The Chicago commercial real estate market is going strong, but its comeback isn’t complete.
Six years after the market hit bottom, an index of Chicago-area commercial property values is still about 7 percent shy of its 2007 pre-crash peak. But the price measure, tracked by Real Capital Analytics and Moody’s Analytics, rose a healthy 7.1 percent in 2016, the seventh straight annual gain for the Chicago market, fueled by a growing economy, low interest rates and an ample supply of debt.
High prices have allowed owners of apartment, office and other commercial buildings to pocket big profits by selling or refinancing their properties. While rising interest rates may cool down the market this year, Moody’s doesn’t expect it to get too chilly, forecasting another 3.5 percent gain for the index this year.
Politics are one wild card: With Donald Trump in the White House and tax and regulatory reform on Congress’ agenda, many real estate investors are uncertain about how potential policy changes could affect property values, said Jim Costello, senior vice president at New York-based Real Capital.
Proposals to allow for faster depreciation of capital expenditures would help the industry, while an idea floating around Capitol Hill to eliminate tax deferrals on property sales would hurt, he said.
“Till we see the rules, (investors) are going to be a lot more cautious,” he said.
On the other hand, the growing economy should continue to boost demand for commercial space, lifting property incomes. Rising interest rates tend to depress property values, but occupancy and rent gains theoretically should help offset the impact.
Still, prices are likely to rise more slowly than they have in the past, Costello said.
“If you’re getting stronger growth in the economy, stronger job growth, that should be good for leasing,” he said. “I don’t think it will ever grow enough to give you double-digit growth” in prices.
A national index tracked by Real Capital and Moody’s increased 9.9 percent last year and is forecast to rise another 3.4 percent in 2017.
A couple of big deals over the past year illustrate the upward price trend in Chicago. Earlier this year, Chinese investor HNA Group agreed to pay almost $360 million for 181 W. Madison St., an office tower that last sold for $302 million in October 2013. In December, Chicago apartment landlord Bill O’Kane paid $225 million for Axis Apartments & Lofts, a Streeterville high-rise that traded for $188 million in February 2013.
But many properties are still worth less than they were before the crash of 2008-09. In January, after going through foreclosure, the office building at 123 N. Wacker Drive sold for $147 million, well below its 2005 sale price of $170 million.
Foreign investors have played a larger role in the U.S. commercial real estate market the past few years, one reason prices have risen and first-year returns—capitalization, or “cap,” rates in industry parlance—have dropped.
Overseas investment fell last year, but rising interest rates tend to attract money from foreign investors seeking higher returns. Whether that lifts real estate values is an open question.
“The wild card is whether further rate hikes will continue to bolster the dollar, and whether prospects of dollar strengthening will drive overseas investors into (U.S. commercial real estate) assets,” Heidi Learner, chief economist at real estate brokerage Savills Studley, said in a statement. “It’s too soon to tell whether 2017 cross-border volumes will fall again, but it’s unlikely that there will be a wave of foreign capital that will be competing with dollar investors to drive cap rates lower.”
Source: Crain’s Chicago Business, Abby Galun March 13th, 2017