By Elise A. Couston, Senior Managing Director at Newmark Grubb Knight Frank
This month we have spoken with three of the top developers in Chicago to get our finger on the pulse of the current market conditions, and what they expect to see in 2014.
We want to express appreciation to the following interviewees for their time and valuable insights: Don Schoenheider, Vice President/City Manager and Co-Leader/National Industrial Practice Group at Liberty Property Trust; John Pagliari, Partner at Panattoni Development Company; and, Jerry Krusinski, President and COO of Krusinski Construction Company.
1) What are your observations about real estate activity during the first quarter of this year?
Don: There continues to be slow and steady growth and activity. There has also been more activity in the smaller end of the demand side, i.e. under 150,000 square feet, than we have seen over the last few years. However, there seems to be less activity in the larger user category, i.e. 500,000 square feet and larger.
John: Increased tenant activity, especially in the smaller size ranges. The 30,000 square feet to 100,000 square feet market seems very active, as smaller user vacancies have dropped and rental rates have risen. We are seeing strong demand from users in our two Bolingbrook buildings, our Turnberry 4 project and our newest project at Howard Street and Gross Point Road in Skokie. All four of these projects cater to users between 30,000 square feet and 100,000 square feet.
Jerry: We have seen an increase in activity across several of the markets we serve. Our healthcare market continues to grow with on-campus facilities as well as medical office buildings, build-to-suit in the commercial office space for users expanding requirements, specialty work such as building projects in railroad yards, and most definitely the industrial market across the board. That includes food-related, manufacturing, warehouse and distribution for a variety of projects that are expansions to existing operations, new construction and even speculative construction.
2) What are your expectations about the activity level, user-demand, and deal-making for the balance of 2014?
Don: It should remain solid, if unspectacular. Vacancy rates are low, rents have continued to recover (in some submarkets, back to ‘06/’07 levels) and even though we are seeing an increase in speculative activity, it is by no means enough to push the market in the wrong direction.
John: Vacancy percentages to continue to decrease across most Chicago submarkets, as user activity increases to fill some of the remaining Class A vacancies. Developers are scrambling for land positions to build spec buildings and/or build-to-suits and a lack of inventory will spur more spec development.
Jerry: We are pleased with the increased activity and market diversity. The decision-making process continues to take a longer period of time for vetting and final approvals. We are seeing the best success when experienced and qualified teams come together and they just make it happen.
3) Are you seeing any increase in pricing from 2013 levels in Chicago or its sub-markets?
Don: Rents in most submarkets have rebounded substantially, many increasing 10%-15% in the past 12 to 18 months. Again, with low vacancy rates, rental rates should continue to rise, particularly in the “infill” and highly land-constrained areas like O’Hare, Central DuPage County, and the I-55 sub-market.
John: Rents have increased over the last 12 to 18 months as space has been absorbed. Landlords are able to hold rents, and in some cases increase rents for class A space, in good locations. Again, as vacancies decrease, tenants are left with fewer options and landlords can push rents higher. It’s still a tenant market, but the pendulum is starting to swing towards equilibrium for good spaces.
Jerry: The economic fundamentals always take over, and when the activity picks up, prices begin trending upward. Building commodities (concrete, steel, roofing, etc.) are increasing in price and labor to put the work in-place typically increases June 1 across most trades. I often recommend people to look at the price of gas as a good reference to building and material cost.
4) What, if any, new requirements are you noticing by users who are currently in the market?
Don: We continue to see demand from food companies, consumer products firms, retailers, and light assembly and manufacturers. And as is always the case, there is a steady stream of 3PLs out in the market with their customers. Most of the build-to-suit users require a high percentage of office area and car parking, higher clear heights in the warehouse, and more features that are specific to their operations.
John: A little more TI is required especially in the smaller spaces, but landlords are able to increase rents to cover the additional TI costs. Food-grade users seem to be active, and they usually require a newer building in order to be AIB compliant. Heavy power and additional car parking are some of the other requirements we are starting to notice.
Jerry: Users are definitely evaluating opportunities across the state borders due to lower tax rates and better incentives. This year, we will have work under construction in Iowa, Wisconsin, Indiana and potentially two other states. The question remains to be seen if that is a short-term trend or will the neighboring states continue to attract opportunities from Illinois?
5) What is driving the increase in build-to-suit activity that we are seeing in the marketplace?
Don: It has really been driven by companies with some type of specialized requirement, for example a higher office and parking ratios, processing needs, etc. We have also seen more BTS activity in submarkets where the vacancy is low, larger buildings are in short supply, and fewer alternatives already exist.
John: This trend goes back to a lack of available space, as the vacancy rates are diving into the single digits in most Chicago submarkets. Big Box demand has been strong in spaces above 350,000 square feet. There were 14 transactions totaling 6.7 million square feet consummated in 2013 as opposed to only seven transactions totaling 5 million square feet in 2012.
Jerry: Multiple factors are driving new BTS projects. Reshoring and manufacturing returning from China and re-focusing on USA; the conducive interest rate climate and availability of financing from the lending institutions; available building inventory diminishing as facilities are leased up or sold. Also, new trends in building requirements for omnichanneling warehouse and distribution facilities supporting e-commerce, to name a few items.
Thank you to Don, John and Jerry for the informative insights! Please check back in June for the next edition of Industrial Insider by Elise Couston. We would welcome your feedback and suggestions for article topics, so please contact me at couston@painewetzel.com.
