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Chicago

Why real estate investors just can’t quit Chicago

The possibility of substantial tax increases to pay for the city’s and state’s unfunded pension obligations hasn’t prevented real estate investors from plunking down big sums—even record-breaking ones—to snap up property in the area.

“I think it’s an issue, but I don’t think it’s stopping anyone from investing in Chicago,” says Mark Stern, senior vice president of acquisitions at Waterton Associates LLC, a Chicago-based hotel and apartment investor whose local properties include Presidential Towers in the West Loop.

In February, for example, a New York financial services firm snapped up a small retail building on Oak Street for about $19 million, or nearly $3,000 per square foot. In May, a California company announced it would pay a record $850 million for a River North office tower. And last month, a Los Angeles apartment firm dropped $78 million for an apartment complex in Arlington Heights, the highest price for a multifamily property in suburban Chicago since February 2013.

“We’re anticipating some sort of tax increase, but we don’t think it will push us away from Chicago in the near term,” says Joshua Behar, acquisitions analyst at Florida real estate firm Accesso Partners LLC, which has purchased five office buildings in the city and suburbs since October.

Mr. Behar declines to specify how much the firm believes taxes will rise but says it is building such figures into its calculations for expenses and projected revenue growth. “Everybody, everybody, everybody is underwriting taxes going up,” he says.

The appetite for Chicago-area real estate is driven in part by a lack of yield-generating alternatives. In addition, interest rates are hovering near historic lows, and modest economic growth is allowing landlords to boost rents and occupancies. That all adds up to a robust market—despite the poor condition of state and city finances.

Since bottoming out after the crash in 2009 with a paltry 244 sales representing $2.4 billion, commercial property sales in the Chicago area have risen each year through 2013, when 902 properties representing $15 billion changed hands, according to New York-based data firm Real Capital Analytics Inc. Through the first half of 2014, investors paid more than $6 billion to buy 405 properties.

Acadia Realty Trust, a White Plains, New York-based real estate investment trust, has built a significant presence in neighborhoods like the Gold Coast, paying eye-popping figures to acquire buildings, including $20.7 million, or $7,065 per square foot, for a structure at Rush and Walton streets in 2012. The company wants to buy more.

“Most, if not all, of our national retailers want to be here,” CEO Kenneth Bernstein says. “Chicago is one of the great cities, and our retailers, whether they’re local, national or international, recognize that.”

Nevertheless, the uncertainty about taxes is forcing some investors to tap the brakes. Milton Pinsky, CEO of Northbrook-based Banner Apartments LLC, hasn’t given up on looking for development opportunities and acquisitions here but says the firm wants to earn a first-year return that’s about a half-point higher than in Texas, for example, in part because of the tax risk. “Because our investment hurdle here is higher, more of our activity is driven to other locations,” he says. “We have a difficult road forward.”

Earlier this year, the Emanuel administration called for boosting property taxes by $750 millionover five years as part of a pension deal it struck with city workers outside of the police and fire departments. In addition to a $590 million payment due to the public safety pension funds, the city needs to find $683 million for teachers’ pensions for 2015.

‘NET LEASES’

Investors and landlords either can pay the higher taxes directly or pass them along to tenants by negotiating so-called net leases. Higher taxes boost operating costs for tenants, potentially pushing them away or limiting their expansion plans.

According to a Crain’s analysis from January, the increase in property taxes necessary to cover a $590 million pension payment for the public safety unions alone would raise Chicago’s commercial property tax rate to the highest among the 50 largest cities in the country. Already, the rate is the second-highest, after Detroit.

That could be bad news for renters. Chicago developer Steve Fifield, who of late has developed downtown apartment buildings, expects higher taxes to tack on as much as 8 cents per square foot for monthly rental rates. Assuming that tax-fueled increase but no others, a 790-square-foot unit in Fifield Co.’s K2 building in the West Loop that costs $2,291 per month today would rise to $2,354.

“A significant increase in real estate taxes to help fix the pension-funding shortfall would put pressure to increase rents,” he says in an email.

Retail tenants facing higher tax bills will push for lower rents, says Andy Bulson, a principal at Oakbrook Terrace-based retail brokerage Mid-American Real Estate Corp.

Even if the prospect of higher taxes hasn’t kept investors from buying properties here, some executives believe it’s keeping companies that employ people from moving to the region. “Businesses aren’t coming to Chicago, and they’re not coming to Illinois,” says J. Paul Beitler, a Chicago developer who wants to build an office tower downtown but has not found an anchor tenant to launch it.

Source: Chicago Real Estate Daily Alby Gallun August 18, 2014