By Brian J. Rogal | Chicago
CHICAGO—During their recent Fall Meeting in Chicago, the Urban Land Institute, with their partner PwC, released the 35th edition of Emerging Trends in Real Estate, a study based on interviews and surveys they did with over 1,000 professionals. And the general feeling was that what had been a modest recovery will gain momentum in 2014. Furthermore, that momentum should increasingly drive growth in secondary markets as investors look beyond core cities in search of higher yields.
Experts from the Midwest echoed this optimism and said much of 2013 was spent preparing for an even busier 2014. And with many top companies relocating to downtown Chicago, their new or relocated workers will increase demand for new apartments, office, retail and restaurant projects in 2014 as they look for the amenities expected with an urban lifestyle.
In fact, some firms spent 2013 staffing up for a big ’14 push. “We recently tripled the size of our estimating staff,” said Chuck Taylor, the director of operations for Lemont, IL-based Englewood Construction, earlier this year. “Activity is through the roof.”
And Tinley Park-based MACK Companies, a REO-to-rental specialist, recently purchased an 8,000-square-foot office facility to accommodate its expansion into commercial development and construction in 2014.
Those in healthcare real estate have begun talking not just about the Affordable Care Act, and the millions of consumers it should bring, but also, the 60 million baby boomers now entering their senior years, and the increased demand for seniors housing that should result.
“As the silver tsunami approaches, senior living providers will find golden opportunities as demographics will demand more senior housing in the coming decades,” said Jacob Gehl, founder and managing director of Blueprint Healthcare Real Estate Advisors. “Likewise, savvy real estate investors will find this asset class to be need-driven, recession-proof, growing, profitable and stable. The aging population should allow for the easy absorption of new construction in the healthcare real estate market.”
However, a 1990's-era building boom in senior housing attracted a lot of developers without much expertise in the sector, and many experts think this contributed to overbuilding and other problems. This time, Gehl said that “those entering the healthcare real estate market should align themselves with an industry focused advisor or operating partner as deals in this sector require an understanding of healthcare as well as real estate.”
And the new US healthcare laws should eventually bring 30 to 40 million Americans under the health insurance umbrella. In addition, due to the ACA, the government now bases its evaluations of healthcare providers on health outcomes, rather than the number or level of services provided. To meet this new demand and gain market share, providers will need to continue developing their network of outpatient facilities, where they can deliver quality, targeted care in a much lower-cost setting.
“Reducing cost will be a driving factor for healthcare providers going forward,” said John Wilson, president of HSA PrimeCare. “Providers have realized treating patients in well-located outpatient centers is convenient for patients and has become a requirement. As a result, real estate has elevated significance in the business strategy of healthcare delivery.”
To further enhance patient access to quality care, providers will adapt their real estate to combine practices and services in a very inviting setting at multi-specialty facilities. Wilson said common lobbies, flexible exam rooms, and shared nursing stations between different practices will be commonplace to eliminate redundancies, control costs, and to facilitate alignment between the health system and newly-acquired physician practices.
Gehl agreed, noting, “competition will be high in this market and providers that deliver comfortable settings and the best patient experiences will come out on top.”
Some of the attention recently lavished on downtown Chicago may get diverted to other submarkets in 2014. According to Lee Kiser, principal and founder of Kiser Group, downtown may experience rent declines, while select neighborhoods will remain stable – and may even see rent increases.
“With the downtown market, it is simply a supply and demand issue. More new construction units will come online in 2014, increasing competition in an already tight market and making it difficult to increase rents,” said Kiser. “However, many Chicago neighborhoods are set to perform better than downtown due to less density. The rising popularity of certain areas and lack of new supply should result in hefty rent increases during 2014, similar to what was experienced during 2013.”
Also bullish on less-mature markets is The Marquette Companies, which in 2013 invested in several non-core urban projects, including a 400-unit rental community in Granger, IN. “As the competition for properties in major metropolitan areas has increased, it has pushed pricing to a point that has made it more difficult to buy in those areas,” said Darren Sloniger, managing director of acquisitions for the Naperville, IL-based Marquette. “Purchasing well-located properties in secondary markets with high barriers to entry provides a good alternative for us right now.”
“The anticipated interest in secondary markets is indicative of how the U.S. real estate recovery is expanding beyond the traditional investment hubs,” said ULI Chief Executive Officer Patrick L. Phillips. “Access to greater amounts of both debt and equity financing, combined with a sustained improvement in the underlying economic fundamentals, means that the opportunities and returns offered in smaller markets are potentially very appealing.”
In some sectors, however, such as retail, investors and developers will probably stick to heavily-trafficked, mature markets. “Cap rates in urban cores are reaching historic lows and rents are continuing to increase in prime locations,” said Greg Schott, managing principal of Chicago-based L3 Capital LLC. “Investors who have entered these markets have seen favorable returns and strong retailers view them as safe moves.”
For example, L3 recently sold two properties in the Beverly Hills and West Hollywood market for a combined $62 million, approximately $27 million more than it paid for the properties just a few years ago.
William Di Santo, president of Englewood Construction, agreed, adding that as consumers and retailers continue to gain confidence, developers should restart large-scale retail projects in urban cores that were sidelined by the downturn. “A lot of projects that were planned four or five years ago never got off the ground. This has produced a number of prime urban locations developers could build on next year. We’ve had steady construction activity in the retail industry for a few years, but big projects have not been too common. I expect that to change in 2014.”
The outlook for the industrial and distribution sectors has also brightened. HSA Commercial broke ground on three industrial spec buildings in 2013 and thinks others will follow suit due to the lack of high-cube, class A industrial product for warehousing and logistics tenants seeing rapid growth due to e-commerce.
"Institutional investors have started to take an active interest in industrial spec development since they are realizing the risk-adjusted rate of return is more compelling than competing aggressively for fully-stabilized real estate assets,” said Bob Smietana, vice chairman and CEO of HSA. “With an infusion of new capital and banks willing to lend to well-capitalized sponsors, developers will continue to build spec projects in core markets like Chicago where vacancy rates below 5% suggest there is still plenty of unmet demand.”
The wave of spec development that started on the coasts has now reached Chicago, and HSA officials expect secondary distribution markets will start to see new development activity next year as well. This week, GlobeSt.com reported that St. Louis-based TriStar Properties has begun development on the first speculative industrial building to be constructed in the St. Louis metro area since 2007.