Developers shunning Chicago

Construction of Chicago-based Sterling Bay’s 545wyn project in Miami could be completed later this year.

After years of luring corporate headquarters downtown, altering the city’s skyline and transforming once-fringe neighborhoods, some of Chicago’s best-known developers are taking a new approach for 2020 and beyond.

They’re lining up real estate investments in other cities.

A decade into a Chicago construction boom, some major players known for focusing heavily on their hometown are shopping for land to develop in places including Denver, Los Angeles, Miami, Nashville, Austin, Atlanta and Dallas.

Chicago-based firms, including Vista Tower’s Magellan Development Group and Lincoln Yards’ Sterling Bay, have determined that property tax increases and other factors make it difficult to finance new projects locally.

“We love Chicago but are super nervous about the headwinds Chicago faces,” said Magellan CEO David Carlins, whose firm’s Vista Tower condominium and hotel project with China’s Dalian Wanda Group will become Chicago’s third-tallest skyscraper when it opens in the fall.

“I would call it as difficult an environment from a capital standpoint as I’ve ever seen,” Carlins said. “In the recession, it was impossible for anyone to find money. Now there’s money, but there are other markets those investors are interested in.”

Investing in multiple cities is nothing new for larger developers. It’s a way for them to spread risk, grow their companies and develop valuable business relationships.

But new concerns about the cost of doing business in Chicago, whether real or perceived, could hurt the local economy in the long run, affecting the employment rate, home values, sales of goods and services and the size of Chicago’s population.

Uncertainty over property taxes is paired with other issues already on the radar of big, institutional real estate investors. Those worries include ongoing city and state fiscal woes stemming from soaring pension obligations, as well as potential Chicago policy changes such as increased affordable housing requirements, rent control and tax-increment financing (TIF) reform. Construction costs also have been rising.

John Diedrich, global head of investments for CA Ventures, calls the inability to accurately project future property taxes as “one strike too many” for major investors such as pension funds and insurance companies that use highly detailed underwriting formulas to choose what development projects should get their investment.

CA Ventures owns a $13 billion portfolio of real estate throughout the world, including investments in a 20-story office building near Old St. Patrick’s Church and the 33-story Arkadia Tower apartment building in Greektown. The firm plans to begin construction of a 46-story apartment tower near Millennium Park in the first quarter of 2020.

“Most of our institutional investors have basically redlined Chicago,” Diedrich said. “They are not going to deploy capital here.”

The fear of the unknown could turn out to be greater than the reality, and it’s unclear whether a slowdown in Chicago investments will be a blip or a long-term trend.

“In my mind, the bark is worse than the bite,” Matt Garrison, managing principal of Chicago developer R2, said of worries over rising taxes. Yet he concedes there’s evidence that a slowdown in real estate dollars to Chicago is real, rather than anecdotal.

Combined sales of office, apartment, hotel and industrial buildings in Chicago totaled $3.9 billion through the first three quarters of 2019, on pace to fall well short of the previous year’s $12 billion volume, according to Jones Lang LaSalle.

Today’s sales volume has an impact on developments in the planning stages. If developers are unable to fully lease a project and ultimately cash in by selling it, it’s far more difficult to line up capital to kick off construction in the first place.

“It’s had a dampening effect on investment sales,” said Garrison, whose firm has converted vintage buildings into creative office space in and around Goose Island, the Fulton Market district and other parts of the city. “The numbers don’t lie.

“Ultimately, I still think Chicago is a relative value to other large cities, and even some smaller cities.”

At a December event attended by dozens of commercial real estate professionals, Cook County Assessor Fritz Kaegi and Chicago Mayor Lori Lightfoot attempted to allay investors’ worst fears, saying they recognize the need for predictability and transparency. Kaegi unveiled an online calculator designed to help property owners estimate future taxes based on a variety of changing factors.

Nervousness about property taxes has been rising since Kaegi defeated incumbent Joe Berrios in March 2018, a win helped by pledges to fix inequities in Berrios’ practices that were identified in “The Tax Divide” investigation published by the Tribune and ProPublica Illinois.

Kaegi has been widely praised by some for his efforts to make the assessment process more equitable and data-driven. Property owners are bracing for growing pains in the next few years as Kaegi implements wholesale changes.

Kaegi’s early work indicates commercial property owners could shoulder a larger burden than homeowners. Kaegi’s first round of new taxes in 2019, covering the northern part of the county and excluding the city of Chicago, caused some property valuations to rise by well over 100%, a Tribune analysis found.

