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Apartment Construction Boom Will Test the Resilience of the Chicago Market

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Solid employment growth and the attractiveness of an urban lifestyle led to improvements in the multifamily market across metro Chicago in 2016. Although there was positive movement in the performance of key indices in both the city and the suburbs, corporate migration from the suburbs to the city brought young professionals and high-paying job opportunities, especially to the core.

Millennials overwhelmingly favored renting over homeownership in 2016 and sought residence in urban centers offering walkability and a live-work-play lifestyle. In 2017, these trends are expected to continue.

Kyle Stengle, Marcus & Millichap

Kyle Stengle, Marcus & Millichap

Job growth acts as catalyst

Last year, Chicago employers hired 65,000 workers, representing a 1.4 percent workforce expansion metrowide. This healthy job growth helped boost the median household income to around $67,168 per year at the end of 2016.

In 2017, job growth is expected to continue at a similar rate, and it is anticipated that Chicagoland employers will hire 70,000 new workers for a 1.5 percent employment gain over the course of this year.

Employment gains last year were led by the professional and business services sectors, which expanded headcount by 2.6 percent with the creation of nearly 21,200 positions over the yearlong period that ended in September 2016. During the same period, the construction sector also contributed significantly to hiring and added 7,000 workers for a 4.3 percent employment gain in that segment.

Construction on steroids

Strong employment growth last year prompted an incredible amount of construction amid unrelenting demand for rentals. In 2016, the strength of Chicago’s apartment market was challenged by the delivery of a staggering 8,370 units to the marketplace. Of that total, the city received approximately 5,270 units and the remaining 3,100 units came on line in the suburbs.

In the city, developers targeted the submarkets with the highest rents metrowide. Two of the most active submarkets were the Streeterville/River North area and the Loop, where 2,344 and 1,908 units, respectively, were delivered as of Sept. 30, 2016.

There are roughly 9,000 units underway in the city with completion dates through 2019. Large towers will remain a favorite among developers, with a number of projects under construction standing more than 20 stories and consisting of over 240 units.

In the suburbs, builders focused their efforts in the central Cook County and Aurora submarkets. Over the next two years, the suburbs will receive approximately 4,825 more rental units, and a majority of the new development in the pipeline will be delivered in 2017, which is shaping up to be the strongest period of construction on record.

The resilience of Chicago’s multifamily marketplace will be further tested this year as developers are expected to deliver an additional 8,400 units marketwide, marking the highest level of apartment completions since 2000. Although the deep pool of city renters will absorb most of the new space, vacancies and concessions may rise as a result. The suburbs will face similar challenges as development also ramps up outside the core, albeit at a lower intensity.

Vacancy to trend upward

In 2016, the vacancy rate metrowide slid 10 basis points to 3.7 percent despite an increase of 20 basis points in the city, which was offset by a dip in suburban vacancy levels. Given the high rate of deliveries over the last two years and the large amount of new supply projected to come on line this year, the vacancy rate metrowide is expected to rise 20 basis points to 3.9 percent in 2017.

That said, urban operators are prepared to handle the incoming wave of new units, and ongoing corporate migration from the suburbs will mute the effects of an uptick in vacancy. The suburbs, too, are expected to perform well, particularly in submarkets like Schaumburg and Oak Brook, where employment opportunities, large regional malls and easy freeway access support fundamental tenant demand drivers.

Rent growth still healthy

Although the metrowide vacancy rate is likely to rise, the average effective rent is not expected to decline as a result. Last year, tight market conditions, coupled with an upswing in high-end construction, supported robust rent growth metrowide. By the end of 2016, the average effective rent stood at $1,380 per month, up 5.4 percent from a year earlier.

In the city, average effective rents rose to $1,717. The most expensive urban submarket in 2016 was the Streeterville/River North area, where effective rents averaged around $2,281 per month by the end of the third quarter.

In the suburbs, average effective rents climbed 6.1 percent to $1,180 per month. The most expensive suburban apartments in 2016 were in the Evanston/Rogers Park/Uptown submarket where tenants paid $1,502 per month on average at the end of the third quarter.

In 2017, the average effective rent metrowide is projected to rise 4.5 percent to $1,442 per month despite slightly higher vacancy, and will mark the third consecutive year of rent growth in the mid-single digits. Improving rents in combination with continued employment gains will support higher asking prices, although the buyer-seller price expectation gap has been widening.

Pushing back on prices

Historically low interest rates throughout most of 2016, along with improving property fundamentals, kept buyer demand high for apartment assets. As a result, deal flow accelerated and cap rates were low. However, buyers began showing resistance to exaggerated pricing due to concern about the length of the current expansion.

Seller expectations trended in the opposite direction, forging a divide between property owners and buyers. As this gap has widened, investors have started investigating Class C properties in the suburbs in search of greater yield, where cap rates average in the mid-7 percent range.

In the city, deal flow registered a modest increase over the 12-month period that ended in September 2016 as investors targeted assets in the Lakeview and South Shore submarkets. Yet the average price per unit decreased 3.3 percent during the same period.

In the suburbs, transaction volume increased as well, posting an 8 percent gain during the same period. Here the average price per unit also increased, rising nearly 16 percent to approximately $150,000 per unit.

Buyer strategies to vary

Enticed by a broad range of investment opportunities, apartment investors will remain active across metro Chicago this year. Institutional investors will likely chase new high-end products in the metro’s marquee neighborhoods, while private investors seeking greater cash flow may target Class C assets in areas with upside potential.

In addition, properties in areas along the North Lakefront such as Lake View, Uptown and near DePaul University will garner enhanced investor interest. A further widening of buyer and seller pricing expectations, however, may moderate the rise in valuations and present a headwind to deal flow.

-By Kyle Stengle, Senior Vice President, Investments, Marcus & Millichap. This article first appeared in the February 2017 issue of Heartland Real Estate Business magazine.

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