Multifamily Conversions Could Be a Lifeline for Chicago's Ailing Hotels

Turning Distressed Downtown Hotels Into Apartments May Just Be Their Highest, Best Use

For most areas in downtown Chicago, the precipitous drop in office occupancy is devastating to more than just the office landlords. Fewer downtown workers equal less demand for retail tenants and for hotels relying on midweek business travel.

By year-end 2021, Chicago hotels’ revenue per available room, or RevPAR, was down 40% compared to 2019, with that performance ranking in the bottom third of the top 25 U.S. markets tracked by STR, CoStar Group's hospitality analytics firm. It doesn’t help that six hotels — making up over 3,400 keys and 2.5 million square feet of inventory — are 90-plus days delinquent on their loans and in special servicing or foreclosure, such as the JW Marriott Chicago and the Palmer House Hilton.

To solve Chicago's hotel inventory problem, owners and investors should consider converting some of these assets to multifamily use.

Looking at what's happening in the downtown apartment market, it makes sense. Demand downtown is at peaks never seen before, with 3,800 units absorbed year over year. The Loop business district and adjacent submarkets command some of the area's highest rents at $2,834 per unit and the most compression in vacancy rates with a 3.6% decline, posting a 5.5% overall rate.

Yet development here appears to be tapering off, with only 3,600 units under construction this quarter, most of which will be completed by 2023. For context, this is below the 10-year average of 5,000 apartments built per year. As such, this amount represents the smallest percentage of multifamily space under construction in the area since mid-2011. There is certainly room for growth.

Missing Business Demand

Meanwhile, downtown Chicago’s hospitality demand is heavily reliant on large citywide conventions, conferences and corporate tourism, all of which have yet to bounce back. Chicago’s challenges in regaining its business travel, and therefore pushing up its hotel occupancy rates, are driven by a multitude of factors that stymie the local hospitality sector’s profitability and cash flow.

Year to date through June, market RevPAR is still 14% below 2019 levels. And office occupancy levels are still only 42% of those reached before the pandemic, according to security tech firm Kastle Systems' Back to Work Barometer. Combine this with increased hotel operating expenses, heightened labor union-related costs, diminished leisure and business travel, and increased fears of recession and discretionary spending dips, and the outlook for Chicago’s downtown hospitality sector is less attractive when compared to urban markets whose occupancy demand is more diversified.

Converting distressed hotel buildings in Chicago certainly comes with challenges that go beyond the necessary space reconfigurations and specific guidelines for preserving the facades and decor of architectural treasures. There is competition from new multifamily construction and proposals far along in the pipeline. At last count, there were another 4,000 units developers hope to deliver by the end of 2023.

However, the potential to turn an underperforming hotel into a thriving multifamily complex is still supported by today’s demand and by key stakeholders, from politicians and city planners to developers experienced with this kind of commercial real estate transformation. Hotel amenities such as parking, pools, restaurants, bars, and dry cleaning and laundry rooms are virtually plug-and-play options for residential use. Mechanical, electrical, and plumbing upgrades and changes should be relatively easy compared to an office-to-multifamily conversion. Some local examples of successful transformations were when the 100-room Seneca Hotel & Suites became the 268-unit Seneca apartments and when the single-room occupancy hotel The Carling was renovated to its current incarnation as the 80-unit Carling Hotel apartments, an affordable housing property.

 

The greatest reason to convert, of course, is the potential upside for investment returns. Year to date, the average three-, four- or five-star apartment building in Chicago sold for $361,000 per unit and $313 per square foot. The average downtown Chicago hotel sold for $155,000 per unit and $147 per square foot. The roughly $200,000 per unit and $170 per square foot differential could result in a solid profit margin from a stable multifamily investment, even after factoring in conversion costs. If one considers the Seneca conversion mentioned above, where the property increased its unit count almost threefold, the creative developer has an opportunity to create more usable, profit-making square footage within a project.

