What Happened To Chicago's Big Industrial Deals?

The overall statistics on the Chicago region’s industrial market remain impressive, with historically low vacancy rates, rising rents and a robust pipeline of new projects underway or just breaking ground. But a significant shift could also be underway in the market, one that leaves many of its largest speculative distribution buildings vacant for several years.

The rise of e-commerce led many companies to reconstruct their supply chains, boosting the amount of space they need. Local developers responded to this explosion of demand in part by creating since 2013 dozens of spec buildings with more than 500K SF, mostly designed for users serving customers across the Midwest or the nation.

However, the number of mega-deals for these spec spaces recently dropped, as more distributors opt instead for massive build-to-suits, or simply go to smaller markets from which they can just as easily reach all of the Midwest, but at lower costs. If this trend continues, it could leave a few big holes in the market.

Still, both experts and developers say it isn’t time to panic.  

“I don’t think the market for big-boxes is necessarily out of whack, but we do need to understand why demand hasn’t been what it was expected to be,” Colliers International principal Frederick Regnery said.  

Mark Goode, a founding principal of Rosemont, Illinois-based Venture One Real Estate, said he has seen a lot of tenants out hunting for big spaces in the last 18 to 24 months, but worries that possible turmoil in the economy, especially about the recent trade disputes with China and other countries, may have had an impact. 

“People slowed down and big deals went on hold,” he said.

Since 2013, developers finished 25 speculative buildings greater than 500K SF in the Chicago region, and have another nine still under construction, according to Colliers’ data. These 34 projects total 23.8M SF, and so far only 47.7% has been leased.

The largest buildings account for a disproportionate share of the vacant space. Seven speculative buildings greater than 800K SF have been built since 2017 or are under construction, six in the I-80/Joliet Corridor submarket, a popular location for national or regional distributors. And only one of those seven new buildings is occupied, a 992K SF building purchased by third-party logistics provider NFI in 2018.

According to Colliers data, five new deals of 500K SF or larger were signed in new spec buildings during 2016, while 2017 and 2018 each only had one new spec deal of this size, and none have occurred so far in 2019.

One of the Chicago region’s challenges is geographic, Regnery said.

Unlike distributors serving the West Coast, which need to be in California’s Inland Empire, or Mid-Atlantic distributors, which typically need space in either New Jersey or Pennsylvania’s Lehigh Valley, a Midwest distributor can opt for Indianapolis, Southeast Wisconsin, Cincinnati or other metros, and have access to a system of roads that covers the whole middle section of the U.S.

“You just have a lot of alternatives to service the market,” he said.

That wasn’t always the case.

Until recently, lenders were leery of funding industrial expansion in these smaller, secondary markets, Regnery said, but the expansion of e-commerce, and the unstoppable demand it created, changed those equations. Today, institutional capital now considers Class-A buildings in all these markets to be solid investments, and these groups are giving builders steady streams of construction funding.

“If your operations are centered on serving Chicago’s population, you are going to locate near Chicago, but if you are involved in e-commerce, servicing the whole middle of the country, the perception that labor is plentiful in Indianapolis, and overall costs are lower, is sometimes the nudge needed to locate there,” Regnery said.

Developers in Indianapolis now have nearly 8M SF under construction, more than half of it speculative, including the 1M SF Crossroads Logistics Center in Whitestown, according to Colliers. That is double the amount under construction one year ago, but tenants in that market have already committed to occupy another 5.9M SF, putting it on track for a historic year.

It isn’t as if the Chicago region doesn’t have users looking for big spaces. But rather than occupying new spec buildings, in the past two years many decided they wanted build-to-suits.

Seven build-to-suit deals of 500K SF or larger were completed in 2018 alone, Colliers found, and one has already been signed in 2019. Of the 14 new deals of 500K SF or larger signed since 2017, 10 were build-to-suit projects.

Regnery said if there is a growing preference for build-to-suits, it may stem from the far greater complexity needed by many users. Running a modern e-commerce operation frequently means thousands of individual orders stacked high, with complex tracking systems. And each firm has its own specifications and processes that developers need to take into account.

“That tends to lead to a lot of build-to-suits,” he said.

Venture One has been one of the Midwest’s most active developers over the past few years, and its new product includes everything from massive build-to-suits and spec buildings in the outer suburbs, to smaller buildings in tight infill markets close to Chicago.

Goode is also seeing strong demand for huge build-to-suits. Venture One recently helped finish a 1M SF build-to-suit regional distribution building for St. Paul, Minnesota-based 3M in DeKalb, Illinois, along with a 675K SF structure for Berner Food and Beverage near Rockford, Illinois, and a 1M SF distribution center for Georgia-Pacific at Gateway 57 Industrial Park in University Park, Illinois.

The largest metro Chicago industrial deal in this year’s first quarter was Fresenius Kabi USA, a pharmaceutical company, agreeing to lease a 590K SF build-to-suit by Venture One Real Estate in Pleasant Prairie, Wisconsin. It is under construction.

The deal with Georgia-Pacific is a good example of how e-commerce is fueling the market for large build-to-suits, Goode said. Under ordinary circumstances, the company may have needed a 700K SF distribution building, but it calculated that an additional 300K SF was needed to handle the increased demand from e-commerce. The company's leaders also gave themselves the luxury of time.

“They went out early and started making plans 18 months before they needed the space,” Goode said.

Venture One also recently helped develop 24101 South Frontage Road, a 1M SF spec in Channahon, Illinois, and even though it remains vacant more than one year after completion, Goode isn’t worried.

“We’re very confident in this location.”

Colliers is handling the leasing of Crossroads 55, and both Goode and Regnery said a healthy number of tenants have looked at the space.

Goode said e-commerce can cause quick shifts in demand, sometimes practically overnight, and that is one reason he believes the region’s big empty specs will eventually fill up.

“If you need something within 90 to 120 days, the only thing that will work is a spec building,” he said.

He believes Chicago just got a little too ahead of the game.

“What happened in certain submarkets was that a significant number of spec buildings were built over a two- to three-year period, and they all came in at the same time.” 

Regnery isn’t quite as confident.

“The question is, has Chicago just experienced some bad luck, or is it something else?” Regnery said. “I don’t know if anyone has the answer to that, so even though demand for industrial space is very healthy, it’s something to keep your eye on if you’re a developer.”

He believes developers may hold off on building any more spec buildings larger than 700K SF, at least until they locate tenants for the existing structures.

Goode said the calculations that go into launching developments of this size are complex and difficult to predict. A developer may secure a particular site and decide there is enough demand to justify breaking ground, even if a few large nearby specs are still vacant.   

This segment of the market can also turn around very quickly, he added.

“If one or two of these buildings gets leased, we’ll definitely see additional buildings get underway.”