Investor Expects 2% Rise in Chicago’s Office Value

Posted on August 12, 2011

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(Crain’s) — Local office buildings will see a 2% increase in value over the next year, a survey of investors forecasts.

The Chicago area is one of 16 U.S. office markets that will see a gain in values in the next 12 months, according to a second-quarter survey by PricewaterhouseCoopers LLC. The survey, which covers 18 metropolitan areas, reflects a guarded optimism among investors amid a stabilized office leasing market but still shaky economy.

“We’re optimistic, but still very pragmatic,” says Robert Six, chief operating officer of Zeller Realty Corp., a Chicago-based office landlord that is scouting for acquisitions. “We are assuming that there will be another six- to 12-month soft patch that we’ll have to deal with, if we’re going to buy anything in that time. We may not be able to buy, because we’re not going to be as aggressive.”

Values of big downtown trophy towers have rebounded over the past year as the lending climate improved and institutional investors returned to the market. Recent deals include UBS A.G.’s acquisition of the Leo Burnett Building, 35 W. Wacker Drive, for about $400 million, and the $369-million sale of Three First National Plaza, 70 W. Madison St., to South Korean investors.

Related story: Loop office tower under contract for $369 million

“Investors are becoming much more aggressive in their bidding, especially in the top-performing markets,’” the PwC report says, quoting one survey participant. “As a result, a slew of offerings recently hit the market as property owners look to capitalize on fervent buyer interest.”

Investors are less enthusiastic about suburban office properties; Mr. Six says the survey’s 2% projected gain for the Chicago area is probably too conservative for the Loop and too optimistic for the suburbs.

At 2%, the Chicago tied for 10th with Charlotte, N.C., among the 18 U.S. markets covered by the survey. Landlords in Dallas, San Francisco and Manhattan are expected to fare best, with gains exceeding 5%, the survey says. Just two markets, Southeast Florida and Phoenix, are forecast to see a drop in building values.

The report paints an improving picture for the Chicago area but also cites reasons for caution — vacancy rates of 16% downtown and 24% in the suburbs. Survey participants reported that 10-year leases locally were coming with five to 15 months of free rent, for an average of more than 10 months. A year earlier the average amount of free rent was less than eight months, and two years ago it was less than six months.

“As market conditions improve and property owners regain control of the leasing market, free rent will likely diminish,” says the report, which adds that “very little rental rate growth is anticipated” in the near future.

Capitalization rates, or first-year returns, have fallen as local office building values have risen. Surveyed investors said local office cap rates average about 8.3%, down from 8.6% a year ago, according to the report. Fifty-six percent of survey participants expect local cap rates to hold steady over the next six months.

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