Urban Density, Tax Incentives and Pension Debt
Nearly 1000 commercial real estate professionals braved the Chicago winter elements on Wednesday Jan. 22nd to attend RE Journal’s 12th Annual Commercial Real Estate Forecast Conference at the Sheraton Hotel & Towers.
The high attendance was partly due to the much-anticipated one-on-one conversation between Deputy Mayor Steve Koch and Shawn Mobley, President, Central Region, of Cushman & Wakefield. During their conversation, Koch spoke about how the young workforce of today is rejecting the sprawl of the suburbs in favor of the efficiency and excitement of the city. He believes that the market will follow their lead.
As gravity shifts in support of urban density, Koch remarked that Mayor Emmanuel’s administration will work to attract small businesses into downtown; it will also work to ensure stricter terms governing the use of incentives to attract large businesses.
Incentives are a fact of life, and while I’m not going to be able to get rid of them in the near term… The mayor has been disciplined about saying that we are going to use incentives in particular areas where we really are trying to accomplish a particular goal. We are not going to use incentives to do something that we think the market will take care of on its own. We think the market will bring jobs to downtown on its own.
Not wanting to completely deflate his audience, Koch told how Method ®, the manufacturer of environmentally friendly cleaning products, was given a modest $1.1 million in tax credits over the next 10 years to move into the Pullman Park area of Chicago. Specifically, the goal is to rejuvenate and bring jobs to the economically struggling areas of Chicago.
Some of you in this room may not be happy with where we’ve gone with that, because we are trying to pull away from a broad use of cash to lure development generally, but I think we are very open to using it for specific goals where it makes particular sense.
In response to a question about how this administration intends to handle the massive pension debt conundrum, Deputy Mayor Koch, former co-chairman of global mergers and acquisitions at Credit Suisse, did his best to get straight to the point.
The simple reality is that the city of Chicago has delivered more services and spent more money for many, many years than it’s taken in. We either over spent or under taxed; you can make your own choice as to which that is. But that’s the simple economic reality. If you spend more than you take in, eventually you are going to owe a lot of people a lot of money…and that’s where we are right now.
Getting to the meat of the matter, Mobley asked Koch if there will be a glide path out of this incredible debt or will there be a big "day of reckoning."
It is essential that we fix this over time. There has been 30 years of financial mismanagement; we’re not going to fix that in a day, or even a year… It is essential that whatever we do to fix the fiscal situation on the public side does not interfere or impede the progress and continued growth of the private economy.
A bitter pill to swallow, but this administration appears committed to fixing the fiscal sins of the past.
The State of the Market
After a brief break, the main conference room filled back up to hear the State of the Market panel featuring commercial real estate heavyweights Tony Smaniotto, Executive Vice President, Colliers International; Tim Hennelly - President, Great Lakes Region, Ryan Companies US, Inc.; Todd Mintz, Executive Vice President, DTZ; Drew Nieman, Executive Vice President, US Equities; Michael Flynn, Executive Vice President, NAI; and Joe Cosenza, Vice Chairman, Inland Real Estate Acquisitions Inc. The moderator was Gunnar Branson, President, National Association of Real Estate Investment Managers.
Starting off in dramatic fashion, Inland’s Joe Cosenza tried to stand up and then with a vaudevillian flair fell out of his chair. “Ouch!” He said quickly, ”I’m ok!” much to the relief of the audience and his fellow panelists. It was all in jest though, as we were soon to learn. Mr. Cosenza was in fact demonstrating what he feels has happened in retail since the recession hit in 2009.
According to Cosenza, the “Ouch!” period is when the retail market fell from grace and got hurt (2009- 2013). This is followed by a period of “I’m ok” which is when we try to cover up the real pain (2013). After that we enter the phase of embarrassment, then eventually we move on. Thus is the emotional ride that happens to anyone that falls down. While the general market is beginning to move on, many retail stores are reporting revenue is down even though their sales are up.
Albertsons is closing 26 stores around the country. This is the embarrassment part after the ‘I’m ok, I’m ok’ period.
Thunderous applause marked the end of Cosenza’s speech and he sat down without incident. The other panelists happily played off of Cosenza’s market metaphor as they gave their perspectives on the state of the market.
Tim Hennelly gave a developer friendly account on the state of industrial in Chicago.
