Lou Kahnweiler, the founder of Bennett & Kahnweiler, the predecessor to Colliers International here in Chicago, is reported to have once declared, “Industrial Real Estate is a great way to get rich slowly.” He meant buying or building buildings, putting 25-year debt on them, keeping them leased and was the way to wake up rich 25 years later.
During the late 1990s and most of the 2000s, industrial real estate in Chicago was the place to get rich quick, as developers couldn't build fast enough to satisfy the demand of well-heeled investors who, by 2006, were actually paying more for vacant properties than those actually encumbered by leases and demanding tenants. “Buy it and figure it out” was their strategy. Flips, portfolio premiums, cap rate compression and an overall “drunken sailor” mentality generated lots of fees for brokers and huge profits for many developers and investors until the music stopped.
I vividly recall touring in 2006 with a group of investors from the East Coast who, after looking at the per square foot prices of property around O'Hare and comparing them to New Jersey, said that they wished they were brokers and owners in Chicago, because it must be so easy to make money here. It was easy to make money for the brokers and sellers, but the investors in their funds must wish they had never come here.
Institutional investors have been back for about a year now buying trophy properties leased long-term to good-credit tenants. Those deals are now in the 6 cap range, and a flood of this type of property is predicted to hit the market in the next few months, as sellers hope to not miss the bubble prices this time.
More interesting than that herd of buyers is the reemergence over the past several months of entrepreneurial buyers. They aren’t as cocky and overconfident as they were a few years back, but it’s obvious there is a lot of money on the sidelines trying to figure out if now is the time to jump back into the market.
It is a similar group to the guys buying a few years ago, but their mantra has changed. Here are some of the things that I am hearing repeatedly from investors as they call, lunch and meet:
- Buy below replacement: Of course they aren’t talking about just below replacement but at a discount of about 50 percent. In Des Plaines, a shell building that had more than $100 per foot into it was sold to an entrepreneur for $50 per foot. The building is still vacant but at a much lower basis.
- Budget for lots of carry, rent concessions and tenant improvement: In most cases, speculators are making offers that suggest vacant spaces will remain vacant for the next 24 months. Most leases now carry a month of gross free rent for every year of the deal, and tenants are not shy nowadays of loading up their RFPs with wish lists of all air-conditioned warehouses and many more tenant specific improvements.
- Don’t sign personally: The most aggressive guys that I know who built fortunes buying vacant buildings, finding tenants and flipping when leased are now in asset preservation mode and will shop dozens of lenders and equity partners to do anything to not actually sign personally. Asset preservation has tempered entrepreneurial zeal.
- Don’t expect rent to go up…ever. Argus is a beautiful software program, and the one thing it does very well is project rent increases now and into the future. Yet, the buyers I’ve spoken to recently project rents staying the same or worsening. The most experienced and sage broker I know, Colliers Executive Vice President Vern Schultz, has reminded us lately that Elk Grove rents are the same as when he started in the business, when users thought Elk Grove was in Iowa.
Lou Kahnweiler was right about something — it sure does take a long time to get rich in Chicago industrial real estate.
— Steven Kohn, SIOR, is a senior vice president and member of the Industrial Advisory Group for the Chicago office of Colliers International.