Chicago’s commercial real estate market is operating under the assumption that the unofficial capital of the Midwest will see a strong recovery from the covid-19 pandemic as residents return to the city and newly built, amenity-rich offices will lure back reluctant workers.

But while there are concerns that include fiscal uncertainties stemming from property tax hikes that will go into effect this year, a slower-than-expected return to office, a population migration toward the US Sunbelt and the worsening financial condition of the state of Illinois, lenders believe it is possible to carve out strong situation-specific opportunities that mitigate some of the potential downsides.

Jason Hernandez, head of debt originations at Nuveen, tells Real Estate Capital USA the investment management company’s debt business sees strong relative value in Chicago over the short-term. Hernandez, a Chicago native, believes it is possible to navigate the fiscal uncertainty around the city and state, and the impact of the exodus away from major cities into the Sunbelt.

“We are making two- to four-year bets on markets in our lending business, which is a much shorter duration than core equity, where you are making seven to 10-year-plus bets. As a lender, you can be much nimbler and take advantage of illiquidity,” Hernandez says. “We think there’s an arbitrage because we can get paid to go there and we have people on the ground that know the market cold. Our job is to find incremental returns for our investors and, if everyone loves the Sunbelt, you’re not going to get incremental spread there.”

Part of Nuveen’s analysis of Chicago is looking at loan pricing and the levels at which the firm can finance its positions in the secondary market as a leveraged lender. “We identified early on that we could get paid really well on the whole loans and where we could finance it very efficiently, and that also creates an incremental spread for our investors,” Hernandez says.

Nuveen earlier this year originated a five-year, floating-rate $296 million loan on 321 North Clark Street in the city’s River North submarket on behalf of American Realty Advisors, Diversified Real Estate Capital and Hines. The building was 88 percent leased at the time the loan was originated.

“The loan had a strong debt yield, bulletproof sponsorship and very little rollover risk,” Hernandez says. “The risk I was taking is that I’ll finance this loan today and in two or three years, they’re going to try and take me out. I’m banking the markets are going to still be liquid at that time. We loved our basis in that asset, and we think the market will be as liquid in two or three years and we’ll get out.”

While Nuveen will take core-plus risk in the city, large developments or redevelopments are still a step too far. “We don’t necessarily want to step in and take a position with a huge execution risk, because I think that compounds the risk,” Hernandez says.

First time lenders

Cain International last year originated its first loan in Chicago, providing a $117 million facility to finance LendLease and Aware Super’s co-development of a large multifamily tower downtown. The partners will use the loan to develop The Reed at Southbank, a 440-unit rental and condo building at 234 West Polk Street. The property is the second step in a larger redevelopment of the area and will include more than two acres of green space and views of Chicago’s skyline and famous lakes, says Matthew Rosenfeld, head of US debt at Cain.

Like Nuveen, Cain is aware of the potential risks associated with the city. But Rosenfeld says the actual story is much more positive – and complex. Chicago has a GDP of $700 billion – which gives it size and scale, putting it roughly on the same footing as Switzerland and Poland.

“When you think about what that $700 billion is really made of, it’s phenomenal universities [and] major global companies. You’ve got roughly 30 to 40 of the Fortune 500 businesses headquartered in Chicago. And you’ve got the infrastructure there to keep and maintain sustained prosperity and growth,” Rosenfeld says.

Cain has tracked a strong rebound in the multifamily market for the past six months, with occupancy levels and rents rising significantly in the downtown market in particular. According to data from Yardi, rents rose by 1.6 percent from July to October and are now more than 9 percent higher than the national average of $1,510. Additionally, the city added 303,700 new jobs in the first half of 2021, which is a 7 percent gain year-on-year, Yardi found. There are more than 16,000 multifamily units under construction in the city, with about 4,500 slated for delivery by the end of 2021.

This rebound was not a surprise to Cain. “Chicago has organic and captive demand in the city insofar as it’s the most important city in the Midwest. It’s a node culturally, economically [and is] the center of this ecosystem in the Midwest,” Rosenfeld adds.

Red herrings

While Chicago’s crime rate has risen as the pandemic has gone on, lenders and borrowers who spoke with Real Estate Capital USA were hopeful that these issues would be resolved as the city emerges from the downturn. These issues are also not unique to Chicago, Rosenfeld says.

“[These challenges are] very much shared across a lot of the cities [in the US]. When you look into the fundamentals of the real estate, we feel very confident in the position we took and at the macro level. We felt very confident about the future of Chicago.”

“You’ve got roughly 30 to 40 of the Fortune 500 businesses headquartered in Chicago. And you’ve got the infrastructure there to keep and maintain sustained prosperity”

Matthew Rosenfeld
Cain International

The pending increase in property taxes, however, is a clear and present risk. The Chicago City Council approved a property tax increase for 2022, an increase that is tied to the US inflation rate rather than local inflation numbers, and could lead to a hike for commercial property owners, market participants tell Real Estate Capital USA.

While investors are projecting a modest rise in real estate taxes, the Chicago office market is a net lease market and real estate tax increases will largely be absorbed by the tenant community. Even with a modest increase in taxes, the overall occupancy, employment, and business costs for downtown Chicago are substantially lower than major urban centers including New York, San Francisco, Boston, and Washington, DC. Those lower total costs plus a very strong labor pool will continue to make downtown Chicago an attractive market for corporate America, says Lucas Borges, a Chicago-based director of capital markets at JLL.

“Despite the uncertainty around property taxes, growth submarkets such as Fulton Market and high-quality assets across downtown Chicago, like the McDonalds Global Headquarters, have received strong pricing from investors and attracted a deep bench of lenders,” Borges says.

Michael Miller, an executive managing director at Cresset Partners in Chicago, says the firm owns more than 3 million square feet in the city and is about to start work on an apartment complex there. “We’re involved in the Chicago market, where we have been for 50 years, and we are also very active in the Sunbelt, and we have found that Chicago’s growth patterns are very similar to those markets,” he says.

Raymond Zanca, head of capital markets at Black Bear Capital Partners, tells Real Estate Capital USA that lenders and borrowers are digging deeper to get their arms around the potential uncertainty in the market.

“Chicago has tailwinds and headwinds that people are trying to really figure out right now,” Zanca says. “The negativity in Chicago is mostly around the taxes and the crime. There has been an uptick in crime, and it’s been a concern, but if you look at the numbers, it hasn’t stopped people from coming back. We’re all expecting dealflow to pick up. At the end of the day, Chicago is a gateway market and is still a large and liquid place.”