By Jay Fahn, Senior Vice President, First Eagle Bank
From Lincoln Park to Hinsdale, from South Shore to Highland Park, construction crews are busy again with spec condos, office space and residential tear-downs, all with full expectations that buyers will appear. While developer optimism may be justified – we’re in the hottest commercial property market since the bust in 2007 – there are fresh concerns that if we’re not careful, Chicago real estate is poised to overheat. And imagination alone won’t save us from the negative consequences.
As on that magical Iowa cornfield turned baseball diamond, real estate is a team sport requiring lenders, developers, realtors, buyers and sellers to consider the big picture. The Great Recession reminded us how quickly “irrational exuberance” or “teardown fever” can turn ugly and then disastrous for players and spectators alike.
So, are we experiencing a robust recovery and healthy growth? Or are we slipping back into those former destructive habits? Recent history, in this case the housing bubble and credit crisis, is not always a foolproof guide to the future, but it should never be far from our collective memories.
Here are three current trends in the Chicago real estate market worth keeping in mind:
- Higher leverage-Following the housing bubble burst, many borrowers had to practically sell their souls to secure bank financing. Now, some lenders are offering loan advance rates up to and beyond 80 percent. When combined with limited or no personal recourse, low interest rates, and longer amortization borrowers have minimal “skin in the game,” and the market will then be well into “bubble territory” again.
- Cheap money – Demand for multi family properties, single-family homes, condos, loft office buildings, and hospitality developments is up and cap rates are down. Record prices are being paid for multifamily properties, loft offices and land. A recent story in the Chicago Tribune cites the case of three adjacent single family homes in Lincoln Park, each of which sold for over $1 million, where the buyer knocked them down to build a home on the triple lot. And this isn’t the only such instance. Most realtors point to cheap money as driving this trend, which in turn attracts more buyers (many of them inexperienced) which then results in overpaying for assets and which then drives prices even higher, creating an even bigger “bubble.”
- Longer amortization-Lower principal payments on amortizing loans means debt remains high and equity low. Combined with higher leverage, borrowers become even more vulnerable to rising property taxes and operating costs. There is less protection for the borrower against tightening credit markets and growing refinance risk, especially if the “bubble” bursts.
With the economy still struggling to recover, all participants should get a reasonable good deal: buyers, sellers, lenders and realtors. Perhaps we should remember that the real estate market is not a Field of Dreams, but rather, a roster of real-world players who all benefit from steady growth in the real estate sector where price and value are aligned. Because if the market tanks again, we all lose.
