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Sunny Outlook For Multifamily, With A Few Clouds On The Horizon

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The Chicago region's apartment sector showed few signs of any real slowdown in 2018, as house-hunting millennials and baby boomers looking for second homes both continue to opt for rental units rather than condos or single-family homes.

Wolf Point South
Salesforce Tower Chicago

Developers, brokers and investors all express confidence that these trends will continue fueling the market. Chicago's downtown is poised to be particularly strong as more corporations choose to migrate from the suburbs to the Loop or other emerging neighborhoods on its periphery, drawing in young job seekers.  

The only storm clouds in sight are the many political changes happening in state and local governments, along with possible impacts from national and international events such as interest rate increases, trade wars or an economic slowdown. 

But experts in the sector say none of these worries do much to dim the luster of the multifamily sector. The demographic changes underway are too deep, and whatever happens over the next year or so, the long-term prospects are sunny. 

“We already have a very healthy balance between supply and demand, and overall, there is just a huge demographic shift taking place across the country that has made homeownership less and less appealing, and as long as companies that offer high-paying jobs keep migrating to Chicago, the downtown multifamily sector will stay healthy,” Marcus & Millichap Chicago Regional Manager David Bradley said.

The metro area market has hummed along for years with high rates of construction and rising rents, and 2018 was no different. Developers completed about 9,200 new units, up from the roughly 8,800 finished the previous year, according to a Marcus & Millichap report on the fourth quarter.

Demand for new apartments has kept up with supply. In fact, for the first time in years, more apartments were absorbed than built. Net absorption totaled more than 11,500 units, Marcus & Millichap found, and that pushed metro area rents up 4.4% to $1,463 per month, on par with 2017’s 4.5% rise, and cut the vacancy rate down 40 basis points to 5.4%.

The urban core was particularly strong — 2018 was a record-breaking year for downtown apartment absorption, according to a new report on the state of the Chicago region’s multifamily market by Cushman & Wakefield Managing Directors Susan Tjarksen, Todd Stofflet and Jason Stevens. By year’s end, more than 4,200 units were absorbed compared to about 3,600 delivered, giving landlords a chance to catch up with the oversupply of 2016 and 2017.

Alta Roosevelt Apartments, a 496-unit development at 801 South Financial Place in the South Loop, was the largest project finished in 2018, and Bradley expects developers to continue breaking ground on projects of this scale in the central core.

Builders have about 16,300 units underway throughout the metro area, including 5,000 in The Loop. Bradley said that is a lot for downtown, especially considering the thousands built there and in adjoining neighborhoods over the past few years, but he doesn’t worry.  

The November decision by San Francisco tech giant Salesforce to establish a new regional headquarters in the newly dubbed Salesforce Tower Chicago, a 57-story office tower that developers Hines Interests and Joseph P. Kennedy Enterprises will construct by 2023 next to the Merchandise Mart, is just one reason for confidence.   

The flood of new firms coming to downtown continued this month when Mondelez International, the maker of Oreo cookies, announced it would move its headquarters from suburban Deerfield to Thor Equities’ 905 West Fulton St. in the Fulton Market neighborhood.

Salesforce plans to create about 1,000 jobs to start, with many getting filled by millennials, most of whom will look for apartments to rent, rather than houses to buy, Bradley said.

“I think those new 5,000 downtown units will be absorbed rather quickly.”

Alta Roosevelt
A unit at Alta Roosevelt Apartments, a development at 801 South Financial Place

That is because it makes more financial sense in most cases for young professionals to rent rather than own, according to Tjarksen, Stofflet and Stevens’ data.

“They are making big salaries, but they are also paying off huge student debts,” Tjarksen said.

The Cushman & Wakefield team examined average costs for condo and rental options in Chicago’s Streeterville neighborhood, and found owners of one-bedroom condos spent $2,499 per month on housing, but renters were spending $2,239, a 10% discount.

The gap was even greater for those with larger units. The costs of owning a two-bedroom was $4,737 per month, compared to $3,628 to rent.

Those differences in affordability could fuel the sector for years, Tjarksen said.

And the gap in costs does not take into account the vast array of goodies downtown apartment developers use to entice prospective renters, while most condo buildings have relatively small amenity spaces, with perhaps a fitness center, an outdoor patio and a pool, she said.  

Alta Roosevelt Apartments offers a resort-like atmosphere typical of downtown’s new apartment communities. Renters have access to a rooftop deck and pool with private cabanas, a multi-screen theater, an outdoor terrace with bocce ball, a coworking hub with conference rooms and a pet spa.

It is hard to compete with that, and condo developers have mostly concentrated on creating small, boutique buildings for very wealthy buyers. That won’t have much impact on the overall apartment market, Stofflet said.  

“That’s been the trend for this entire cycle.”