 

 

Source: Multifamily Conversions Could Be a Lifeline for Chicago’s Ailing Hotels

https://www.creconsult.net/market-trends/multifamily-conversions-could-be-a-lifeline-for-chicagos-ailing-hotels/

Chicago Unveils Effort To Create Hundreds of Affordable Apartments in Converted Office Buildings

Mayor Offers Tax Breaks, Other Incentives for Adaptations of Buildings in City's Longtime Financial Corridor

Chicago officials are soliciting proposals to convert vintage office buildings into hundreds of affordable apartments on a stretch of the city’s one-time LaSalle Street financial corridor that in recent years has lost large tenants to new developments.

The city is offering several types of financial incentives, including tax increment financing, to developers willing to set aside 30% of the units as affordable in a residential conversion, Mayor Lori Lightfoot and other officials announced.

If the plan succeeds, it could become a national model as large cities grapple with the effects of COVID-19 on central business districts.

The long-expected initiative is designed to address two challenges in Chicago’s Loop business district, which have taken on greater urgency since the onset of the pandemic in early 2020: high vacancy in older office buildings and a low supply of housing with below-market rents.

"There is nearly 5 million square feet of vacant commercial space on the LaSalle Street corridor, but not a single unit of affordable housing," Lightfoot said in a statement. "Diversifying this corridor is an essential component in our strategy to restore LaSalle's vitality, create more neighborhood-serving retail, and foster a more inviting pedestrian environment in the heart of the Loop that will benefit all Chicagoans."

Chicago wants to create more than 1,000 new residential units in historic office buildings on and adjacent to LaSalle, with 300 units that meet affordable-housing standards. Officials also want to see vacant retail spaces converted into neighborhood amenities such as locally-owned grocery stores and restaurants.

The city also is looking into potential changes to the street’s infrastructure to make it more pedestrian-focused, according to the statement.

Business First

LaSalle Street is known for its canyon of historic skyscrapers, anchored at the south end by the Chicago Board of Trade Building. In recent years, LaSalle has lost large tenants, including Bank of America and BMO Financial, to new skyscrapers along the Chicago River and, farther west, to Fulton Market developments.

The pandemic’s effects on the area have been studied extensively, including an Urban Land Institute report, the city’s “Central City Recovery Roadmap” study and input from groups including real estate professionals and the Chicago Loop Alliance.

Chicago’s initiative “is a direct response to the need for a coordinated and comprehensive strategy that repositions the street as one of the most innovative, equitable and forward-thinking thoroughfares in the country,” the city’s planning commissioner, Maurice Cox, said in the statement.

“As one of Chicago’s most architecturally compelling and transit-served corridors, there should be more mixed uses and far more economic activity both inside and outside of corridor properties,” Cox added in the statement.

Now the city wants to move fast to line up proposals. The Chicago Planning Department scheduled an Oct. 18 conference for interested developers, and it plans to pick as many as three winning adaptive reuse proposals following a Dec. 23 deadline.

The selected projects would be eligible to submit plans requesting some combination of TIF funds, historic tax credits, low-income housing credits, and tax credits for energy efficiency upgrades.

The city said it already is in contact with property owners that are considering residential conversions, have a building up for sale or would be willing sellers, but city officials will not seek acquisition authority for privately owned buildings.

Architecturally Significant Buildings

Preference will be given to conversions involving architecturally significant buildings. Most of the LaSalle corridor already is on the National Register of Historic Places as part of the West Loop-LaSalle Historic District, and seven buildings are Chicago landmarks, according to the city.

No specific financing models or dollar figures are outlined in the city’s invitation for proposals document.

Applicants are expected to already own the building or provide confirmation of a contract to buy it, which can include contingencies. Proposals also should include plans to accommodate or relocate existing office tenants.

To be eligible, buildings must be located on LaSalle or within a block to the east or west, from Washington Street to the north and Jackson Boulevard to the south.

Chicago’s planning and housing departments and downtown Alderman Brendan Reilly of the 42nd Ward will review proposals, which then will be presented to the Community Development Commission for recommendation to the City Council.