Actual tax bills typically rise at a much lower percentage than assessments do, and the Board of Review, which considers tax appeals, has scaled back many assessment increases, the Tribune reported in December.

Even so, property owners in Chicago said it’s difficult to calm their investors as they await city assessments in 2021.

“When we saw what happened in Evanston, we realized we needed to start diversifying,” John O’Donnell, CEO of Riverside Investment & Development, said of 2019 assessments in northern Cook County, which included massive increases in Evanston.

O’Donnell’s known for building trophy office towers, including two under construction now — the 55-story Bank of America Tower at 110 N. Wacker Drive on the river and the 50-story BMO Tower that recently broke ground alongside Union Station at 320 S. Canal St.

Riverside is now looking at its first projects outside the Chicago area, including an office development site under contract in Denver. The firm is also searching for sites in cities including Nashville and Charlotte.

“We’ve invested our careers and money in Chicago and we love the city,” O’Donnell said. “I don’t ever want to be in a situation where I have to fire a bunch of highly qualified people. We have to go where it’s possible to build.

“Right now it’s harder to finance a building in Chicago than it is in, say, Denver.”

Another firm that has been known in recent years for rapid growth while maintaining an almost exclusive focus on Chicago is Sterling Bay. Sterling Bay is redeveloping swaths of the once-gritty Fulton Market district, including McDonald’s new headquarters and Google’s Midwest headquarters, and plans the $6 billion Lincoln Yards mixed-use project between Lincoln Park and Bucktown.

The firm also is redeveloping a historic building in Portland, Ore., where Google has leased space. Sterling Bay also has an office building under construction in Miami’s Wynwood district, with plans for a second office project in the artsy, formerly industrial neighborhood, as well as an office development in Dallas’ Deep Elum arts and entertainment district.

Sterling Bay also is exploring projects in cities such as Atlanta, Denver and Los Angeles, said Sterling Bay managing principal Keating Crown.

“We spend most of our day trying to convince companies to come to Chicago, either from the suburbs or from outside the state,” Crown said. “We love the city. Focusing elsewhere isn’t something we take lightly, but we believe it’s the prudent thing to do.”

Sterling Bay’s broader reach is a natural evolution for a firm that has ballooned in size in recent years and is branching out into new types properties, including apartments, hotels, senior housing, life sciences and warehouses.

But Sterling Bay’s expansion also is partly a response to its investors’ concerns about potential rises in expenses, and thus drops in profits, for Chicago properties, Crown said.

“It’s hard to underwrite unknowns, and that’s what you’re seeing in Chicago right now,” he said.

R2’s move into cities such as Milwaukee — where the firm may eventually redevelop a 1 million-square-foot post office that it owns and leases to the U.S. Postal Service — and Minneapolis has been opportunistic, after finding that the supply of interesting older buildings to repurpose has become picked over in Chicago, Garrison said.

“A lot of the low-hanging fruit has been harvested in Chicago, so we’re looking at places where we can find the type of opportunities we saw five or six years ago in Chicago,” he said.

Garrison said even with a big increase in property taxes, Chicago’s rents and cost of living will compare favorably with the country’s other major cities.

Rob Bond, co-founder and president of Bond Companies, concurs.

“It’s important to say that deals are still getting done and money is still flowing into the city,” said Bond, whose firm has offices in Chicago and Los Angeles, two cities where the firm is an active residential and retail developer. “The sky isn’t falling.”

His firm’s local projects have included the retail portion of the Center on Halsted in Lakeview, the Maxwell shopping center in the South Loop and the 363-unit Spoke apartment building in River West. The firm also plans an approximately 100-unit apartment building at 1140 W. Erie St. along the west side of the Kennedy Expressway.

The firm has ongoing projects in Los Angeles and is looking at new cities including Dallas, Nashville and Denver, Bond said.

In Chicago, Bond said he and other developers have discussed itemizing rent statements so residents will realize how much of their monthly payments is going to offset the landlord’s property taxes.

“I think the consumer needs to know, because it takes everybody to weigh in on this,” Bond said.

Although Bond remains mostly positive on Chicago, he worries about the long-range impact if city and state officials fail to make structural changes to their finances.

If higher costs push away residents and businesses, the spiral of higher taxes will only accelerate for those who remain, he said.

“Personally, I would like to see a solution to the rapidly rising pension obligations, because it’s not sustainable,” Bond said. “If it drives business out of the city, state and region, who’s going to be left to pay the piper?”

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