Now Is the Time to Invest in Chicago’s Office Market
There is a widely held belief that investing in the Chicago office real estate market in 2020 is potentially a bad bet. While some investors are concerned by headlines decrying the fiscal health of Illinois, the supposed overvaluing of Cook County tax assessments and softening of the Chicago market, our experience tells us those fears will create opportunities for contrarian investors willing to dig deeper.
Because these misperceptions are scaring away some institutional investors, the time is ripe for continued investment in Chicago office properties to take advantage of opportunities that more cautious investors are passing up.
At the state level, much has been written about Illinois’ fiscal health. In a report released in September 2019, government watchdog Truth in Accounting labeled Illinois a “Sinkhole State” and ranked it 49th in the nation for its financial condition. After failing to raise enough revenue by hiking taxes to fund the state’s debt, leaders from Illinois have said that massive pension reform — not tax hikes — is the way out of our current debt crisis. Consequently, office real estate investors should not be overly concerned that the state of Illinois will potentially shift the state’s tax burden onto their buildings’ tenants.
Recently, Cook County Assessor Fritz Kaegi has made the biggest impact on changing the perception of the Chicago real estate market. Kaegi’s position is that his office is using new criteria to assess property values that make the process more accurate and transparent than his predecessor, while some commercial property owners feel he is unfairly shifting the tax burden onto them.
Although commercial property values in the northern suburbs increased by 74.4 percent in 2019 from the previous year, versus a 15.6 increase for residential property, that figure only tells part of the story.
A recent analysis of 50 properties that were sold within the last two years and re-assessed in 2019 found that 62 percent of those were assessed below their recent sales prices. Of the 50 evaluated, nine were office properties and all but one was valued below the prices for which they were recently sold. This analysis makes the case that fears of above-market commercial assessment increases are not only overstated but are also factually inaccurate.
Additionally, in Chicago, the election of Mayor Lori Lightfoot has caused some office investors to take a wait-and-see attitude. Unlike her predecessor Rahm Emmanuel, Lightfoot is viewed as potentially less friendly to business interests, a concern cited by nervous investors.
Her economic development initiatives have been primarily focused on the distressed South and West sides of the city, areas where real estate investors have been historically reticent to invest. That, combined with the city’s own underfunded pension issue, is proving problematic for some out-of-state investors, but creates opportunities for local investors familiar with the Chicago landscape.
What we’re hearing
The uncertainty of Cook County assessments is the biggest concern among office investors in the Chicago market. Investors are making assumptions in their cashflows that rents won’t grow enough and tax rates will increase by more than double or triple their current value. This harsh and aggressive approach is making it more difficult to complete deals in the current market and has been driving prices downward.
In particular, institutional investors are shying away from the Chicago market due to its financial uncertainty.
However, this has opened up opportunities for other investors who are willing to take on an unknown risk. The types of investors we’re seeing in the current market are more local, entrepreneurial and have private equity capital.
“We’re definitely seeing more investment opportunities as out-of-state buyers shy away from the Chicago market,” asserts Benjamin Nummy of commercial real estate investment and management firm Ameritus LLC. “Because we’re local operators, we have a greater understanding of the market conditions than those who aren’t based in Chicago.”
Lenders are also bullish on the Chicago market and have not pulled back in the wake of this trend.
“Commercial real estate in Chicago is still a strong market and our pipeline reflects that,” states Sarah Hunter, vice president of commercial real estate at Byline Bank. “While there are valid concerns from investors on the stability of the market going forward, including real estate taxes, Byline takes a very balanced approach to underwrite each opportunity.”
Factors to consider
While office investors are concerned that higher real estate assessments will raise their taxes, that is not necessarily the case. Other variables that determine a property’s tax include the tax rate and local tax levy. Anything is possible, and no one can be certain of the amount office owners will pay until the tax rate is released later in 2020.
Also, if investors who are concerned about Cook County taxes feel they are safe going instead to Lake or DuPage counties, it should be noted that their rates are increasing as well. While the collar counties are more inexpensive than Cook County, they will also feel the need to raise their tax rates to fill the gap of lost sales tax revenue due to the changing nature of retail real estate.
The key to increased office investment sales activity is to find the proper equilibrium between buyers’ risk tolerance and sellers’ price expectations. Both sides need to understand the unknown fiscal and tax issues in Illinois and Chicago and absorb some of the impact.
Chicago will continue to be a magnet for recent Midwest college graduates looking to relocate and provide a strong workforce, which has recently resulted in the phenomenal growth of local and national technology companies who have been driving office demand. Cook County has some of the most favorably located real estate to attract tenants and sustain long-term investment. Investors willing to look past the short-term uncertainty and bet on the future of Chicago will reap the benefits of this market rebalancing.
— By Alissa Adler and John Homsher, Senior Vice Presidents, Colliers International. This article originally appeared in the March 2020 issue of Heartland Real Estate Business magazine.