Selected developers will have the option of selling or leasing the affordable portion of their buildings to an authorized affordable housing agency.

“This is a major step in helping revitalize an important corridor in Chicago’s central business district,” Reilly said in the statement. “I look forward to reviewing the final proposals and working alongside Mayor Lightfoot to reinvigorate and redevelop the heart of Chicago’s economic engine."

Upping Requirements

Chicago in recent years has increased the threshold for the Affordable Requirements Ordinance to require new residential projects to provide 20% of the units at affordable rents.

Yet conversions of existing buildings don’t trigger ARO standards unless they require a zoning change or other action by the city.

That has meant that a developer could buy existing offices and covert them to residential without providing any affordable units. One such example was the recent conversion of a 13-story office building at 29 S. LaSalle into 216 apartments.

Under the city’s new plan, a developer still could convert a building without providing any affordable units. The Lightfoot administration hopes the multiple layers of funding available will offset the loss of market rents enough that developers will lean toward affordable projects.

Details of the plan are emerging not long after Google’s announcement in July that it plans to buy and occupy the 1.2 million-square-foot James R. Thompson Center at 100 W. Randolph St., which is expected to bring thousands of new workers to the Loop and revive a formerly state-owned building in need of extensive repairs.

Chicago-based Prime Group, which is involved in the Thompson Center redevelopment for Google, is involved in one office-to-residential conversion already in the works.

Prime Group bought the Helmut Jahn-designed building for $105 million, with Google agreeing to later buy the redeveloped building from Mike Reschke’s firm for an undisclosed price.

Reschke’s Thompson Center deal came as his firm also was finalizing an approximately $118 million purchase of two buildings on and alongside LaSalle that BMO Financial is in the process of vacating.

The $105 million payment to the state for the Thompson Center included $30 million in cash and title to one of the former BMO buildings, a 37-story tower at 115 S. LaSalle where Illinois employees will move from the Thompson Center. That building was valued at $75 million in the exchange.

 

Reschke has said he plans to convert at least part of the other structure, a 23-story building at 111 W. Monroe St., into apartments. In August, he said Prime Group planned to invest about $80 million in switching the top 10 floors to about 275 apartments, with the possibility of converting the entire building to residential if office leasing remains soft.

Source: Chicago Unveils Effort To Create Hundreds of Affordable Apartments in Converted Office Buildings

https://www.creconsult.net/market-trends/chicago-unveils-effort-to-create-hundreds-of-affordable-apartments-in-converted-office-buildings/

Chicago's Apartment Demand Fundamentals Offer Upside Stability to Investors

The Chicago multifamily market features some of the most steady and stable demand fundamentals in the United States. Over the past five years alone, Chicago increased its occupancy levels and households and doubled its rent growth returns, all while population growth declined in absolute numbers.

 

Source: Chicago’s Apartment Demand Fundamentals Offer Upside Stability to Investors

https://www.creconsult.net/market-trends/chicagos-apartment-demand-fundamentals-offer-upside-stability-to-investors/

Housing Market Outlook: Builders Could Stop Construction Due to Expense Falling Demand

 

• Despite falling demand from homebuyers, experts have maintained that the US real estate market is healthy.
• But recent data on homebuilding highlights a dark storyline brewing.
• Builders are feeling the pain of tanking demand and are slowing down new construction, fueling a vicious cycle.

For months economists and housing experts have maintained that the US housing market is in relatively good standing despite a decline in affordability and buyer demand.

While it's not the foreclosure crisis of 2008, today's real estate market also has a dark side.

It all stems from the fact that fewer and fewer Americans can afford to buy the limited homes available, especially as interest rates rise. Homebuilders are feeling the pain of tanking demand and are slowing down housing construction — contributing to the housing crisis vicious cycle.

Peter Schiff, the chief economist at investment company Euro Pacific, told his more than 800,000 Twitter followers that soon "new home construction will almost completely shut down."

