The Sky is Falling - Or at Least Your Rent Is

Chicago Crain's Reports:

Downtown apartment rent falls by most in 7 years

By: Alby Gallun Feb. 23, 2009

(Crain) — Rents at top-tier downtown apartment buildings last year fell the most since 2001 as a development boom and deepening recession gave tenants the upper hand over landlords.

Effective rents at Class A downtown buildings fell to $2.11 a square foot in the fourth quarter, down 6.2% from $2.25 in the year-earlier period, according to Appraisal Research Counselors, a Chicago-based real estate consulting firm. It was the first annual drop since 2003 and the biggest decline since 2001, when effective rents slid 7.7%.

In a case of bad timing, rising unemployment is depressing demand for apartments amid a surge in supply of both apartments and unsold condominiums that are being rented out. Many landlords are still holding the line on face rental rates, but a growing number are offering one or two months free, driving down so-called effective rents.

“I think this next year is going to be really tough,” says Appraisal Research Vice-president Ron DeVries. “We’ve just been having lots of ugly conversations lately.”

Effective rents fell 6.6% between the third and fourth quarters, the biggest quarterly drop since Appraisal Research began surveying the downtown market in 1997. The fourth quarter is typically slow for most landlords, with rent declines even in strong markets.

The downtown Class A occupancy rate, meanwhile, fell to 90.6%, from 92.8% in the third quarter and its lowest level in six years, according to Appraisal Research. While Mr. DeVries expects the occupancy rate to slip further, he doesn’t see effective rents dropping as low as they did in the last downturn, when they bottomed out at $1.83 in 2003.

The depressed for-sale residential market initially benefited apartment landlords, as many would-be buyers rented instead, either because they couldn’t qualify for a mortgage or didn’t want to buy a house or condo that could fall in value.

But the worsening economy now is depressing demand, forcing some renters to save money by doubling up or moving back home with their parents. The job market, which drives demand for apartments, continues to shrink: Moody’s Economy.com forecasts that the Chicago area will lose 133,000 jobs in 2009 — about the same number lost during the last recession — and won’t start adding them until after 2010.

Still, an oversupply of apartments is the larger problem for landlords right now, especially in the South Loop. Developers completed three buildings comprising 1,016 apartments in the South Loop last year, according to Appraisal Research.

And condo rentals are becoming a bigger competitive threat, with developers adding nearly 3,200 condos to the South Loop in 2008 and 2009. Unwilling or unable to sell their units in a lousy market, many condo owners are renting them out for the time being.

Some are offering good deals on rent, one reason new apartment high-rises in the South Loop have been slow to fill up. A 278-unit building at 1401 S. State St. developed by Chicago-based Equity Residential and Dallas-based Lincoln Property Co. is only 60% leased 10 months after opening, according to Appraisal Research. Under normal market conditions, a similar building would be at least 90% full at this point.

The new South Loop projects “have hit the market at the worst time,” Mr. DeVries says. “If you want to live in the South Loop, you have lots of options. That has really slowed down the leasing.”

Lincoln and Equity Residential representatives did not return calls for comment.

Some landlords are trying to address the competitive threat posed by condo rentals by playing up the advantages of living in an apartment building, which usually have on-site customer service staff.

“We talk about the benefits of being in a professionally managed building,” says Mark Segal, president and CEO of Chicago-based Habitat Co., whose downtown properties include Kingsbury Plaza, a 420-unit apartment tower at 520 N. Kingsbury St. When tenants have a problem, they “can go directly to our management staff as opposed to going to a unit owner.”

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