TOPIC 10
Real Estate Market Analysis: Chicago
(Plus my overall market forecasts)
Real Estate Market Analysis: Why do it?
• “Real estate market analysis” refers to analyzing a variety of real estate
decisions.
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Where to locate a branch office?
What size or type of building to develop on a specific site?
What type of tenants to look for in marketing a particular building?
What the rent and expiration term should be on a given lease?
When to begin construction on a development project?
How many units to build this year?
Which cities and property types to invest in so as to allocate capital where
rents are more likely to grow?
– Where to locate new retail outlets and/or which stores should be closed?
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Broadly Speaking…
• Real estate market analysis usually requires quantitative or qualitative
understanding (& prediction) of both the demand side and supply side of the
space usage market relevant to some real estate decision.
– The focus might be micro-level, such as a feasibility analysis for a specific
site or property
– Or, the focus might be more general, such as a general characterization of
the supply/demand conditions in a particular space submarket.
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Variables of Interest in Market Analysis
• To evaluate a real estate space submarket, analysts tend to focus on a few
primary indicators that characterize both the supply and demand sides of the
submarket and the balance (equilibrium) between them.
– Vacancy rate
– Market Rent
– Quantity of new construction starts
– Quantity of new construction completions
– Absorption of new space
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Vacancy Rate
• By definition, the vacancy rate refers to the percentage of the stock of space
in the market that is not currently occupied.
– Vacancy Rate = Vacant Space/Total Space
– The vacancy rate reflects the balance between supply and demand.
– In most markets, it is normal for some vacancy to exist (the natural
vacancy rate) even when supply and demand are in balance.
• When actual vacancy rises above the natural vacancy rate, rents tend
to fall.
• When actual vacancy falls below the natural vacancy rate, rents tend
to increase.
• Natural vacancy rate can be 6-12%
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Market Rent
• By definition, market rent is the level of rents being charged on typical new
leases currently being signed in the market.
– asking rents may differ from effective rents
– Market rent is another indicator of the balance between supply and demand
in a market.
– Can be tricky to measure because
• it is private information and
• lease terms may differ dramatically from tenant to tenant
• Result: Sometimes hard to get accurate “rent measures” – usually
collected via surveys.
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Constructions Starts and Completions
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Construction is an important “supply side” indicator.
– “Starts” indicate the amount of space currently in the “pipeline” and likely to
be added to the supply in the near future
– “Completes” indicate the amount of space just arriving in the market.
– Of course, we need to consider the net addition to supply (after taking
demolition and renovations into account).
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Absorption of New Space
• By definition, absorption refers to the amount of additional space that becomes
occupied during a year.
• Absorption is a “demand side” indicator (i.e., does not account for amount of
supply available).
– Gross absorption – total amount of space leased, regardless of where tenants
come from
– Net absorption – net change in the amount of space occupied in a market.
• Positive net absorption rates:
• Negative net absorption rates:
Demand increasing in market
Demand falling in market
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The Concept of “Months Supply”
• The variables we just reviewed are commonly used indicators of supply/demand
conditions in space submarkets.
• The concept of “months supply” combines several of these variables to help us
understand a market even better.
• By definition, months supply is the sum of current vacant space in the market
and new construction started but not completed, divided by 1/12th of the annual
net absorption in the market.
VacanctSpace  ConstructionSpace
Months Supply 
NetAbsorption /12
• This measure tells how long it will take (in months) for all of the vacant space in
the market to be absorbed, driving the vacancy rate to zero.
– Analysts compare the months supply to the length of time it takes to
complete new construction to see if the market can support a new project. If
the months supply is much greater than the average construction period, the
market is “oversupplied.” Otherwise, it might be time to start a new project
in this market.
– Meaningless measure if net absorption is negative
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Some Tips for Market Analysis
• Define the market carefully along geographic and usage dimensions,
recognizing that most metropolitan areas form markets that can be usefully
divided into smaller submarkets. The next slide describes how the Atlanta office
market can be “divided.”
• Carefully consider the time period to be covered in the analysis
– 5 – 10 years into the future is desirable
– 3 years is more feasible in most cases
• Recognize the differences between and the benefits of a simple trend
extrapolation and a structural analysis
– Trend extrapolation predicts the future purely based on historical trends and
patterns
– Structural analysis attempts to predict the future by identifying and
quantifying the underlying determinants of market trends.