"That's because it will be too expensive to build new homes that most buyers can actually afford," he said in a tweet. "The housing market will consist almost exclusively of existing homes that will sell for less than the cost to replace them." Although dramatic, Schiff's pessimistic tweet may foreshadow what's to come in the real estate market.

In July, residential housing construction plummeted 9.6% to an annualized rate of 1.4 million units, according to the Census Bureau. The decline marked the slowest rate of home construction since February 2021 and highlights how rising costs are leading to less affordable housing options for Americans.

"Affordability is the greatest challenge facing the housing market," Robert Dietz, the chief economist at the National Association of Homebuilders said in a housing report. "Significant segments of the home buying population are priced out of the market."

Indeed, higher housing costs have dampened affordability for many Americans. Data from the US Census Bureau shows that an increasing number of people are falling behind on their rents.

Americans have a volatile economy to blame for surging housing prices. Inflation and interest rate hikes have increased the costs of everything from construction to mortgage lending. It has made it harder for builders to construct more low-cost homes and as a result, buyers' ability to afford home purchases. This has led to increased rental demand and ultimately higher rents across the nation — it has also created a downturn in the US real estate market.

With fewer people competing for homes, the real estate market is losing steam. In July, nationwide new home sales fell to a six-year low, declining to just 511,000 units. During the month, existing home sales — a measure of sales volume and prices of existing housing inventory — declined for the sixth consecutive month, falling to a two-year low as only 4.81 million units were sold.

In August, Diane Yentel, the president and CEO of the National Low Income Housing Coalition, testified in front of the US Senate Banking committee that the nation's housing ecosystem has taken a turn for the worse.

"Pre-pandemic millions of extremely low-income households — disproportionately people of color — struggled to remain housed and more than half a million people experienced homelessness," she said. "Now as resources are depleted and protections expire, low-income renters are faced with rising inflation, skyrocketing rents, and eviction filing rates are reaching or surpassing pre-pandemic averages."

As emerging data points to a possibility of a housing recession, Yentel is not alone in her concerns — more economists are giving warnings.

"The whole housing sector is now in retreat," Ian Shepherdson, the chief economist at Pantheon Macro, "told Forbes, adding that housing construction will likely continue falling until early 2023 — and that could mean the US housing affordability crisis is just getting started.

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Source: Housing Market Outlook: Builders Could Stop Construction Due to Expense Falling Demand

https://www.creconsult.net/market-trends/housing-market-outlook-builders-could-stop-construction-due-to-expense-falling-demand/

Sunny with a chance of headwinds: CRE forecast, according to its leaders

 

If you don’t like the weather in Chicago, wait a few minutes…it’s likely to change.

Another thing that is seeing a fair amount of change is the overall sentiment for CRE in Chicago. Last year’s DePaul Real Estate Center Mid-Year Report found that 60% of industry participants were generally optimistic about the industry as they looked ahead. But in 2022? The DePaul-ULI Chicago Report found that 65% are trending toward concern when looking at 2H2022.

Headwinds have gained steam locally, nationally, and internationally, as professionals are concerned about construction costs, labor issues, inflation, interest rates, and speculation of a recession. There’s also less confidence that related issues like crime and the effectiveness of the local political system can be resolved quickly or easily. But through it all, one asset class has remained largely untouchable. Industrial.

According to DePaul, Hugh Williams, Principal, MK Asset Brokerage, and Director of Entrepreneurship/Strategic Relationships for Sterling Bay, when asked about the health of the market, pointed to Prologis’ initial offer to acquire Duke Realty. Prologis was offering a premium, plus upside.

“When you see that, and with vacancies in the sub 4% range, it signals strength and optimism,” Williams said. “We are at one of the high water marks. No one knows if we are at the top, but over the recent long-term, the strength of the market has only gone in one direction, and new baselines have been established.”

That’s not to say the market is exempt from concerns, though. Even the strongest markets must remain creative and be willing to approach issues a little differently. CRG President Shawn Clark noted that, on a recent project in Country Club Hills, the increasing cost of steel prompted CRG to purchase the necessary steel for the 1,033,450-square-foot building before they closed on the 70 acres of land, based on the report. But if the steel had been purchased as typical, the cost would have been more than double.

