Most forms of real estate in Chicagoland are back in the black, thanks to recent increases in occupancy levels, rents and property values. That's the upshot from those in the know, as a group of some of Chicago's most high-powered real estate executives met recently for a private breakfast to discuss the state of Chicagoland's property markets with NATIONAL REAL ESTATE INVESTOR.

Q: How do things compare to last year in the office sector?

Jim Connor: We all saw a continuation of last year in the early first quarter, with absorption continuing at a pretty good pace. That has since flattened out fairly dramatically in the second quarter. People would attribute that to a typical slowdown this time of the year. Some of it could be people listening to a lot of our economists projecting a slowdown for the second half of the year. If we look at the pipeline of business, pending deals and trasactions in the marketplace, there is still a strong pipeline, a lot of interest as things continue to improve, so we're optimistic about the second half of the year.

There is still a fairly substantial difference between the health of the downtown market and the health of the various suburban markets. Some of the suburban markets are very tight on space. We're starting to see spec building again. All of the suburban markets are still a couple of years ahead of the downtown market.

Q: You just released a new industrial report. Can you give us an overview?

Connor: Industrial continues to move along quite strongly. We've got some 3.5 million sq. ft. of spec space that's been commenced or completed thus far this year. A lot of big box, high-distribution space. DuPage County and the I-55 corridor continue to lead the market there. Demand for good quality space continues to be very strong. A lot of major American companies are redoing their national distribution systems and Chicago continues to always be one of the top three or four locations nationally so I think the strength of the industrial market will continue. Investor demand for quality industrial space continues to outpace supply as it has for the last three or four years. Some of the lowest cap rates we're seeing in any property type are in the industrial market.

Q: How is technology impacting the demand for office space and tenant retention?

Van Pell: It's a factor we're going to have to deal with both short term and long term, but probably more long term, the reason being the shelf-life of a given piece of technology versus 10 years ago. When a certain PC or Mac came out, it had a shelf life of aobut three years. Anything that comes out today like that from a hardware or software perspective has a shelf life of approximately six months.

I think it's almost impossible to predict what office space utilization will look like five or 10 years from now.

For us, the buildings that we manage downtown won't go away. Physically they will trade because there's capital coming back into the market. They're going to trade at a slow pace. The growth will be in the suburbs and the growth will be in other areas of management, facilities, taking advantage of corporate consolidation.

Q: Randy, you're finishing the fifth tower at your Westbook Corporate Center in Westchester. How did you arrange the financing for it, and how is the office market out there?

Podolsky: You're already hearing that suburban space is tighter than downtown space, and it's been that way for some time. If you look at the east-west corridor, which is the marketplace that Westbrook competes in, you can find maybe a couple of buildings that will offer you 100,000 sq. ft. of space or more.

The fact is that although we know there are no large blocks of space and we might be the only choice on the block, we don't really want to fill the tower with one or two tenants. Our preference is to build a tower with a lot of full floors (tenants). In the last 10 day we've sent out 330,000 sq. ft. of proposals.

I can sell Westbrook's financing to you as we did to the bank from many different perspectives, but it was no easy task.

The fact of the matter is that it's a nonrecourse loan, which is very unusual for spec construction loans or any type of construction loans. We had to put in the first $7 million of land, garage and functional building, some of which we had already put in. Our ground beams, caissons and foundational walls and some of the sitework has been done for three or four years. When you get past that, we have the $25 million. If we don't meet leasing benchmarks we have to put cash on the table. And since that cashflow is available from the other towers, although the loans couldn't be cross-collateralized because we have first mortgages, we could offer the cashflow.

Q: How is leasing?

Podolsky: It's consistent, we have no leases signed!

Van Pell: Based on our statistics that submarket (eastwest) vacancy is down to 15%. There's no big blocks of space out there.

Bob Rosen: Arguably the worst submarket in the country is O'Hare. If you're looking for 100,000 sq. ft. of Class-A space you can't find it there. There will be quasi-spec construction for the first 50,000 to 75,000 sq. ft. tenant who comes along.

Q: Corporate America continues to cut costs. U.S. Equities recently created a division to serve the facilities management outsourcing function. Will this trend continue?

Nancy Pacher: If you look at the cost to Corporate America's bottom line of owning their own facilities versus utilizing those who can do it less expensively, that is the next big function they can outsource. They've already outsourced their consulting work, in terms of brokerage kinds of activities. We believe they will continue to outsource and outsourcing facilities management will be one of the things that real estate consultants will do better than they can.

Q: Where do you see your niche?

Pacher: Clearly we've got a niche on Michigan Avenue in terms of both office leasing and office management and retail. We continue to have a niche in the tenant rep business, a niche I see more and more companies deciding they don't want to be in. And there's no question that we want to go full steam ahead with the facilities management. Firstar is our biggest client so far, they've outsourced all of their facilities management throughout the Chicago area to us.

Q: A lot of money is being invested in Chicago real estate these days, but where is it coming from?

