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Midwest Experts Forecast 2017 Commercial Real Estate Trends

January 16, 2017

Commercial real estate transactions fell 6 percent in November 2016 compared with the year-earlier period, continuing a trend of year-over-year monthly declines – the result of an exceptionally robust 2015, when sales totaled $533 billion, according to Real Capital Analytics. While a lack of megadeals translated to slightly lower totals in 2016, commercial real estate remains attractive to both foreign and domestic investors, some of whom have begun entering new asset classes and pursuing deals in secondary and tertiary markets as they seek out higher yields amid rising property values.

What factors will impact development, sale and leasing activity in 2017? Chicago’s leading commercial real estate experts recently shared their predictions for the year ahead. (Note: please see trend headlines below, then scroll down for full write-ups and click here for photos):

  • Retailers, Developers Woo Millennials with Shop-Dine-Play Centers
  • Industrial Flight to Quality Fuels Renovations
  • Mixed-Use Mania
  • New Kids on the Office Block
  • Healthcare Providers Take Pulse of Real Estate Footprints
  • Tech Disrupters Shake up Commercial Real Estate

1) Retailers, Developers Woo Millennials with Shop-Dine-Play Centers: With the buying power of millennials surging – estimates say this group currently spends $600 billion per year in the U.S., with projections of $1.4 trillion by 2020 – retail center developers and operators are wooing this generation by infusing new and existing centers with the engaging lifestyle-oriented experiences they crave.

“We’re seeing that millennials have different shopping habits from previous generations and simply don’t value apparel as much as Gen Xers and baby boomers,” said Tim Blum, executive vice president of retail development at HSA Commercial Real Estate. “They prefer to spend their disposable income on dinner and drinks with friends or a fun activity. And when they do shop for clothes, they’re seeking deep discounts for designer brands. These choices are causing a seismic shift in how we analyze the tenant mix and overall design at new retail centers.”

For example, HSA Commercial’s The Mayfair Collection in Wauwatosa, Wis., features national off-price retailers like Nordstrom Rack, Saks Fifth Avenue OFF 5TH and J. Crew Mercantile paired with a mix of upscale bars and new-concept restaurants to not only enhance the overall experience for shoppers, but also to create a dining and nightlife scene that is a destination in its own right.

National general contractor Englewood Construction is also seeing new food-entertainment concepts emerge in malls to address the millennial generation’s preference for experiences. “We’re working with clients to build fun, social venues like bowling alleys and ping-pong clubs that offer a more restaurant-caliber menu rather than basic bar food,” said Bill Di Santo, president and CEO of Englewood Construction. “Many existing mall operators are even adding these restertainmenttenants as the anchor for their center, in lieu of or filling vacancies left behind by traditional department stores.”

2) Industrial Flight to Quality Fuels Renovations: The effects of e-commerce are being felt beyond the retail sector. Online sales – expected to reach $591 billion in 2020, up from $394 billion in 2016, according to Forrester Research – are electrifying the industrial market as well, a trend that will continue in 2017 as retailers look to further reduce delivery times. “Today’s consumers are not only making more of their purchases online, but also expecting them to be delivered in a matter of minutes or hours rather than days,” said Bob Smietana, vice chairman and CEO of HSA Commercial Real Estate. “This so-called ‘Amazon effect’ is fueling industrial leasing and development activity, particularly in distribution hubs with road, rail and runway access, resulting in record-low vacancy rates and rising rents in many markets.”

HSA Commercial is currently developing three distribution centers – in suburban Nashville, Indianapolis, and Chicago – all of which are being built on a speculative basis, or without tenants lined up in advance. “Users small and large, including those from the fast-growing automotive and healthcare sectors, are demanding modern, Class A facilities, so we’re in a flight to quality that has resulted in many spec developments filling up before construction is complete,” Smietana said.

And it’s not just new developments that are benefitting from the trend, noted Michael Marconi, managing broker of Transwestern’s industrial practice in Rosemont, Ill. “In some submarkets, larger tracts of land are in short supply, making older Class B and C assets attractive as a value-add play,” said Marconi. “Existing properties that may have been overlooked in previous cycles are being updated with additional parking and loading docks, improved lighting, and higher ceilings, allowing investors to raise rents by as much as 50 to 60 percent and achieve an attractive return at sale.”