The ‘Ouch!’ phase in the industrial segment was from 2009 to 2010. Our debt absorption was negative and our vacancy rate soared to 11%; about 100 million square feet left empty. Fast forward to the “I’m ok” period and we are at about 8% vacancy, which is still 84 million square feet vacant. The important part about that locally is that a lot of that space is functionally obsolete.
Long story short, most of the vacant industrial buildings are not built to accommodate modern logistic needs, typically with a 32 ft. or greater clearance. Older buildings are being torn down to make way for new, more ecologically efficient and economically responsible buildings. Needless to say, the development and redevelopment market in Chicago is very strong.
Harkening back to the subject of businesses moving out of the suburbs and back into the city, Michael Flynn spoke about how the suburban property owner can survive the gravity shift.
The buildings that are better positioned and better differentiated from others are capturing the market demand and pushing the suburban office market vacancy rate below 20% for the first time in more than five years. The buildings that have the appropriate amenities, access to transportation, infrastructure and vision going forward will continue to be well positioned.
Density was the buzzword de jour regarding office property. We heard about the increasing density of the downtown population earlier from Deputy Mayor Koch, but Todd Mintz touched on another trend where density refers to the new age of technology inspired, space conscious office design.
For office, the trends going forward are going to revolve around density and space usage. Locally, companies will continue to want to move downtown or to at least have a downtown office, as there is a draw to being in the city and increasing density.
Foreign money dominated the discussion about the Investment market. According to Gunnar Branson and Tony Smaniotto, there have been many investors coming in from Europe, Canada and Asia. Overall, the investment market in Chicago seems to be very healthy.
Last year we did about $3.7 billion in transactions, compared to $2.6 billion and $2.8 billion over the previous two years. The bulk of interest downtown last year came from investors looking for core product, but now we're seeing investors willing to take higher risks and potentially realize higher yields moving into the market.
Retail Breakout Session
After the general sessions concluded the smaller breakout sessions started up. Held in smaller rooms on the 2nd floor, the breakout sessions were more intimate panel discussions that focused on specific areas of the commercial real estate market.
The retail breakout panel was held in the Ohio room. This impressive panel of speakers comprised of Derek McGavic, Managing Principal, Newport Capital Partners; Scott Carr, EVP and Chief Investment Officer, Inland Real Estate Corporation; Evan L. Halkias, Senior Director Capital Markets, Investment Sales & Acquisitions, Cushman & Wakefield; Gregory Kirsch, Executive Managing Director, Newmark Grubb Knight Frank.
Gregory Kirsch, who works mainly with the luxury retailers that line our fair city’s more glamorous streets, offered reassurance that the super luxury retail market is thriving. Chicago feels like a bargain to European and coastal luxury retailers who do not see Chicago’s swelling property taxes as a deterrent.
The super luxury retailers are performing very well in Chicago. Right now there is only one space available on Oak Street. In my entire career I cannot remember an instance where there has been only one space available on Oak Street.
Later on, Kirsch shifted his focus and talked about the developments at the southern end of Michigan Avenue.
“There is a really interesting deck shuffling going on down Michigan Avenue… The Wrigley Building has changed the complexion of the southern end of the Avenue. When you look right across the river, the redevelopment of 360 N. Michigan as a hotel and will really help that southern end. Wirtz just finished renovations at 333 N Michigan …The narrative of the southern movement continues past the river to 200 N. Michigan where John Buck is building about 430 luxury residential units with ground floor retail space.
On the other side of the retail spectrum, Derek McGavic expressed his concern for the smaller retailers who would be adversely affected by an increase in property taxes.
The multi-tenant, convenience store, and Subways of the world are extraordinarily sensitive to property taxes. If the pensions get funded by the city, Chicago will become the highest commercial property tax city in the country… Once rents get over a certain threshold retailers are just not going to be able to make money. I worry about a choking effect on potential rent growth as an investor.
The panelists were then asked to divulge who the sellers are in today’s market? Evan Halkias said that many sellers are groups that are purging non-core assets from their portfolios.
(Sellers are) People that have either been dictated by Wall Street or are investors who need more rent growth and more density. Also, I think we are seeing people that have added significant value to a property during a short period of time taking advantage of the cap rate compression.
When asked what the future will hold for the retail market in general, Scott Carr noted that while the opportunities for quick and fast profit are not presenting themselves as many had theorized, the market is better for it in the long term.
The capital markets have restored themselves in the way that the Fed was hoping they would. Things are being refinanced; things are being worked out. There is capital coming in. Whether people bring in partners or what not, to recapitalize projects, in the long run it’s probably been healthier for the real estate market.