Chicago Business - Alby Gallun - 14 November 2016
As new luxury apartment towers in downtown Chicago fill up, they're doing it at the expense of their older competitors.
Landlords are starting to feel the impact of an historic building boom that is adding thousands of apartments to the downtown market. While rents are holding steady so far, the occupancy rate for high-end buildings fell in the third quarter to its lowest level in nearly seven years, according to a report from Appraisal Research Counselors, a Chicago-based consulting firm.
The occupancy rate at Class A buildings fell to 92.2 percent in the quarter, down from 94.8 percent in the second quarter and 93.7 percent in third-quarter 2015, according to the report. The Class A occupancy rate, which does not include buildings in their lease-up phase, hasn't been that low since late 2009.
Though apartment leasing typically slows in the third quarter, downtown landlords may need to get used to a weaker market over the next couple of years as supply exceeds demand. Developers will complete a record 3,830 apartments in downtown Chicago this year; another 4,500 in 2017; followed by 4,200 in 2018, according to Appraisal Research. That represents a 39 percent increase in the number of downtown apartments.
“Where we're at right now is not surprising,” said Appraisal Research Vice President Ron DeVries. “Next year is going to be a tough year. There are a lot of units coming online.”
While it could be a tough year for downtown landlords, that's good news for tenants, who have endured about seven years of steady rent hikes. Landlords have had the upper hand amid a strong downtown job market and the preference for renting over buying among many downtown residents.
Still, rents haven't yet followed occupancies lower. The average Class A net rent, which includes concessions such as free rent, rose to $2.91 per square foot in the third quarter, down from a record high of $3.03 in the second quarter, but up from $2.82 a year earlier—a 3.2 percent rise.
But that figure includes new buildings, which skew the average because they charge such high rents. Rents at downtown properties that had been open for a year rose just 0.6 percent on average in the third quarter from the year-earlier period, according to Appraisal Research.
New high-rises are creating a challenge for existing buildings nearby because the developers that built them are more willing to offer free rent just to fill them up. In some cases, developers are giving new tenants two months of free rent if they sign an 18-month lease.
That's hard to match, said developer Tony Rossi, chairman of RMK Management. A 332-unit tower near Millennium Park that Rossi completed in 2014 is facing tough competition from Marquee at Block 37, a 690-unit tower that recently opened about two blocks away, and Mila, a new 402-unit building that's offering two months of free rent.
“When someone across the street is offering two months free, at these rent levels that's four or five thousand dollars,” Rossi said. “If they're doing two months' free rent, you might be able to get away with one. You're going to have to give something.”
Rossi's building at 73 E. Lake was 85.8 percent occupied at the end of the third quarter, down from 92.8 percent in the second and 90.1 percent a year earlier, according to the Appraisal Research report. The building's net rent fell to $3.20 per square foot, down 4.8 percent from a year earlier.
Many developers are offerings deals right now because the market will get even slower over the next few months, and they don't want to wait until it picks up again come springtime.
“There's no hesitancy to give that away because we are heading into winter,” Rossi said.
LOOKING AHEAD TO SPRING
The big question is what happens after that. Many landlords are crossing their fingers that enough renters will come out to give them the pricing power they seem to be losing.
“It wouldn't surprise me if we saw concessions increase over the winter, but in the spring (landlords) are probably going to try to pull back,” DeVries said.
Though the development boom is affecting Class A buildings, the Appraisal Research report shows it having little impact so far on older, less expensive Class B buildings. The Class B downtown occupancy rate was 95 percent in the third quarter, down from 95.3 percent in the second quarter but up from 94.5 percent a year earlier.
The average net Class B rent, meanwhile, was $2.58 per square foot, versus $2.63 in the second quarter and $2.47 a year earlier, according to the report.