Long-term demand fundamentals are paving the ongoing strength of the industrial and data center markets in Chicago as the most likely sectors for deploying capital over the next 24 months, despite a rather seismic shift in the pecking order from 2023.
According to the 2024 Chicago Market Sentiment Report published by The Real Estate Center at DePaul University and Urban Land Institute, Chicago District Council, data centers became the highest-rated sector. When the sectors were rated on a scale from 1 to 5 (1 very weak and 5 very strong), data centers scored a 4.25, an increase of 24 basis points (bps) from last year, which catapulted the sector to number one. The industrial sector fell to number three after declining to 3.7 from 4.29 in 2023.
Reagan Pratt, the Douglas and Cynthia Crocker Endowed Director of The Real Estate Center at DePaul University, said the ~60 bps drop for industrial largely reflects near-term supply concerns. He said both data centers and industrial properties continue to have strong long-term demand fundamentals.
AI Platforms Drive Data Center Favorability
According to Jim Kerrigan, Founder, North American Data Centers, the consistent performance and appeal of data centers as a sector can be attributed to a variety of factors, including the expansion of AI platforms and capabilities.
“In markets like Chicago, Dallas and Northern Virginia, increasing demand tied to AI really took off at mid-year 2023 and continues,” Kerrigan said. “Of the major markets, Chicago remains among the top five.”
Today demand is broader than before reaching beyond the large enterprise users like Google, Oracle, Apple, Meta and Microsoft, which drove the market in the past. This results in different types of data center demand, including centers that are geared more to multi-tenant colocation users.
At the same time, Kerrigan said his greatest long-term concern for the sector relates to fundamental infrastructure matters, like the ability to deliver power to a site and the availability of the equipment and components necessary. He also said the potential for AI-related regulations could impact the sector.
The Outlook For Industrial Real Estate is Promising
Two prominent investment and development firms in Chicago—LINK Logistics and Logistics Property Company—are bullish on the industrial marketplace in large part because of the diverse base of industrial users fueling the market. This is despite the slide in the ranking of the sector.
Caitlin Sullivan, Senior Vice President, Link Logistics, cited NAI Hiffman statistics revealing that in the first quarter, the actual lease transaction count was up by 20% even though leasing square footage was down approximately 15%. That trend can be attributed to the active user base, which includes manufacturers, light assembly and suppliers, occupying smaller footprints.
“It’s not just third-party logistics (3PL) and enterprise user driven,” Sullivan said. “It’s all part of the larger ecosystem and continues to be driven by more local and regional business activity.”
For much of the industrial market’s long and historic run, a lot of activity was headline-grabbing. It was million square foot developments and leases and large portfolio acquisitions. Today’s sweet spots, according to the experts, include buildings that range in size from 100,000 to 300,000 square feet or, from a purchase perspective, $20 million to $30 million.
Aaron Martell, Executive Vice President, Logistics Property Company, said his view has shifted and he feels positive about the market. “I feel better about the market than where we were six months ago and I feel even better than three months ago.”
Martell attributes that, in part, to the lack of fluctuations in interest rates.
“In order for long-term investors like LPC to feel strongly about the market, transaction volume needs to be occurring from the leasing and capital market side.”
While rates haven’t gone down through early September, as had been expected, they haven’t fluctuated for the last nine months. That gives investors a greater level of comfort, which is needed to complete transactions.
“We’ve always deployed the strategy that if a deal presents itself, you make the deal; you don’t get cute or try to over negotiate,” Martell said. “Do a fair deal and move on to the next one to fill your vacancy.”
That strategy has further credence in today’s market, compared to a couple of years ago, when there may have been 10 users lining up for a space instead of perhaps only a couple now. When looking at the Chicago market from a historical perspective, the vacancy rate is below the historical 10-year average, Sullivan said.
A rapidly increasing level of capital market activity is Martell’s greatest source of optimism for the industrial market over the long term. On the flipside, concerns for the market include something of a lingering supply issue, a result of what Martell calls commodity development and the belief that regardless of where buildings were developed, they would be leased.
Sullivan suggests a lot of development can continue to happen on the outer edges of the markets, as you continue to go into more Suburban areas. “We tend to concentrate on the infill locations, but those are harder and harder to develop.”
Industrial: Still the Investment of Choice
Capital markets sources were asked how they would allocate a big Chicago property acquisition spend. Keith Largay, JLL, would anchor his investment in Chicago real estate with as much as 50% in industrial real estate. Ami Adachi, Heitman, would invest approximately 25% in industrial property.
In the report, Greg Warsek, Associated Bank said industrial real estate is one of three asset classes Associated would be most inclined to finance. He added that industrial property could be underwritten at as much as a 75% loan-to-value (LTV). “But it would all be dependent on factors such as new construction vs. existing properties, spec vs. build-to-suit, and tenant quality,” Warsek said.
The 2024 Chicago Mid-Year Sentiment Report was sponsored in part by Pioneer Realty Group and Crowe.
