Is The Second City Luring Investors Back From Secondary Cities?

Quite a few commercial real estate experts predicted an exodus of homeowners and investors from crowded urban areas like Chicago during the coronavirus pandemic. Big cities were perceived as increasingly inhospitable to residents, who were expected to move en masse to so-called secondary cities, smaller metropolitan areas such as Nashville or Austin where the cost of living was lower and residents could get more space.

If nothing else, it was expected the pandemic would create an incentive or added sense of urgency for people who were already planning or contemplating moving out of big cities like Chicago in 2020, said Sean Connelly, a principal at Chicago-based 33 Realty. He noted the trend was expected to create a mini-boom for smaller cities and a hollowing out of occupancy in high-rises and other residential properties in some of Chicago’s neighborhoods.

But did it?

“Yes, there was a big shake-up when people started to work remotely due to the Covid-19 pandemic,” said Connelly, whose firm provides management, brokerage and other services for multifamily properties. “But there was a market overreaction to the damage that the cities would suffer. What we've seen is that the big cities have actually bounced back much quicker than we thought they were going to a year ago.”

Connelly, who has more than a decade of experience in Chicago commercial real estate, attributed the phenomenon to a variation on an old axiom that could apply to CRE and just about everything else. 

“Maybe the grass isn’t always greener, after all,” he said.

Investors found that secondary markets lacked the product and support infrastructure to accommodate a sudden influx of buyers. At the same time, the availability of Covid vaccines and a cooling of the urban unrest seen in 2020 restored people’s comfort level with living in dense, older cities.

As a result, he said, places like Chicago are again attractive to buyers, and the outlook for the multifamily market there is much more positive and upbeat than it was a year ago.

“We are seeing existing products filling up a lot quicker than we anticipated when we looked at the horizon for leasing last year,” Connelly said. “We've seen rents return, not all the way to pre-pandemic levels, but they're close. We anticipate rent growth in the spring of 2022 as a result of demand from younger renters returning to the city. Everything that attracts someone to live in Chicago is still here, and we remain an international destination for both tenants and investors.”

However, he added, some important questions remain on the horizon for Chicago’s multifamily market. 

One of them is the Affordable Requirements Ordinance updated by the Chicago City Council earlier this year. The ARO requires developers to devote a percentage of new apartments or condominiums to low- and moderate-income residents. In the city’s largely upscale downtown, the ordinance calls for developers to set aside 20% of new development for affordable housing — or pay additional fees to the city.

This has created some uncertainty for Chicago developers who, like their peers across the country, have already seen their projects slowed by supply chain disruptions and labor shortages, Connelly said.

“It's hard to build right now in Chicago, given the new ARO,” he said. “Products that were already in the pipeline for permitting and that were entitled are moving forward. But the new ARO is going to make it more difficult to make deals pencil. Until developers can figure out a market solution to the new ordinance, I think that we'll see a slowdown on the construction side.”

Further complicating matters is that 2021 is a year for property tax assessments in Chicago. People are also keeping a wary eye on inflation. 

“There's a real fear over what will happen with property taxes for the long-term Chicago owners who may not have had a real push on their taxes for quite some time,” Connelly said. “Conversely, there are buyers who have done well in other markets trying to put capital into the real estate market as a hedge against inflation."

With today's historically low interest rates, he added, a property purchased today is likely to be worth significantly more in 10 years despite the current headwinds in the Windy City. Also, the odds are favorable that investors with fresh debt will weather the uncertainty surrounding tax increases that inevitably will be passed on to tenants. 

Despite uncertainties, Connelly is upbeat about the future of multifamily in Chicago.

“We anticipate that the market is coming back to normal and will quickly return to a growth trajectory,” he said. 

This article was produced in collaboration between Studio B and 33 Realty. Bisnow news staff was not involved in the production of this content.

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