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Performing/Understanding a Market Analysis
• In both types of analysis (extrapolation and structural) the steps are:
– First, inventory the existing supply and evaluate the pipeline.
– Second, relate the demand sources to the space usage demand.
– Third, forecast future demand for and supply of space
– Compare the forecasted demand for space with the forecasted supply of
space to see if the market will be “over” or “under” supplied in the future.
• In tight markets (under supplied, landlord market), we expect to see higher rents
and lower vacancy rates.
• In loose markets (over supplied, tenant market), we expect to see lower rents and
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higher vacancy rates.
Recent “Hot” Office Property Markets
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Recent “Cool” Office Property Markets
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U.S. Office Market Vacancies 2002Q1 – 2005Q1
(Average Gross Asking)
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U.S. Office Market Net Absorptions 2002Q1 – 2005Q1
(Average Gross Asking)
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Chicago Office Market (Downtown and Suburbs): 2005Q1
(Average Gross Asking)
Chicago Office Inventory (2004):
117 million sf
Chicago Office Vacancy(2005Q1):
15.7% (highest rate since 1996)
Downtown Vacancy (2005Q1) = 18.4% (21.4 million sf of space available for leasing)
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Chicago Office Market (Downtown and Suburbs): 2005Q1
Net absorption rate for downtown 2005Q1 was -1 million sf.
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Chicago Office Market (Downtown): 2005Q1
Construction Activity Due to Become Available in 2005-2006: 4 million Sq
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Asking Net Rent Prices Chicago 2004
• Class A (prime):
$18 - $25 per sf
• Class A (broad):
$9 - $25 per sf
• Class B
$7 - $15 per sf
• Predicted to fall further through 2005 given the high vacancy rates
• Concessions will increase (free month rent)
• Large amount of activity by tenants to extend leases (look in lower rates while
they have the power).
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Chicago Market Break Down
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Forecast from the Chicago Office Market (Downtown)
Chicago unemployment rate not decline (as of yet) – looking for a recovery?
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Chicago Forecasts
• Imminent Demand
– No signs of a dramatic increase in demand on the local level (no industry
shift moving towards chicago)
– U.S. economy may be “fragile” – oil prices/global economic uncertainty
acting on a drag on U.S. economy (see recent trend in stock prices)
– Demand predictions “moderate” at best
• Supply
– Lots of slack in the office market (vacancies high and construction
continuing)
– Rents will not pick up for awhile (good for tenants).
– Still profitable to build (new construction is filling up quickly (at expense of
existing properties) – however rents in new construction still low).
• I would not develop office space in chicago at this time! Interest rates likely to
rise (to fight inflation) – decreases returns to owning (along with low rents and
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high vacancies).
Chicago Office Forecasts
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Imminent Demand
– No signs of a dramatic increase in demand on the local level (no industry shift
moving towards chicago)
– U.S. economy may be “fragile” – oil prices/global economic uncertainty acting on a
drag on U.S. economy (see recent trend in stock prices)
– Demand predictions “moderate” at best
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Supply
– Lots of slack in the office market (vacancies high and construction continuing)
– Rents will not pick up for awhile (good for tenants).
– Still profitable to build (new construction is filling up quickly (at expense of existing
properties) – however rents in new construction still low).
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I would not develop office properties in Chicago at this time! Interest rates likely to rise
(to fight inflation) – decreases returns to owning (along with low rents and high
vacancies).
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Chicago Retail Forecasts
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Retail development is a better opportunity
– Vacancies are lower
– Effective rents have been increasing slightly
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People still consuming in Chicago (both natives and tourists). Residential areas of
Chicago are still developing (south/west loop).
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Interest rates will still likely increase – as a result, financing costs will still rise.
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Other Markets: Downtown Office Boston
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Other Markets: Downtown Office Boston
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Other Markets: Downtown Office San Francisco
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Other Thoughts….
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My macro assessment
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Fundamentals “solid” not “strong”
Oil and Inflation (has me worried)
Consumers and Business (going strong)
Government (too much debt)
Net Exports (of no concern to me)
– Business investment is most stable! Lots of capacity to expand – they are hesitant
given past mistakes (late 1990s) and oil/political uncertainty.
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Residential Property Markets
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They will come down (either bubble burst or supply adjusts)
Increase in interest rates may quicken this effect
Re-adjustment will occur slowly (it always does)
Will investors adjust to/plan for a higher (normal) interest rate regime?
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