Strong demand from renters has kept up with a high pace of new construction, allaying fears of overbuilding in the market.
By Bendix Anderson (NREI Online Article) — New renters are filling thousands of gleaming, new apartments in downtown Chicago. That’s been a pleasant surprise in a market that experts had worried would be buried in a flood of empty, new units due to a wave of overbuilding.
“There has been a lot of confidence restored to the market… we can handle this new supply,” says Brandon Svec, a market economist in the Chicago office of CoStar Group. Last year, “we were all telling a story of oversupply.”
For example, the Streeterville and River North neighborhoods of Chicago, just outside of the Chicago Loop, developers opened 2,927 new apartments over the year that ended in the second quarter 2018, according to Marcus & Millichap. Developers also have 3,360 new apartments under construction in these neighborhoods.
Yet strong demand from renters has filled those vacancies this spring and summer, and that has reassured investors. Despite the huge number of apartments developers still have planned for the metropolitan area—and particularly the neighborhoods downtown—rents continue to grow.
Rents are expected to rise 5.32 percent for class-A apartments in Downtown Chicago in 2018 compared to last year, according to JLL. Rents are expected to rise more slowly for other types of apartments in 2018: 2.78 percent for class-B and class-C apartments downtown; 1.16 percent for class-A in the suburbs and 2.17 percent for suburban class-B and class-C apartments.
Overall the percentage of apartments that are vacant in the Chicago area is a relatively healthy 5.5 percent, as of early September, according to CoStar. The percentage of apartments that are vacant in Downtown Chicago fell to 6.8 percent in early September. That’s down from 10.2 percent the year before, according to CoStar.
As a result, investors, backed by readily available financing, are still paying high prices and accepting low investment yields for apartment properties.
“Apartment buildings, if priced correctly, are selling very quickly,” says Ryan Engle, senior vice president investments and senior director of the National Multi Housing Group for Marcus & Millichap.
Prices still high for Chicago apartments
“Cap rates have remained very stable since 2016,” says Svec. Cap rates represent the income for a property as a percentage of the selling price. Investors paid cap rates averaging in the low 5 percent range over the 12 months that ended in early September. “Cap rates likely have bottomed out for this cycle.”
The cap rates in Chicago are a few percentage points higher than in the top markets on the East and West Coasts like New York City or San Francisco. “Investors chasing yield still find Chicago’s central business district multifamily to be a relatively safe play,” says Chuck Johanns, executive vice president for JLL. “Suburban cap rates have not compressed as fast, and we continue to see healthy transaction activity in suburban areas.”
Apartment experts now hope that demand from renters can fill what had seemed like a tsunami of new apartments scheduled to open. “If we can get eight or ten more quarters out of the real estate cycle, then we can get these new apartment absorbed,” says Svec.
Developers still have 18,416 new apartments in some stage of the construction process in Chicago—a number equal to about 4 percent of the existing inventory of apartments in the city, according to CoStar. That’s about the same level as last year, though developers seemed to be taking out fewer building permits to add to the number of apartments under construction.
“We are starting to see construction fall off a little,” says Svec. “It’s getting harder and harder to make deals work as the cost of land and construction goes up.”