From the perspective of Molly McShane, CEO of The McShane Companies, “Going from just-in-time to just in case is a real strategy businesses are using, and it is driving demand. As long as that continues, the market is in a good place.”

So while it’s true that there are concerns about the remainder of 2022, 50.9% said they are bullish or optimistic about market conditions in 2023. And despite headwinds, there are investors who continue to believe in the future of Chicago. DePaul said while it may be based, in part, on a “right corner, right project” viewpoint, there remains an appeal about Chicagoland and a belief that all issues will soon be resolved.

 

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Source: Sunny with a chance of headwinds: CRE forecast, according to its leaders

https://www.creconsult.net/market-trends/sunny-with-a-chance-of-headwinds-cre-forecast-according-to-its-leaders/

Commercial Real Estate Investor Sentiment

Commercial Real Estate Investor Sentiment

The top investor concerns for the next 12 months are, not surprisingly, interest rates and inflation.

Despite the Federal Reserve increasing interest rates by 225 basis points in the last six months, 74 percent of investors indicated this is not affecting their investment plans.

The market is going through a recalibration with the rising cost of capital, but the survey numbers aren’t telegraphing a significant market change as investors continue to adapt their investment strategies.

The last 12 months through the second quarter of 2022 were by far, the most active CRE transaction year on record. 

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Source: https://www.linkedin.com/posts/johnchang_commercialrealestate-investorsentiment-surveyresults-activity-6972997819196465152-ah-Y?utm_source=share&utm_medium=member_desktop

https://www.creconsult.net/market-trends/commercial-real-estate-investor-sentiment/

Fed’s Beige Book Is a Mix of News for CRE

 

Interest rates are staying but there’s some welcome easing of commodity prices.

The Federal Reserve’s September Beige Book—more formally known as the “Summary of Commentary on Current Economic Conditions by Federal Reserve District”—is not going to make commercial real estate professionals jump for joy. But the bad news is already known and the good provides hope for some relief in construction.

First, the obvious bad, that inflation is still proceeding, as “price levels remained highly elevated.” That means don’t hope for an early cessation of interest rate hikes.

“Substantial price increases were reported across all Districts, particularly for food, rent, utilities, and hospitality services,” the report said, although nine of the Fed’s 12 districts “reported some degree of moderation in their rate of increase,” indicating that at least the rate at which inflation was increasing had slowed. That’s an important sign of eventually prices coming back under control. But that is still apparently some way off.

“The Fed still has an inflation problem and is committed to front-loading rate hikes as aggressively as possible,” Jeffrey Roach, Chief Economist for LPL Financial, said in an emailed statement. “The likelihood of a 75-basis point hike later this month could increase if next week’s inflation report surprises to the upside.”

Also, the Fed noted that parts of real estate continue to face challenges. “Despite some reports of strong leasing activity, residential real estate conditions weakened noticeably as home sales fell in all twelve Districts and residential construction remained constrained by input shortages,” the report said. “Commercial real estate activity softened, particularly demand for office space. Loan demand was mixed; while financial institutions reported generally strong demand for credit cards and commercial and industrial loans, residential loan demand was weak amid elevated mortgage interest rates.”

Among the districts that specifically mentioned real estate, Boston saw the outlook worsen, in Richmond activity was flat to moderately down, Atlanta had mixed commercial real estate activity, construction and real estate declined modestly in Chicago, and residential activity eased in San Francisco.

There was also some positive news in an important area: materials. “While manufacturing and construction input costs remained elevated, lower fuel prices and cooling overall demand alleviated cost pressures, especially freight shipping rates,” the report noted. “Several Districts reported some tapering in prices for steel, lumber, and copper.” But most contacts outside of the Federal Reserve system though price pressures would continue at least through the end of the year.

 

Source: Fed’s Beige Book Is a Mix of News for CRE

https://www.creconsult.net/market-trends/feds-beige-book-is-a-mix-of-news-for-cre/