Some in the Chicago real estate industry might see the ranking as confirmation that high taxes and crime are pushing investors away, but the ranking may say more about Chicago’s status as a mature market. It’s part of “the establishment,” a group of 20 metro areas, including New York and Washington, “that have long been the nation’s economic engines,” according to the report.
Many Sun Belt cities, meanwhile, are “magnet” markets, “migration destinations for people and companies” with the strong growth characteristics that attract investors and developers. The geographic disparities are striking: Of the top 10 markets in the report, just one—Boston—is in the northern United States.
PwC and the Urban Land Institute published the 109-page report, the 44th annual “Emerging Trends” survey, based on survey responses from and interviews with investors, developers, fund managers, brokers and other real estate professionals. The report identifies 10 key trends that will affect real estate in 2023. No 1: A coming slowdown in the market amid rising interest rates and a potential recession.
“These conditions would be problematic for property markets: slowing or falling economic growth dampens tenant demand, while higher interest rates raise the cost of developing or acquiring properties,” the report says. “Both factors would cut returns and reduce values. Indeed, rising interest rates and uncertainty over future market conditions are already killing deals since sellers have not been ready to capitulate to buyers’ growing demands for price concessions.”
Locally, rising interest rates already are squeezing some properties financed with floating-rate loans, like the Willis Tower and Oakbrook Center mall. And investors are having a hard time completing acquisitions amid climbing borrowing costs and tougher lending standards: In late August, a New Jersey-based investor put a $190 million takeover of a 51-story River North condominium tower on hold amid “economic pressures.”
The “Emerging Trends” report also discusses the lingering impact of the COVID-19 pandemic. Though shoppers have returned to stores, online retailing is here to stay, which “ultimately means that fewer shopping centers and retail space can survive.”
Business travel also has rebounded and more professionals have returned to the office, but hotel and office investors shouldn’t count on demand returning to pre-COVID levels, according to the survey. Office space will be converted into apartments or some other use.
“The pandemic forced structural shifts in how and where we live, work and recreate in ways that seem destinated to endure at least at some level, even if less extreme than our behaviors during the peak of COVID,” the report says.
The survey divides the 80 U.S. real estate markets into four broad categories: magnets; the establishment; niche, which includes cities like Chattanooga (ranked 65th), Las Vegas (21st) and Pittsburgh (41st); and backbone, which includes Albuquerque (72nd), Milwaukee (75th) and Louisville (63).
Magnets have attracted the attention of Chicago investors and developers, including Sterling Bay, which has projects in Miami, Atlanta and Dallas. Magellan Development Group, meanwhile, has been busy in recent years in Nashville, Miami and Austin.
Chicago has plenty of good company in the establishment category, including San Francisco (58th), Manhattan (27th), and Los Angeles (20th).
“Though growing more slowly than the magnet markets, the establishment markets still offer tremendous opportunities,” the report says. “This group’s average rating is second among our four major groupings. However, the appeal of these markets to investors and developers has waned in recent years as growth has slowed across many of these markets while challenges have increased.”
The report also places Chicago, San Jose, Los Angeles and Seattle in a subcategory, “multitalented producers,” reflecting their large, diversified economies.
“Though their elevated cost of doing business and getting deals done limits their appeal for some real estate professionals, the multitalented producers nonetheless continue to attract a disproportionate share of investment dollars,” the report says.
The report doesn’t get into specifics about Chicago’s shortcomings, but local business leaders, including McDonald’s CEO Chris Kempczinski and Citadel CEO Ken Griffin, have been outspoken about the city’s crime rate. In June, Griffin, who once described Chicago as “like Afghanistan on a good day,” announced plans to move Citadel to Miami.
The departures of Boeing and Caterpillar add to the narrative that Chicago isn’t business-friendly, and rising real estate assessments in Cook County don’t help its image with investors, either.
Whether they deploy their capital in Chicago or in a magnet like Nashville, investors should lower their expectations for 2023 amid rising rates and a weaker economy. Real estate is a cyclical business, after all. The “Emerging Trends” survey summed up the outlook with a quote from an unnamed developer.
“I feel like we’ve been on a little bit of a sugar high with this stimulus and cheap debt. There’s going to be a slowdown,” the developer said. “There’s got to be this normalization. So, what does that mean? I think it’s going to be a little bouncy; it’s going to be a little bit turbulent. But then we bottom out, and we start back into growth.”