The Chicago Market Both Supported By Tailwinds, Buffeted By Headwinds

Chicago is just a little paradoxical as a real estate market, according to the speakers at Bisnow's Chicago State of the Market event Wednesday. 

Chicago property fundamentals are strong, but there is weakness in the region's economic fundamentals, especially because of the state's fiscal mismanagement. Companies and employees want to be here, so there is demand for office and residential space, but it is increasingly hard to make developments work, considering labor costs and shortages. Chicago is one of the great cities of North America — but not quite a global megacity.

As an office market, Chicago will be reasonably strong in the near future, McCaffery Interests Senior Managing Director Clayton McCaffery said. "But not a huge win."

That is partly because net rents in the Chicago market are lower than in some of the hotter markets in the country, such as suburban Washington, D.C., by as much as $20/SF on average.

"In the long run, however, untapped value might be realized for Chicago office properties," McCaffery said. "If the fiscal mess is fixed, and the violence in the city subsides, Chicago will emerge quite strong, because it has a lot going for it."

The Missner Group CEO Barry Missner agreed that Chicago has its strengths, but even so, its various headwinds make it hard (but not impossible) to create long-term value in the office sector here.

Among Chicago's strengths are an urban texture that attracts workers, a relatively low cost of living and a nexus of dark fiber, he said.

Amenities are more critical than ever in the success of the Chicago office market — of any office market, according to the speakers.

Traditional office space is learning from coworking space, The John Buck Co. Senior Vice President Justin Parr said, citing some of the technology available at John Buck's 151 North Franklin, where the event was held. One example is uninterrupted cell and WiFi coverage from garage to rooftop, something not every building can boast, though it is increasingly expected. Common area usage is another.

"Curating common spaces is an essential part of the future of office product," ESD President Kurt Karnatz said. "But what does that look like? How will hospitality affect office going forward?"

"Buildings need all the amenities," McCaffery said. "No single one stands out any more, because tenants expect a lot."

Office lobbies, for instance, used to be pass-through space, but not anymore, McCaffery said. "Now they are more like a hotel lobbies, and people are gathering in them. Office buildings need to adjust to that reality."

A lot of buildings, especially pre-2000 product in the suburbs, are playing catch-up when it comes to adding common space, though suburban office still competes more on price than much urban space — it is still more of a commodity, the speakers pointed out.

The surprise announcement by Chicago Mayor Rahm Emanuel that he will not run for re-election was fresh at the event, and the speakers were split on whether it actually was a surprise, considering the mayor's political problems.

In any case, his departure adds some uncertainty to the market, including to any chance Chicago has to land Amazon HQ2.

"The odds didn't go up with his announcement," Parr said. "But they weren't that great to begin with."

"One would hope that Amazon is analytical enough in its selection process not to let the prospect of a new mayor change things," Oxford Capital Group and Oxford Hotels & Resorts President and CEO John Rutledge said. "But even so, it's tough competing with Washington, D.C."

In the Chicago hospitality market, Radisson Hotel Group Vice President Development Dinesh Chandiramani said the outlook is positive, even though there is a lot of development. That is because there is also a lot of absorption. 

The wider economy is going to continue to drive demand, Chandiramani said.

"We've heard that we're late in the cycle for years, and each time the cycle lasts a little longer. The economy has to slow down eventually, but I don't think there will be a crash like 10 years ago."

In the medium to long term, Rutledge is bullish on hospitality in Chicago.

"There is an over-reliance on convention business, but tourism is on the rise, and Chicago is on the verge of becoming a megacity, with more than 10 million people in the MSA," he said. "It isn't yet, but it will be one in the future."

In the short run, there are some headwinds to growth, Rutledge added, such as the pension crisis and real estate taxes.

Aparium Group Vice President Michael Kitchen said he is concerned that hospitality development is crowded at the top of the market.

"All the new four- and four-and-a-half star rooms are competing for the same guests," he said.

Overbuilding isn't as much of a risk in Chicago as in some markets, especially trendy secondary markets, Kitchen said. There has been a lot of supply growth, perhaps too much, in markets like Austin, Nashville and Portland.

Moreover, hotel developers are looking to repeat secondary-market successes in other cities that are perceived to be on the rise, such as Pittsburgh, Kansas City and Indianapolis, Kitchen said.

Ground-up hotel development is difficult in any part of Chicago because of labor costs and taxes, Rutledge said. "Redevelopment or adaptive reuse usually makes more sense in the current market," he said.

Chicago itself is one of the main amenities for hotels in the city, and the city's urban texture is becoming more attractive to hotel guests.

For example, Millennium Park was a game changer for South Michigan Avenue and environs as a hospitality market, Rutledge said.

"The city is especially important as an amenity in certain places," Chief Design Officer Tim Swanson said. He cited Fulton Market as a particularly hot market for boutique hotels. "People have heard of the neighborhood, and that's where they want to be," he said.