Ironically, the decline of big-box retail could create additional opportunities for industrial developers. “The final leg of the delivery chain, or ‘last mile,’ has become increasingly dependent on urban warehousing facilities that facilitate same- or next-day delivery,” said Marconi. “As big-box stores become obsolete as showrooms, some will be converted to modern fulfillment centers due to their flexible floorplates, abundant parking and infill locations.”

3) Mixed-Use Mania: While mixed-use construction has existed for decades, today’s projects are more purposeful in their design to encourage synergies among all tenants while also filling a neighborhood void.

“Even as online shopping continues to grow in popularity, retail centers with a residential component are raising the bar with destination-oriented tenants, including a mix of daily traffic-drivers such as restaurants, grocery stores and medical offices,” said Mike Drew, founder of Structured Development, the Chicago-based developer behind the award-winning NEWCITY retail and residential complex in Lincoln Park. In addition to 199 luxury apartments, NEWCITY houses the area’s only Mariano’s grocery store as well as an ArcLight movie theater – amenities that benefit a much larger customer base than just NEWCITY’s residents.

The same neighborhood anchor concept also applies to Addison & Clark, a mixed-use project of 148 luxury apartments and 150,000 square feet of retail across from Wrigley Field. A joint venture of M&R Development and Bucksbaum Retail Properties, Addison & Clark will help transform the area from a stadium neighborhood to a year-round shopping, dining and entertainment district when completed in 2018.

Scale and scope are also vital to a successful mixed-used project. “If you’re going to develop the biggest high-end grocery store in one of Chicago’s most affluent neighborhoods and want new housing as part of the plan, then that project should have residences on par with the upscale retail offerings,” said Steve Fifield, chairman of Fifield Companies, which is developing the Sinclair, a 390-unit luxury apartment tower in the Gold Coast with a 58,000-square-foot flagship Jewel-Osco grocery store as the ground-level anchor. “In previous cycles, retail was often an afterthought in a multifamily building or vice versa. Now, we’re much more strategic in developing projects where residential and commercial components are equally essential and intentionally synergistic.”

The rise in mixed-use construction can be attributed to progressive zoning laws that no longer seek to keep residential uses separate from retail, according to FitzGerald Associates Architects. These zoning changes have not been lost on high-profile national retailers such as Target, which is opening multiple “flexible-format” stores in the Chicago area. Several are part of larger mixed-use developments like the FitzGerald-designed Elevate Oak Park, a 271-unit transit-oriented development anchored by a 26,000-square-foot Target.

Similarly, Lakeview 3200, just one block east of the Belmont ‘L’ station in Chicago’s popular Lakeview neighborhood, will feature a 33,000-square-foot flexible-format Target below 90 upscale apartments. Developed by BlitzLake Partners, the development has already begun pre-leasing.

4) New Kids on the Office Block: Chicago’s downtown office vacancy rate continued its descent in third-quarter 2016, dropping to an eight-year low of 11.4 percent, according to Transwestern. And while asking rents rose to $35.48, up from $32.98 a year earlier, the completion of the city’s first high-rise office towers to deliver since the recession – 150 North Riverside and River Point – will likely tip the scales in favor of tenants in 2017. “Together, these developments will add a total of 2.3 million square feet of space to the market,” said Transwestern Midwest President Mike Watts. “While the majority of that space is pre-leased, much of it is being filled by tenants relocating from older buildings, so we’ll begin to see recently vacated space flood the market over the next 12 to 24 months.”

Among those bullish on downtown’s new-construction office market is CA Ventures, whose office division, CA Office, is part of a partnership developing a speculative 432,000-square-foot office tower at 625 W. Adams in Chicago’s bustling West Loop. “If you are a large user looking for a contiguous block of 150,000 to 300,000 square feet in a newly developed building, you’ll have very few options in the downtown area over the next two years,” said John Dempsey, principal of CA Office.

As new towers prepare to open their doors, existing buildings are undergoing renovations to stay competitive. At 500 West Madison, Transwestern transformed unused mezzanine space into a multistory fitness center with a half-court basketball court. Nearby at 200 West Madison, a $5 million capital improvement program included an updated lobby, new clubroom and expanded fitness center. Similarly, FitzGerald Associates Architects was recently tapped to reimagine the ground floor of 300 South Riverside Plaza, a 1.1 million-square-foot office tower built in 1983. The renovation included converting ground-level office and storage space into a new lobby accented by floor-to-ceiling views of the Chicago River. A new restaurant and riverside patio were also added. “Many of today’s office amenities are inspired by those traditionally found in residential buildings,” said Kristen Larkin, associate principal at FitzGerald.