Rosen: The traditional sources are there -- the pension funds, the insurance companies -- stronger than ever. In my opinion, an investment market that was moribund for a number of years has rebounded from in some cases looking like 1989 and 1990, and actually in most cases looks like 1984, 1985 and 1986. The markets are strong.

Q: Any fear that there's too much money out there?

Rosen: I guess if you're a seller that could never be a fear. If you're a buyer you're always concerned about that. Prices have been driven up and cap rates driven down in a number of product types. Now suburban office is hot with certain properties trading at over $100 a sq. ft. There is even money looking for downtown properties. It's not frothy like it was in 1989, but that was not the norm for any industry. I think there is tremendous demand for industrial development.

Q: Why is industrial so hot?

John Gates: A lot of it has to do with macro-economic issues. A lot of the things that were going wrong for the midwest in the '80s are now going right for us. All of the reengineering we did in the late-'80s and early-'90s. A lot of companies that have been changing the way they do business have now made up their minds how they want to do business. They want to do long-term commitments in their distribution systems, in their manufacturing capabilities to prepare for the 21st Century.

I think people don't really understand how big this market is. It's almost 900 million sq. ft. That makes it by far the largest (industrial) market in the country.

Q: John Buck, you're an active retail player on North Michigan Avenue. What's your take on the retail market?

John Buck: We're just getting into the retail business, but it's my opinion that as you look at the tenants, there's no question but that we will have consolidation. It will come rapidly, it will come hard, and we will see a lot of business failures in my judgment over the next three to four years.

We are seeing a lot more street activity. You'll see a lot more activity going further west, as opposed to east off of Michigan Avenue. There will be a lot more exciting retail. Things change so rapidly in that field. A lot more emphasis on enterainment and even your traditional retailers are getting into more entertainment modes. I think it's a very exciting field. It's extremely vibrant.

Q: Mark Tanguay, what are your thoughts on the retail scene?

Mark Tanguay: There are going to be a lot of big, empty boxes out there. And it's going to be a lot sooner than people realize.

I think with Home Depot entering all of the major markets now across the country, there's going to be a devastation of many of the regional operations. Marshall's is for sale. Their earnings are terrible and they've lost money for several quarters in a row. The effect of the Target stores move into Chicago, which we are still handling, will have 50 Target stores opening here.

Q: Where are the shoppers coming from for these stores? Have we been underretailed?

Tanguay: The people who are really on top of their game, that really understand the consumer, that really know how to merchandise properly, how to profile themselves properly, will survive and will do very well. Those that are at all asleep at the switch are going to be gone.

We're representing Builders Square right now in dispositions. Dispositions are going to be a very big part of our business over the next five or six years.

Q: Hotels are hot again after a long down cycle. How is the transaction business these days?

Paul Jones: Transactions continue to grow, and whereas the transactions done in the past were the smaller hotels, the larger ones now are being sold. They were held by larger institutions, Japanese banks who were non-sellers and this kind of product has not been on the market. There is a pent-up demand. There weren't any buyers for it, which is why it wasn't on the market. The money is there now saying, "Please let me buy it."

Chicago is representative of what's been going on across the country, which is a lot of shifting of existing properties. You can forget about building new ones, certainly not full-service hotels. Except for some hotels that have some captive customers such as casino-related and convention-related hotels, there is no full-service hotel construction going on.

There is still a lot of activity in the limited-service product, with some concern about overbuilding. The market is in pretty good equilibrium, but the demand continues to outpace the supply, and the supply growth is virtually nill.

Q: Amli Residential did its IPO early last year. What kind of growth are you expecting in the apartment market?

John Allen: In the markets we are active in, multifamily is doing very well. Occupancies are holding in the low- to mid-90s, concessions are pretty much out of the market, including here in Chicago. In some areas, like Atlanta, you're seeing significant rent increases currently. You're also seeing new construction which we haven't had for some time. Dallas has a number of starts now that have people concerned about where the supply is going. Chicago has some construction starting. I think you're going to have community constraints that are limiting the number of places where you can really build apartments today.

One of the things that we find that has not been prevalent before that will impact multifamily is the technology change that's been referred to here. People I think will spend more time and more money in their apartment thant they used to. We have to deliver the things that the tenants are going to say they want as part of their lifestyle. We have to build a product that will allow the technology to go into those units and then try to deliver a system with entertainment, with education, shopping convenience.

John Allen, Vice Chairman Amli Residential Properties

John Buck, Chairman & CEO The John Buck Company

James B. Connor, Managing Director, Cushman & Wakefield

John Gates, President & CEO CenterPoint Properties

Paul Jones, Principal Hotel Partners

Nancy Pacher, President & COO U.S. Equities Realty, Inc.

Van Pell, Executive VP, COO Miglin-Beitler

Randy Podolsky, President Podolsky and Associates

Robert Rosen, Vice Chairman Frain Camins & Swartchild

Mark Tanguay, President Tanguay-Burke-Stratton