Ongoing economic recovery and renewed residential development bode well for Chicago’s retail sector, according to a retail market research report from Marcus & Millichap Real Estate Investment Services. In the city, retailer demand should rise substantially in coming quarters as high-rise apartment development swells, the report noted.
Mark Hunter, Midwest retail market lead for Jones Lang LaSalle, said the Chicago retail market is benefiting from a more stable economy and lower unemployment. Metrowide, payrolls will rise 1 percent in 2013 with the addition of 44,000 jobs. Last year, employment grew 0.7 percent, according to Marcus & Millichap.
“With the additional job creation and younger people wanting to live closer to work, I think retailers in the downtown area have seen improvement,” Hunter said.
Retail leasing in the city began to gain traction last year, driving vacancy in the area down to the low-6 percent range, according to the Marcus & Millichap report. Through 2013, national discount and grocery chains, such as Walmart and Target, will continue to make a play for a greater share of downtown dollars.
“The retail market is bifurcated in that retail in the urban areas is doing well,” said Greg Schott, managing principal at L3 Capital. “I think some of the discounters continue to do well – tenants like Target, Walmart and Nordstrom Rack.”
“I think that value retailers probably have seen the most significant sales gains because most people are more price sensitive and are shopping more for value than they were in the past,” Hunter added.
Chuck Taylor, director of operations for Englewood Construction, said he is noticing renewed activity from mid-range apparel retailers such as Banana Republic, Gap and J. Jill.
“For the past couple of years, value-based retail and high-end retail was the only thing that was showing any signs of activity,” he said. “Now we’re seeing everything in the middle come back, such as apparel retailers.”
The anticipated influx of high-income households into the city is also luring more apparel and specialty retailers to the area, a trend likely to gain momentum and help offset the uptick in completions, according to Marcus & Millichap.
“There have been a lot of new apparel retailers interested in the city of Chicago,” Schott said. “You’re seeing some restaurants come along, but you’ve also seen some new apparel and designers, so there’s definitely been an interest from fashion.”
In terms of construction, Marcus & Millichap’s report points out that developers will complete 2.3 million square feet of retail space this year, up from 910,000 square feet in 2012.
However, Schott said there is a supply-demand imbalance when it comes to well-located retail real estate.
“There’s more demand than there is supply right now,” he said. “I think it’s a combination of the economy getting better and retailers wanting to locate stores in proven areas because they’re more careful about expansion.”
Taylor noted that there has been an uptick in retail construction.
“The activity that we’ve seen in Chicago since the beginning of 2012 into 2013 has been fantastic to watch,” he said. “At the start of the downturn, which was the end of 2008, we started watching all of the brands shutter. We started watching all of the brands either leave the Chicago market or close up completely. Now we’re watching them refresh, rebrand, renew leases and relocate, which is always great for the construction market.”
The Marcus & Millichap report predicts that retail vacancy should decline 30 basis points to 11 percent this year. In 2012, the vacancy rate ticked up 10 basis points.
“I think that so long as the economy continues to remain stable and grow, you’re going to see the vacancy steadily decline and rental rates go up as the supply of space dwindles,” Hunter said.
James Pape and Rob Burda, senior vice presidents and team leads for Associated Bank’s Commercial Real Estate Division, agree that the market is seeing smaller tenants taking up space as opposed to big-box tenants.
“I think the biggest trend that we’ve seen is smaller retail projects versus the larger big-box centers,” Burda said. “We see a lot of activity with smaller centers that are substantially pre-leased before they get built. Pharmacy, auto parts, dollar stores and even some bank branches dominate that kind of project. The other thing you see is some grocery activity, but most of that is smaller than it used to be. It’s sort of the smaller niche grocer that’s out there.”
“I think if you look at a lot of the retailers, they’ve re-looked at the size of their buildings and their operations and it seems like they’re downsizing in some cases,” Pape added.
Taylor also noted that many retailers are signing short-term leases.
“We’re still seeing a lot of short-term users go into some of the vacant spaces,” Taylor said. “I would like to see those filled with more long-term leases because I think that will be a great sign for the industry in general. A lot of landlords have gotten creative as far as filling space.”
Suburban retail
In the suburbs, vacancy remains elevated at approximately 12 percent as larger grocery and big-box chains maintain their preference for build-to-suit space, according to Marcus & Millichap’s report. Shopping center operations in the suburbs, however, vary by asset quality and location, as fitness clubs, niche grocers and various junior big-box chains are backfilling some well-located properties.
The Marcus & Millichap report goes on the point out that despite still-elevated vacancy, cap rates for better-quality properties have slipped due to a shortage of for-sale inventory and persistently low interest rates. The trend appears most pronounced in the single-tenant sector, particularly among corporate-owned McDonald’s and national drugstores. Cap rates for the former start in the mid-4 range, while Walgreens assets with extended lease terms remaining change hands between 5.5 and 6.0 percent.
The report notes that a shortage of quality single-tenant listings has driven many net-lease investors to high-credit multi-tenant deals. The resulting increase in competition has driven cap rates for such properties in the suburbs to the low- to mid-7 percent range, while centers with high-credit tenants in the city average 6.0 to 6.5 percent.