(Crain’s) — After taking two steps forward, downtown apartment landlords took one step back in the third quarter.
Demand for apartments remains surprisingly strong, but competition for tenants is heating up amid a swelling supply of new units. That’s one reason rents and occupancies at high-end downtown buildings slipped in the third quarter after rising in the first two, resuming a downward trend that began more than two years ago, according to a report by Appraisal Research Counselors.
“It’s really not a signal that it’s a weak market,” says Ron DeVries, vice president at the Chicago-based real estate consulting firm. “Demand is strong. We’ve just got a supply bubble right now.”
The average net effective rent at Class A downtown apartment buildings fell to $2.10 a square foot in the third quarter, down 3.2% from the second quarter and 7.1% from the year-earlier period, according to Appraisal Research.
Effective rents, which include concessions such as free rent, have fallen 10.6% from their peak of $2.35 in third-quarter 2007.
The average Class A occupancy also declined, to 91.9%, down from 93.4% in the second quarter and 92.8% in the year-ago period.
Demand for apartments typically falls in a recession as more renters try to save money by doubling up or moving in with their parents. But that hasn’t happened in downtown Chicago, where more people are renting now than were before the economy went south.
Renters occupied 17,617 downtown apartments surveyed by Appraisal Research at the end up the third quarter, up 16.7% from 15,093 two years earlier. Appraisal Research tracks about 80% of the apartments in downtown Chicago.
Normally, apartment landlords lose a certain percentage of tenants who move out to buy a condominium or single-family home. But the turnover rate has slowed dramatically, possibly because would-be buyers are hesitant to commit to a mortgage when the economy is so shaky and condo vales could fall further, Mr. DeVries says. Other renters simply may not be able to qualify for a mortgage.
“The path to home ownership is a lot tougher right now,” Mr. DeVries says.
While that’s good for landlords, the current building boom isn’t. Developers have added 3,270 units to the downtown apartment market in 2008 and 2009 and will complete another 2,236 next year, boosting the total downtown inventory by 25%, according to Appraisal Research.
“I could still see demand remaining reasonable, but I could see pressure on rents because of the supply,” says Michael Newman, president and CEO of Golub & Co., the Chicago-based developer of Streeter Place, a new 480-unit apartment tower at 355 E. Ohio St.
Golub is offering tenants two months of free rent on a 12- to 14-month lease in the building, which is about 55% leased, he says. Though the property is not meeting financial projections set a few years ago, when the market was much stronger, “we’re kind of happy where we’re at,” considering the state of the economy, Mr. Newman says.
The so-called shadow rental market is another concern. Amid a glut of condominiums, more downtown condo owners are renting out their units rather than trying to sell them. And they’re competing with traditional landlords for tenants.
There were 1,747 downtown condos listed for rent on the Multiple Listing Service at the end of the third quarter, up 45% from the year earlier, according to Appraisal Research.
Whether the market can absorb all the extra supply will depend in part on the job market, the key driver of demand for apartments, says Anthony Rossi, president of RMK Management Corp., a Chicago-based property manager. He’s also a partner in the Parc Huron, a 221-unit apartment building under construction in River North.
“The big thing that we’ve got to hope for is that employment stabilizes and comes back,” Mr. Rossi says. “That will make everybody a little more comfortable.”
By Alby Gallun, Nov. 23, 2009
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