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A Lot More Nerves About Chicago In 2020, But It Likely Won't Be All Doom And Gloom

The talk of a recession keeps hovering over the world of commercial real estate, but the expected downturn never seems to arrive. As the expansion extends into its tenth year, some experts are saying it may be time to calm down, and consider the economy’s fundamental strengths.

James Shilling

“I wouldn’t say there aren’t any reasons to be anxious, but I don’t think next year will be one of doom and gloom,” said James Shilling, chair of DePaul University's Real Estate Department, at the recent 15th Annual Real Estate Investors Association/DePaul Fall Summit.

“There are some real bright spots in the economy, especially personal consumer expenditures, which represents two-thirds of the economy, and is still going strong,” he said. “Income growth is also strong, especially in low-wage industries.”

He considers that one of the keys to the economy’s long-term health, as it might help relieve the tremendous pressure on millions of lower-income households that struggle to meet housing costs. After many decades with minimal rent growth, most metro areas, including Chicago, saw major escalations beginning in the 1980s and continuing ever since, fueling movements to enact rent control.

Shilling’s generally optimistic mood is not shared by every industry professional.

According to the second annual Chicago Mid-Year CRE Sentiment Report produced by The Real Estate Center at DePaul University, those bearish on the future increased to 17.7%, from only 3.9% last year. And the number of optimists also changed rather dramatically, to 9.8%, down from 21.2% in 2018. Nearly half were somewhere in the middle, but said they were concerned about the market’s direction.

“It’s clear the bears outweigh the bulls now,” Shilling said.

The report is based on a survey of real estate professionals affiliated with DePaul — sponsors of The Real Estate Center as well as members of DePaul’s graduate and undergraduate programs — along with follow-up interviews.

Much of the unease about Chicago’s future relates to local and state concerns, rather than macro issues with the U.S. or world economy, DePaul reports.

“We’re unique in Illinois, and in Cook County, because of lingering financial issues,” RPAI Chief Operating and Investment Officer Shane Garrison said. “It is a significant structural problem.”

Shilling highlighted executives’ nerves about the possibility of rent control, but said the biggest concern is what will happen with property taxes over the next five years.

“Many expect tax hikes of around 35%, across the board in every commercial sector, and that’s going to be hard to absorb.”

Garrison also cited Gov. J.B. Pritzker’s expressed desire for a progressive income tax as a possible problem for real estate.

“When you combine those factors with negative population growth, it is very difficult to come up with a compelling investment thesis to come and invest capital here,” he said.

Scannell Properties' new spec buildings at 2451 Bath Road and 1755 Britannia Drive in Elgin, Ill.

Shilling does not disagree that these factors could have negative impacts, but points out that real estate has many underlying strengths.

The population decline of the Chicago region hasn’t slowed down the burgeoning multifamily residential market, he said, and that growth shows many signs of continuing for years, especially in and near the Central Business District.

The number of jobs in the CBD jumped to 613,000, a 28% increase from 2010, according to a capital markets overview by HFF (now JLL). And, using census data, the firm found almost 40% of Chicago's 25-plus-year-olds now have a bachelor’s degree, more than New York City or Los Angeles.

That is a big and affluent renter pool, and it is getting deeper. The largest percentage of millennials are now aged 28, Shilling said, and many will probably continue renting apartments into their mid-30s.

“That means we will still see five, six, maybe even seven years of strong demand growth on the rental side.”     

But if Chicago has a true standout sector, one which could withstand even the headwinds of a recession, it is industrial.

“The industrial sector, in Chicago, other major markets and nationally, is outperforming the rest of the economy by a lot of different metrics, including rent growth and vacancy,” Venture One Real Estate principal Matt Goode said.  

New development is surging as well, and the sector shows no sign of being overbuilt.

Developers finished 8.8M SF of new product in Q3 2019, the greatest quarterly tally since this development cycle began in 2013, according to a report from Colliers International. Of the 27 projects delivered, 15 were built on spec, totaling 4.3M SF.

Despite the massive amount of spec space opening up over the past six years, the vacancy rate for these buildings continues to decline, Colliers found. By the third quarter, it fell to just 29.8%, the lowest it has been this cycle.

“That tells you, as owners and developers, we’re probably delivering the right amount of product,” Goode said.

He points to e-commerce as the sector's true fuel. And the need to construct a vast set of new warehouse and distribution buildings, while important in every major metro area, plays an even bigger role in the economies of distribution hubs like Chicago and coastal areas like New Jersey and Los Angeles.

He estimates that e-commerce comprises about 11% to 12% of retail sales, and said experts believe it could grow to anywhere between 17% and 30% over the next few years.

“Potentially, that means it could prove a buoy even in a downward economy.”

And although Amazon announced last Friday that Venture One Real Estate will soon break ground in suburban Channahon on its latest 1M SF fulfillment center, Goode said the expansion of e-commerce is creating demand for much more than 1M SF giants.

“It is touching every single asset class and building size. We’re even seeing expansion on the part of a lot of tenants with just 2K SF to 5K SF; these are small, local businesses selling products on their own websites, and it is only speeding up.”