Chicago's commercial real estate market reflects the overall U.S. economy: Despite some weak spots and the persistent feeling that the good times cannot last forever, the Windy City continues to display surprising strength.

Commercial property rents are rising, though optimism for more hikes is tempered by a belief that the big jump in lease rates is over. Space is being absorbed, though the current demand for big chunks of office spots seems to be weaker than in previous quarters. New buildings are under construction, although only one small office structure is underway downtown amid rumblings that office space in the suburbs is overbuilt.

Retail properties are on uncertain ground, with grocery-anchored community centers as the only sector showing new construction. Even Michigan Avenue retail has seen some softening as some big retailers bailed out of the Magnificent Mile when sales were less than anticipated.

The industrial base in Chicago has held firm. According to a year-end 1998 report from Los Angeles-based CB Richard Ellis, industrial vacancy rates dropped during the year from 7.9% to 7%. Big properties of 100,000 sq. ft. or more saw vacancies decline from 8% to 7.1%.

As capital markets tightened in the third quarter of 1998, buying activity, especially from the REITs, dwindled dramatically. Industry observers say, however, that investment activity has increased somewhat since late summer with more properties being brought to market and sold, primarily to private investors.

"The general picture in Chicago reflects the solid market across the country," says Harold S. Ulvestad Jr., senior managing director and regional manager in CB Richard Ellis' Chicago office. "The markets are in balance in terms of supply and demand, which is positive."

Office market Perhaps the most obvious example of the office market's health, at least from the landlord's perspective, has been the huge jump in downtown rents. According to a fourth-quarter report from Chicago-based Julien J. Studley Inc., overall gross asking rents increased by 22%, from $19.84 per sq. ft. to $24.26 per sq. ft., between year-end 1997 to year-end 1998. The Studley report attributes the rent rise to the lack of new development and continued strong space demands from businesses. The report also says more than 6.9 million sq. ft. was leased in 1998, of which 1.5 million sq. ft. was leased in the fourth quarter.

Downtown rents will not make dramatic jumps in 1999, says Jacque Ducharme, senior executive vice president, director and branch manager of Studley's Chicago office. He projects rent increases will be 7% to 8% for the year.

"We should expect to see only a small increase in the demand for space, as fewer people are added to the work force," he says. "Additionally, there remains approximately 1.3 million sq. ft. of Class-A sublease space in the Loop, and corporate downsizing could place even more sublease space on the market in the near future."

For example, Chicago-based Amoco Corp., which was purchased by London-based British Petroleum, announced that it will eliminate 1,500 jobs in Chicago. There also are concerns that other corporate mergers could dump more empty space on the market. Even so, the mood among real estate executives is generally upbeat. They point to declining vacancies and lack of new supply as positive signs for the future.

The overall vacancy rate downtown fell to 12.2%, the lowest rate since the second quarter of 1998, according to the year-end report from the Chicago office of New York-based Cushman & Wakefield. Class-A properties posted a remarkable low of 5.6%, the lowest Class-A overall vacancy in over a decade.

Cushman & Wakefield reported that 7.3 million sq. ft. of space was leased downtown in 1998. The largest lease transaction of the fourth quarter was signed by New York-based Merrill Lynch for approximately 79,000 sq. ft. at 222 N. LaSalle St.

For the year, the largest downtown lease was at 115 S. LaSalle St., where Chicago-based law firm Lord, Bissell & Brook's renewed for 200,000 sq. ft. More big tenants seemed poised to renew leases, and it looked less likely that new buildings, a number of which had been proposed before the capital markets shut down, would ever break ground.

At the end of 1998, the 320,000 sq. ft. Union Tower at 550 W. Van Buren St. was the only new office building underway. The only large office building that may be built, at least for now, is a 1.2 million sq. ft. tower at One North Wacker Dr., a joint venture of The John Buck Co., Chicago and Atlanta-based Lend Lease Real Estate Investments Inc. Press reports say insurance giant Chicago-based Aon Corp. will be the lead tenant. But, so far, no deal has been finalized and construction has not begun.

Investment activity was strong in 1998 until the bottom dropped out of the financial markets late in the year. In big deals, the 4.2 million sq. ft. Merchandise Mart, the world's largest commercial building, was sold by the Kennedy family for approximately $575million to Saddle Brook, N.J.-based Vornado Realty Trust. Toronto-based TrizecHahn Corp. purchased the 110-story Sears Tower for approximately $850 million in debt and cash. The Amoco Building, Chicago's second tallest office tower, was sold to New York-based Blackstone Group L.P. for $470 million.

