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Chicago commercial real estate market dodges collapse, begins recovery

The local commercial real estate market is coming back, defying expectations of a prolonged collapse like the one that decimated the housing market.
Loan delinquencies are falling, property values are rising and leasing is picking up at the area's office buildings, shopping malls and warehouses, signs that the market is in the early stages of a broad-based recovery. Though it is far from reclaiming the ground lost in the deepest downturn since the early 1990s, Chicago clearly will avoid the devastating crash many predicted two years ago.
“Eighteen to 24 months ago, people were saying commercial real estate was the next shoe to drop,” says Bob Bach, senior vice-president and chief economist at Santa Ana, Calif.-based commercial real estate firm Grubb & Ellis Co. “We've come a long way from there, where the worst seems to have passed.”
For landlords struggling to make mortgage payments, the latest real estate data suggest that finding new tenants and keeping old ones will get easier. For businesses, it's an end to bargain-basement rents as the pendulum of power slowly swings back to landlords. For lenders, the figures show that the mountain of bad loans that piled up over the past two years is starting to shrink.
But the implications go beyond the real estate market, offering further evidence of a local rebound from the credit crisis and recession.
Delinquencies in two key categories—commercial mortgage-backed securities loans and bank loans—have fallen in recent months after rising for more than two years. The local delinquency rate on CMBS loans, which are packaged and resold, declined to 6.75% in January, the fourth straight monthly decline from a peak of 7.60% in September, according to New York-based research firm Trepp LLC.

The national CMBS-loan delinquency rate, meanwhile, continues to climb, hitting a fresh high of 9.31% in February. The Chicago area's rate is lower than metropolitan areas such as Philadelphia and Houston, although higher than premier markets like Washington, D.C., and San Francisco.
LOOKING UP
The delinquency rate on local commercial real estate loans held by banks also fell in the fourth quarter, to 7.3%, down from 7.7% in the third quarter, according to Foresight Analytics LLC, an Oakland, Calif.-based research firm.
Chicago's bank-loan delinquency rate is higher than the national average, which also fell in the fourth quarter, to 5.3%, from 5.5% in the third quarter.
The rates are falling as lenders resolve troubled loans faster than they stack up. With leasing slowly starting to pick up, more landlords once headed for trouble are now able to cover their loan payments. And more are showing a willingness to recapitalize their properties.
“As the market has turned, owners have gotten more bullish on their properties and more willing to invest their money to either restructure their loans at more favorable terms to the lender or offer more to the lender in a discounted loan payoff,” says real estate lawyer David Neff, partner in the Chicago office of law firm Perkins Coie LLP.
Many property owners slipped into the danger zone during the credit crunch of 2008-09 as plunging property values and a lack of lending made it impossible to refinance maturing loans. The biggest local victim was General Growth Properties Inc., the Chicago-based mall owner that emerged from Bankruptcy Court protection in November after defaulting on billions of dollars of debt.

The Allerton Hotel, above, is in foreclosure, but rising property values may allow its owner to pay off a $69-million loan. In retail, Meijer Inc. has agreed to open a store in Melrose Park's Winston Plaza, below, which lost its anchor tenant in 2008. Photos by Erik Unger

Today, rising property values and the return of lenders are saving some borrowers from the dire circumstances that existed just months ago. Included is the partnership that owns a half-empty, 540,000-square-foot office building at 111 W. Jackson Blvd. It defaulted on a $24-million loan last March after failing to pay it off at maturity. The 24-story building was appraised at just $21.7 million in January 2010.
Still, the story could have a happy ending: A group led by New York investor David Werner is buying the building for about $35 million to $40 million, sources say. The partnership, which includes north suburban investor Richard Colburn, is loaning money to finance the purchase.
GOING UPSCALE
Investors also have jumped back into the high end of the market, bidding up prices on some of the city's premier apartment buildings and office towers, like the Hyatt Center, a 49-story high-rise in the West Loop that the Pritzker family sold in December for $625 million. Unless interest rates jump, investment activity here is expected to stay on an upward path.
Yet it will take longer for leasing markets to fully recover. While the financial markets drive investment, demand for office, retail and industrial space is more closely tied to economic fundamentals.
“We're going to see continued capital flows (into real estate) and a continued healing,” says Bruce Cohen, chairman and CEO of Wrightwood Capital LLC, a Chicago-based real estate investment firm. “We obviously need job growth and consumer spending, the things that induce tenants to want to pay rent.”

To recover fully, ' We obviously need job growth and consumer spending, the things that induce tenants to want to pay rent.'

— Bruce Cohen
chairman and CEO
Wrightwood Capital LLC

That process has begun, according to recent data for the major property sectors—office, retail, industrial and apartments, which are leading the way. Rents at downtown Class A apartment buildings rose 7.2% in 2010 and may rise another 7% to 8% this year.
The 389-unit apartment tower at 215 W. Washington St., which opened in April, is more than 74% leased, ahead of a projected 71%, says Jerry Ong, a principal at Jupiter Realty Corp., its Chicago-based developer.
“Our partners are happy, our lenders are happy,” he says.
Other property types are turning around, too, although their recovery is fragile. Downtown and suburban office vacancies have fallen the last two quarters, while local retail vacancies have fallen for three quarters and local industrial vacancies have fallen two out of the last three.
Developers in most sectors won't get busy again until leasing fundamentals improve further, but the apartment market already is strong enough that as many as six downtown projects comprising more than 2,000 units could get under way this year.
Fear has not disappeared, however. Some observers worry about another wave of loan defaults in the next few years as a big batch of loans made during the boom come due and borrowers struggle to refinance them. Nationally, Foresight Analytics estimates that as much as half the loans maturing from 2011 to 2015 exceed the value of the property secured by them.
Others say the risks are overblown, comparing them to widespread predictions of computer meltdowns because of the 1999-2000 date change. “We've been calling for some time this ‘tsunami' of debt maturities Y2K,” Wrightwood's Mr. Cohen says.