5) Healthcare Providers Take Pulse of Real Estate Footprints: Technology has had a profound impact on the delivery of healthcare in recent years, from electronic medical records that put a patient’s medical history at the provider’s fingertips to mobile apps that facilitate face-to-face consultations between physician and patient without an actual office visit. The increased mobility, along with broader consolidation of hospitals and physician groups spurred by the Affordable Care Act, is leading providers to closely examine their real estate portfolios as they look to eliminate redundancy and inefficiency in the location and layout of their clinics.

”Technology is changing the way patients access care, with providers moving lower-acuity services off-campus in an effort to reduce costs and improve patient accessibility,” said John Wilson, president of HSA PrimeCare, which develops and manages a variety of outpatient facilities, including medical office buildings, ambulatory surgery centers and cancer centers. “While the future of the ACA is uncertain, it’s already had a profound impact on the industry as providers have sought to increase market share and gain economies of scale through consolidation. And to avoid duplication of service locations, health systems have started combining smaller clinics into larger multispecialty facilities and moving physicians to centers with higher patient volumes.”

The decrease in foot traffic created by telemedicine and other technological advancements is not only impacting the size of outpatient facilities, but also how those facilities are being used, according to Manish H. Shah, executive director at KTGY Architecture + Planning‘s Chicago/Midwest office, which recently designed the Northwestern Medicine Delnor OB/GYN Clinic in Geneva, Ill. “Healthcare providers are closely examining the function of each square foot of their facilities and looking for ways to increase the amount of billable space on the hospital campus,” said Shah. “This has resulted in non-revenue-generating functions, such as administrative services, to also be moved off-campus.”

In addition to centralizing services off-campus, providers are also reimagining the design of traditional exam rooms, Shah added. “Doctors are relying more heavily on mobile devices, even during a patient visit, thereby reducing the physical space required to perform an examination,” he said. “Additionally, as more waiting areas are shared among providers, and group medicine rooms service multiple patients at a single time, healthcare design is becoming more efficient without compromising quality of care.”

6) Tech Disrupters Shake up Commercial Real Estate: Historically known as a late adopter, the commercial real estate industry made great strides in 2016 in pursuing tech innovations designed to streamline operations across all major asset classes, laying the groundwork for additional advancements in 2017.

One of the biggest disrupters was the proliferation of commercial drones, which are used in everything from marketing to construction. One early adopter was CA Ventures and its student housing entity, CA Student Living, which uses drones to maximize operational efficiency throughout the life cycle of a project. “Unlike traditional multifamily housing, student housing deliveries are tied to hard deadlines, which, if missed, can mean an entire year of lost revenue,” said JJ Smith, chief operating officer of CA Ventures. “Our use of drone technology has proven invaluable in keeping our developments on time and on budget, giving us a regularly updated, bird’s-eye view of each project. And, it’s very handy for showing off the panoramic views while a project is under construction.”

Another company fostering innovation in commercial real estate is Waterton, an investor/operator specializing in multifamily and hospitality properties. In addition to launching its own Innovation Portal, through which the company’s 1,700 employees can submit ideas for new technologies and processes, the firm is an operating partner of Elmspring, a Chicago-based venture accelerator for tech startups specializing in housing and real estate.

Waterton is also exploring how to apply many of the technologies it uses in its hotel properties at its multifamily communities. “In the hospitality sector, you see widespread use of virtual check-in, keyless entry and social media,” said David Schwartz, co-founder and CEO of Waterton. “We want to use similar technologies in multifamily management to offer residents a more convenient, service-oriented experience. Technology also allows us to harness the power of big data as a means of improving portfolio performance.”

In 2016, the Chicago office of Transwestern hosted CREforge, the country’s first commercial real estate hackathon. The event paired real estate firms with coders and software developers who worked collaboratively to create tech-enabled solutions tailored to each company’s needs. Transwestern plans to organize similar events in additional markets in 2017.

“As one of the country’s fastest-growing tech cities, Chicago was an ideal place to launch the hackathons,” said Anthony Katsivalis, Transwestern’s national manager of technology and innovation. “The commercial real estate industry is a natural end-user for so many disruptive technologies, and we need to be proactive in developing and adopting new platforms that allow us to move away from old, inefficient software.”

PHOTOS:       Click HERE to view photos and captions that accompany this release via Flickr.