Logan Crossing
Logan Crossing, Chicago

Many renters choose to stay in the city, but still need apartments more affordable than ones downtown. To satisfy this demand, builders in the past few years began creating transit-oriented developments in outlying neighborhoods like Wicker Park, Bucktown, Logan Square, Lakeview and several others.

Whether this kind of building will continue at a high level is an open question, especially in the vast stretches of the city covered by a new pilot program that changes the Affordable Requirements Ordinance.

That law generally required developers of new multifamily communities with more than 10 units to set aside 10% of those units as affordable, or pay an in-lieu fee into an affordable housing fund. In the pilot neighborhoods, mostly on the West, Northwest and Near North Sides, the in-lieu fee option was removed, and the set-aside requirements boosted to between 15% and 20%.   

“These are the neighborhoods we want to be in, but it’s hard to make deals pencil out under the pilot program,” Fifield Cos. Vice President Lindsey Senn said.

In the aftermath of the recession, Fifield helped lead the transformation of the West Loop into a luxury residential neighborhood by creating massive towers like K Station. Then it branched out into outlying neighborhoods. The company broke ground last summer on Logan Crossing, a six-story, mixed-use apartment development in Logan Square right off a Blue Line Stop.

The project, on the former site of the Megamall at 2500 North Milwaukee Ave., was approved before the pilot program was established, and Fifield committed to setting aside 10% of its 220 units as affordable housing. 

Under the new rules, the requirement would have been 20%, a burden the company probably could not have shouldered, Senn said. 

She believes other developers have also balked at launching projects subject to the pilot program. Coupled with a growing lack of sites suitable for high-density communities, she thinks those strictures will slow multifamily development in outlying areas to a trickle once projects like Logan Crossing start leasing.

That may impact the thousands of potential renters that want new units near the trains.

“I was looking for an apartment in Logan Square myself,” she said.

Like many young professionals in Chicago, she spent a lot of time in Logan Square in the past several years, sampling the many new restaurants popping up, but could not find an apartment that included a washer and dryer.

That experience helped her see where unmet demand existed.

“It wasn’t about punching in a bunch of numbers, it was getting to know the city intimately and seeing where people wanted to be.”

There is a pent-up demand for new units, and with developers struggling to find sites for large projects, Senn expects many in the coming year will break ground on smaller efforts that don’t need much land or come under the ARO restrictions.

She hopes the political winds start blowing in a different direction and help create new incentives for developers. Senn said tax abatements that kick in when developers build affordable housing could unlock the neighborhood markets.

“I think you would see developers move forward,” she said.  

Politics is also on the mind of Cushman & Wakefield’s Tjarksen. She agrees the development community would like to see new tools that would help deliver affordable housing and make market rate construction work.

This week’s turnover in the governor’s office, and the upcoming end of Mayor Rahm Emanuel’s administration, has caused some uncertainty among those in commercial real estate, but no real fear, she added. 

“As long as these are orderly turnovers, and not complete disasters, it will be business as usual,” Tjarksen said.

Some recent political changes could benefit commercial real estate, according to Marcus & Millichap’s Bradley. He considers the elevation of political newcomer Fritz Kaegi to the Cook County Assessor’s office as an opportunity to remake that key government agency in a way that will attract more investment.

Kaegi said throughout the campaign that his predecessor, Joe Berrios, had favored wealthy and politically connected commercial developers at the expense of county homeowners. Bradley believes the former assessor’s methods also confused investors, especially those from outside Chicago and from overseas.

Some have found it difficult to estimate what county taxes they would owe if they purchased buildings here, and that has led some to walk away from potential transactions.

“If we can get a property tax assessment system that is more transparent, the way the new assessor says he wants to set it up, I think that will definitely help capital flow into the area,” Bradley said.  

He does have one concern about the new governor, J.B. Pritzker. Democrats in the legislature, supported by community groups and affordable housing advocates across the state, have put forward several proposals to repeal the 1997 Rent Control Preemption Act, which prohibits local governments from regulating rents.

Advocates and their legislative allies say such a move is necessary to halt spiraling residential rents, especially in gentrifying neighborhoods such as Logan Square. Real estate brokers, developers and investors counter that rent control would smother new development.

Pritzker said he supports repealing the statewide ban. It is not clear whether this is a high priority for the governor, but if one of the proposed bills passes and reaches his desk, Bradley worries he would sign it into law.  

“That could be a game changer.”

Others have a similar confidence in the region's multifamily market, but still worry about what may happen outside Chicago.

Redwood Capital Group partner David Carlson said his firm is very bullish on the suburbs. It once concentrated on value-add properties, but so many other investors began jumping into that space it also started buying new construction in 2018.

Redwood plans to maintain a balance in its 2019 suburban investments, as rents and occupancy levels throughout these towns keep increasing for both workforce housing and the more expensive new units.  

"The only thing that keeps me up at night are possible economic headwinds, but even if something occurs, we don't think it can make much of a dent in multifamily for the next few years," he said.