartments last winter fell for the first time in five years. 

Golub Executive Vice President Lee Golub said that with abatements on new lease-ups, like one month free rent, apartments have become a transient business for the renter. Golub has seen retention rates decline at some of his firm's developments over the past two years, and said sometimes 35% to 45% renewal rates are seen as strong. With a growing inventory of new apartments, renters have opportunities to seek out favorable abatements to keep their costs down, and shop the market.

"A real renter does not care where they are," Golub said.

Golub said rents cannot keep increasing and, coupled with new ARO requirements and higher construction and commodities costs, it is now tougher to pencil out new construction.

JRG Capital Partners principal Harry Huzenis said the length of the development cycle and changes to the ARO are negatively affecting land pricing. Land values keep increasing when developers thought they would do the opposite, and outsized expectations from land sellers are contributing to the rise. Huzenis said he had a deal to sell the LaSalle/Erie Body Shop site in River North that almost fell through because the owner was not going to sell unless he received his asking price.

"He would still be holding on to it if he didn't get his number," Huzenis said.

Huzenis said JRG has a number of land deals under contract, waiting to see if developers come back to them for a retrade or to drop the deal entirely, based on some of the new rules.

"It is one more obstacle they city is throwing up at developers," Huzenis said. He believes Chicago is in the late innings of the cycle, judging from the number of apartments in the pipeline, flat downtown rent increases, and vacancies in submarkets where there were waiting lists a couple of years ago.

"You cannot get bigger units rented," Huzenis said. 

JDL Development President Jim Letchinger said that while the city has taken bold steps to address developer concerns, the new neighborhood-specific affordable housing requirements may be too aggressive and could kill development in the city. 

"Every time the city imposes new rules, it hurts," Letchinger said. "We have been raising rents but there will be a point where that will no longer work."

Letchinger believes that the city needs to work with developers to come up with solutions that will not curtail development, that go beyond simply raising rents to absorb the costs. 

"Rents do have a cap. It is emotional for some renters, but it is real," Letchinger said.