The Chicago industrial market continues its charge full steam ahead in 2016, driven by strong fundamentals, our diverse economy, intense investor demand and constrained development.
After a strong first quarter, the second quarter seems to be keeping pace. Demand remains high and continues to outpace new construction. We will also see more new projects announced as developers see continued success with existing projects.
At the end of the first quarter, the overall vacancy rate in metro Chicago was slightly over 7 percent, down 10 basis points from the end of 2015, according to CoStar Group. All of the major submarkets posted vacancy rates of 10.1 percent or lower.
Robust leasing activity
Positive absorption in the first quarter was approximately 3.4 million square feet. Chicago has seen positive absorption every year since 2011, and this year looks to be headed in the same direction.
The most active submarkets of O’Hare, I-55 and I-80 recorded vacancy rates of approximately 4.8 percent, 7.4 percent and 8.9 percent, respectively. Vacancy rates in those submarkets will continue to improve as speculative development is gobbled up as quickly as it is built, and existing product continues to get leased up.
The I-80 and I-55 submarkets alone have seen over 2 million square feet of leasing in recent weeks, with more than 700,000 square feet in additional transactions expected to close in the second quarter. This activity will continue to drive rent growth and new development opportunities.
Unique advantages
Adam Haefner,
Darwin Realty
Chicago has one of the most diverse economies in the country, benefiting from its location as a transportation hub and the third-largest population in the country. For industrial distribution users, Chicago is arguably the most vital market between the coasts.
Recent large transactions reinforce that importance with companies that include e-commerce, warehousing, tires, food, transportation, electronics and furniture completing recent sale and lease transactions.
Two of these transactions include Amazon’s lease of almost 750,000 square feet in Joliet, and a lease in Wilmington for about 700,000 square feet, which has reportedly closed but has not yet been announced.
With three potential users in the market searching for 1 million square feet or more, activity should continue at the blistering pace that we have seen so far in 2016. This is in addition to multiple tenants searching for 100,000 to 500,000 square feet.
Investment magnet
Demand from investors will remain high for the balance of 2016. Core product in prime submarkets will continue to trade at capitalization rates at 6 percent or lower.
Demand for Class B product is also increasing with smaller private firms backed by institutional money. The increased demand for Class B product is driven by lack of supply of Class A product, less competition from foreign and institutional players, and higher rates of return.
Cap rates for Class B product in Chicago are in line with what the Certified Commercial Investor Member Institute reported in its recent market trends survey: 8.1 percent average cap rates on warehouse transactions in the Midwest, compared with just 7 percent in the West and 7.4 percent in the South and East.
The competitive pool is increased by the fact that many users are considering buying properties instead of leasing. Users are often left no other option but to lease buildings because demand from institutional investors has driven building prices to levels that users are unwilling to meet.
There are currently 40 development projects either under construction or recently completed in the Chicago metropolitan area that total over 14 million square feet. Half those projects are speculative developments, and the other half are build-to-suits.
The hottest markets for development are I-80, I-55 and I-88, with approximately 9.2 million square feet of projects underway. These projects should keep lease rates from overheating, but demand will continue to outpace supply in the short term.
Dearth of available land
The biggest issue for developers is the lack of available land in infill submarkets. Vacancy rates are low enough in most markets to call for more development, and the lack of land does not allow developers to overbuild.
In markets like I-80 and Southeast Wisconsin, where land is plentiful, most developers have learned from the last downturn, and they are voluntarily constraining new development. Even with the large number of new developments, vacancy rates remain extremely low.
The industrial market in Chicago remains extremely strong, and we do not expect that to change for the remainder of 2016.
While some pundits worry that the economy may be nearing the next recession, we believe that strong market fundamentals, Chicago’s diverse economy, steady investor demand and constrained development will help the industrial market weather any storm.
In short, 2016 is a great time to be in the industrial real estate industry, and we expect the train to stay on the tracks.
— By Adam Haefner, Director of Brokerage Services, Darwin Realty. This article originally appeared in the June 2016 issue of Heartland Real Estate Business.