Real Estate Forum - February 2008

retail projects under way are almost fully leased, the firm agrees that the consumer base has fallen significantly with the housing market’s standstill. This is likely to halt speculative development in the coming year.—Danielle Douglas

MIDWEST

Chicago

THE FOCUS IN CHICAGO IS ON THE CBD office sector, which is expected to perform well due to rising rents, positive absorption and little new supply coming on line.

According to a recent report by Delta Associates, overall rents Downtown rose 6.2% in 2007, while class A rates jumped an average of 10%. Delta anticipates the demand for office space to increase throughout the metro area, which will push vacancy rates lower and rental rates higher.

Marcus & Millichap also sees office rents rising in the coming year. The firm forecasts that asking rents for class A buildings in the Central and West Loop submarkets will likely increase 4.5%. The cost of class B and C properties in the region will rise at a slower pace, but could pick up if tenants can’t afford the rates for high-end buildings.

Absorption should also be steady, aided by a lack of new space completions. The only building slated for delivery in the CBD this year is the 400,000-sf 22 West Washington, reports Grubb & Ellis.

“In 2007, direct net absorption Downtown was more than 2. 8 million sf,” notes Dan Ryan, Chicago market director for Jones Lang LaSalle. “For 2008, we anticipate further tightening in the class A office market. In turn, concessions will likely diminish as landlords will not only enjoy a 12-month window of leverage before three new office towers totaling 3. 6 million sf are delivered in 2009, but are also challenged to meet elevated pro formas of recently sold buildings.”

Continued job growth will likely also benefit the office sector. According to Marcus & Millichap, an estimated 30,000

new positions will be created this year, with office-using firms accounting for half that total.

“The legal sector and other professional service organizations will drive demand for office space,” says Chris Wood, SVP and managing director of UGL Equis.

It’s a different story in the suburbs, where office vacancies are expected to increase and absorption will likely be sluggish. Marcus & Millichap is forecasting a 50 basis-point rise in vacancies to 19.3% this year, mainly due to troubles in the housing-related financial service sector.

“Excess vacancy of older class B and C space, especially in the O’Hare and Northwest submarkets, will also weigh on the overall vacancy rate in the suburbs,” the Marcus & Millichap forecast states.

Grubb adds that availability will likely creep higher in the O’Hare submarket as several large tenants leave the area. However, the firm noted that class A space in the I- 88 East/West corridor should perform well, although the market will have 465,000 sf of new speculative space delivered.

Though it’s weighing the office sector down, the trouble in the residential mortgage market, combined with employment growth, will keep up demand in the multifamily market. Marcus & Millichap expects the Downtown vacancy rate to drop 10 basis points to 4.6%. Few new developments and a soft for-sale market will likely cause vacancies to dip 30 basis points to 4.4% in the suburbs. Rents are expected to increase 3.2% this year.

The industrial sector could see mixed results this year. “The Chicago industrial market will rely heavily on how the economy plays out in the year ahead,” says Shawn Mobley, EVP and managing director at Grubb & Ellis. “Vacancy should continue on an upward trend as a result of an oversupply of speculative product.”

At the end of 2007, Grubb reports nearly 15 million sf of industrial space was under construction, mostly in the Central Will submarket. Despite this, Delta says overall industrial vacancies fell to 9% at year-end from 9.5% in the prior year. Rents increased by 3.7% last year and are expected to rise slightly this year, as demand should keep pace with the new supply.

Uncertainty about the impact of the housing slump marks the retail sector as well, although Grubb is optimistic about the property type. According to its forecast, the average shopping center vacancy rate fell below 5.5% by the end of 2007. Overall retail leasing was consistently strong last year, causing the availability to hover in the mid-7% range. Activity is expected to remain strong as tenants continue to open new stores.

Marcus & Millichap, however, predicts that slower economic growth and consumer spending will reduce tenant demand and contribute to a slight rise in vacancies, causing developers to scale back on the number of new property completions this year. In urban markets, vacancy rates should move up 50 basis points to roughly 6% while rents will rise about 2.5%. In the suburbs, vacancy will likely climb into the low-9% range. This is partly due to temporary availabilities at older properties that are being redeveloped. Overall, Marcus & Millichap expects 5. 1 million sf of new space to be delivered in ’08, with 1. 5 million sf Downtown. Asking rents should jump 3% this year to $20.13 per sf.—Jennifer McCandless

Cleveland

THE POSITIVE ABSORPTION OF 37,228 SF during the year kept the vacancy rate around 18% in the fourth quarter, marking the lowest vacancy rate the CBD has seen since midyear 2003, says CB Richard Ellis. And with several larger tenants looking for significant class A space and companies relocating or expanding, it is likely that new office space will be constructed in Downtown Cleveland this year.

“With limited options in the class A market, it is anticipated one of several planned new developments will break ground,” says Bob Nosal, EVP and managing director at Grubb & Ellis.