A lack of supply is becoming an issue in the 446,100-unit investment-grade Chicago apartment market, as vacancy falls and few new apartments complete construction. While rent gains remain moderate for the moment, the pace is picking up. “Reduced vacancy and higher rents attest to the stability and sound health of the Chicago apartment sector, though a transition to a new phase of the recovery awaits in the quarters ahead,” according to Marcus & Millichap. “High prices paid in recent sales of large, modern city properties continue to make many proposed projects feasible, and pipelines of planned apartments continue to swell in many submarkets.”
Reis reports a vacancy rate of 4.1% for the second quarter of 2012, down 30 basis points from the prior quarter and 100 from a year earlier. The current rate is lower than any year-end rate since 2001, though the rate had been below 3.0% for five years from 1996 to 2000. The recent peak rate had been 6.7% in the first quarter of 2010. The Class A and B/C vacancy rates are similar at 4.3% and 4.1%, and each fell 20 basis points in the second quarter. Two thirds of the inventory is Class B/C.
“Strong demand and a second consecutive year of limited construction will support a 50 basis-point drop in vacancy this year to 4.1%, the lowest year-end level in 11 years,” Marcus & Millichap predicts. In the City of Chicago, according to this source, the vacancy rate has fallen for 13 consecutive quarters to 4.3%, while the suburban rate is lower at 4.1%. Reis predicts the overall vacancy rate will fall to 3.7% at the end of 2012, lower than previously predicted. After leveling off for two years, the rate is forecast to drop to just 3.3% by the end of 2016. Chicago vacancy trends are expected to continue to track the U.S. and Midwest region averages, but with the local vacancy rate remaining below those averages.
SUPPLY AND DEMAND
Demand remained strong for Chicago apartments in the second quarter, with the net absorption of 1,094 units bringing the half-year total to about 1,860. The net absorption totals for 2010 and 2011, at 6,580 and 5,100 units, marked the strongest period for Chicago apartment demand since the early 1990s, and Reis expects the total for 2012 to be nearly as large at 4,350. Looking back further, demand for apartments was strong throughout the 1990s but weak during the 2000s, as tenants (and in many cases the apartments themselves) shifted to owner-occupied housing. Reis predicts the 2010s will be more like the 1990s, with more than 5,000 units of net absorption forecast for 2013 and 2014.
Like demand, new supply was greater in the 1990s than in the 2000s. From 2001 to 2010 an average of just 1,725 new apartments were completed per-year, a total that fell further as a result of the financial crisis and recession. Just 279 new apartments were completed in 2011, and just 48 came online in the first half of 2012. Development, however, is set to surge with more than 5,200 units under construction and more than 2,000 planned units now having announced completion or construction start dates. Many projects in the latter category are expected to break ground later this year. Following the completion of about 650 units in the second half of 2012, therefore, Reis predicts more than 5,000 apartments will complete construction in both 2013 and 2014, temporarily halting the decrease in vacancy.
One reason for the low apartment completion totals of the 2000s was a shift to condominiums, and about 1,140 condos remain under construction. It a sign of just how much the multifamily market has turned around, another condominium project is expected to break ground in late 2012 in the suburban O’Hare submarket.
Chicago’s apartment rents picked up steam in the second quarter as the market tightened. The average asking rent increased 1.1% to $1,100 per month, while the average effective rent rose 1.3% to $1,032 per month. The year-over-year increases are 2.2% and 2.9%, respectively, higher than the annual gains for the prior two years. The Class A average asking rent is $1,429 per month, up 1.2% during the second quarter and 2.4% from a year earlier. The Class B/C asking average of $937 per month is up 1.0% over three months and 2.1% over twelve.
“Changes in store in the second half of 2012 and beyond include a faster pace of rent growth fueled by tight vacancy, dwindling concessions and a greater role for developers,” Marcus & Millichap predicts in its third quarter report. “For the entire year, asking rents will rise 2.6% to $1,093 per month and effective rents will surge 3.6% to $1,027 per month.”
Chicago’s apartment rent gains were weaker in the 2000s than they had been in the 1990s, even as the for-sale housing market was stronger. Both locally and throughout the nation, however, predicts a period of relatively large rent gains through 2016. Thus Chicagoland rents are forecast to rise by 3.1% for the asking average and 4.1% for the effective average for all of 2012. The typical annual gains during the 2013 to 2016 period are expected to fall between 4.5% and 5.5%, with the effective average rising 24.4% from its mid-2012 level by the end of 2016. Moody’s Economy.com, however, predicts income gains will accelerate as well, with household average income rising 23.7% during that period. Whether the market allows landlord to benefit at the expense of tenants or merely profit from their rising prosperity, however, the forecast is bright for Chicago apartment owners.