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Despite Intensifying Renter Demand, Many Multifamily Investors Shy Away From Downtown Core

It is a good time to be a multifamily landlord. That is especially true for the owners of downtown Chicago properties, as well as those in areas such as Lincoln Park, Lakeview and other neighborhoods on the North Side, where demand for Class-A apartments is rising, according to Marcus & Millichap’s 2022 national investment forecast.

The pandemic initially led to speculation that the nation’s downtowns would suffer steep drops in demand, but even though most offices remain either empty or underpopulated, renters have continued flocking to urban cores. At the same time, the costs of construction keep rising. That means fewer new units will open up in the near future, which should further tighten vacancy over the next few years and send rents even higher.

The outlook is strong across much of Chicagoland and for many types of buildings, Marcus & Millichap found.

Shoreham and Tides at Lakeshore East

“In addition to the demand surge downtown, vacancy continues to tighten in suburban areas after falling below 4% last year,” according to the Marcus & Millichap report. “Payroll projections are still climbing towards the 2019 peak, but tech, finance, and corporate opportunities supply jobs for high-income renters while roles in transportation support Class-C rentals.”

If the pandemic subsides and tourism revives later this year, there is still a lot of room for employment growth in sectors such as hospitality and leisure, which would fuel yet more demand for Class-C apartments, the firm added.  

Overall vacancy in the Chicago area rose to around 6% as the pandemic took hold in 2020 but fell to about 3.9% by the end of 2021 and is set to sink even further. Marcus & Millichap forecasts a vacancy rate of 3.7% by the end of this year, a drop of 20 basis points and the lowest year-end rate since 2000.

In addition, Chicago-area builders will add up to 6,500 rentals in 2022, a bit more than the 6,200 units added in 2021. But that projection is roughly 2,000 units lower than the five-year average, and the limited construction should also help push up the average effective rent to $1,720 this year, a 4.2% year-over-year boost, which will follow last year’s roughly 12% jump.

But all those solid numbers haven’t fully impressed investors, who are being a bit picky when it comes to acquiring properties. Many have focused attention on suburban areas and in neighborhoods outside the downtown core, according to Marcus & Millichap.

The chief worry about the core has been the reform effort launched in 2018 by then-newly elected Cook County Assessor Fritz Kaegi, who won office after promising single-family homeowners to put more of the property tax burden on commercial owners. That led to higher value assessments of many multifamily properties in Chicago, valuations that will take effect this year and possibly lead to higher taxes.

Supply and demand in the Chicago metro area

Kaegi in 2021 set the value of the 480-unit Cityfront Place in the Streeterville neighborhood at $227.9M, a 137% increase from 2020, according to Crain’s Chicago Business. Such increases haven’t made much of an impact on sales outside of downtown, though, Marcus & Millichap said in its report.

“While this has curbed sales velocity in the core, exchange volume has remained constant in North Side, South Side and other suburban neighborhoods,” the company reported. “North Side from Old Town to Lincoln Square is the most liquid region in the market and regularly records transactions involving all apartment classes, with assets here yielding close to 6% on average.”

Buyers are also seeking out deals in moderate-income neighborhoods, the firm found.

“Investors looking for prices below market average are targeting lower-tier apartments in the South Side area and achieving cap rates in the mid-8% range; however, these returns can tick up higher in areas farther from Lake Michigan toward South Chicago.”

Big downtown sales did occur even with the uncertainty over taxes. PNC Realty Investors sold The Tides and The Shoreham in the lakefront’s 28-acre Lakeshore East neighborhood to Chicago-based Waterton as part of a transaction that closed Dec. 22. Sales prices weren't disclosed for the multifamily properties, which have a total of 1,156 units, but Crain’s Chicago Business reported in September that the total price for the then-pending sale would be close to $400M.

Marcus & Millichap is hopeful the impact of new assessments will lessen in 2022 as investors adjust to the changes Kaegi made.

“Investment activity in the districts in and near the city center should return as details of the tax reassessment materialize and upon tightening vacancy rates in the reassessed submarkets,” the report says.