The 100-story John Hancock building was bought by San Francisco-based Shorenstein Co. for $220 million. John Hancock Mutual Life Insurance Co. of Boston had the property on the block since last June, but the deal was not concluded until early this year due to the slowdown in the capital markets.

"Investment activity is picking up again," says Ulvestad. As evidence, Chicago-based Prime Group Realty Trust finalized its purchase of 33 W. Monroe St. from Draper & Kramer, the real estate company that developed the building in 1980 and has its offices there. The 28-story, 843,000 sq. ft. office building sold for $94.5 million.

In the suburbs, the picture for landlords is less clear. A round of construction has kept vacancies about even with last year, despite a major building boom that delivered 2.4 million sq. ft. of speculative office space to the market. A CB Richard Ellis report states that the suburban office vacancy rate stood at 8.6% at the end of 1998. This is down slightly from the 9% at the close of 1997. The net amount of space leased during the 12-month period was 2.8 million sq. ft., up from 2.7 million sq. ft. of absorption in 1997.

Construction activity continues to be the focal point in the suburbs. Cushman & Wakefield figures 3.7 million sq. ft. of space is currently under construction. Among the big new developments are:

* Highland Landmark II by Opus North, 275,000 sq. ft., in Downers Grove.

* Westwood of Lisle II by SSR Realty Advisors, 150,000 sq. ft., in Lisle.

* Bannockburn Lakes V by The McShane Co., 106,000 sq. ft., in Bannockburn.

* Transamerica by John Buck Co., 205,000 sq. ft., in Hoffman Estates.

Five projects totaling a little more than 750,000 sq. ft. are now under construction in the northwest Schaumburg submarket. The east-west corridor had 11 new buildings open in 1998 totaling 1.4 million sq. ft., according to CB Richard Ellis. The North Cook/Lake counties market had six buildings open with 579,000 sq. ft.

Washington, D.C.-based Carr America began construction on Four Parkway North, a five-story, 167,000 sq. ft. office building at Parkway North Center in Deerfield. Also started was a 99,000 sq. ft. office building, while the four-story Six Parkway North with 93,000 sq. ft. was completed.

"Building will slow in the suburbs," predicts Ducharme of Julien Studley. He adds that merger and acquisition activity in suburban companies has already caused some concern among developers and landlords about the amount of sublease space being dumped on the market. Companies currently marketing excess space include Cendant, USN Communications, Experien/Metromail and Alltel/360 Communications.

Also, catalog retailer Spiegel announced the availability of 210,000 sq. ft. at their corporate headquarters at Mirror Lake Corporate Tower in west suburban Downers Grove. Zenith is expected to vacate 120,000 sq. ft. of its Glenview facility by June and the remaining 300,000 sq. ft. by the end of 1999.

Questions remain whether rents will flatten, stabilize or decline. Observers say tenants are evaluating their options. A year-end report from Northbrook, Ill.-based Grubb & Ellis estimates that in 1999 rents will flatten or decline in some submarkets where the most building is taking place.

Cushman & Wakefield expects suburban rents to continue a steady climb, reaching just under $25 a sq. ft. by 2003. Also, real estate brokers say suburban landlords, especially those in competitive markets, are showing increased flexibility, granting shorter term leases and hikes in tenant improvement allowances.

Investors that bought suburban office buildings at a rapid pace during the first half of 1998 have yet to resurface. Observers expect private investors, such as opportunity funds, to buy the most property. REITs have yet to return to the market, though some real estate brokers think that may happe n in the next few months as REITs are forced to acquire more property to increase their liquidity and revenues.

Indianapolis, Ind.-based Duke Realty Investments entered the Chicago market with two major acquisitions. The company purchased Executive Towers West, a 650,000 sq. ft., three-building office complex in Downers Grove; and Central Park of Lisle, a 345,000 sq. ft. office building in Lisle. The Prime Group Realty Trust bought the 841,513 sq. ft. Continental Towers in Rolling Meadows.

Industrial market Chicago's industrial market should remain steady, but perhaps not as robust as it has been. Industrial property activity will not come to a grinding halt, however, according to Terry O'Hara in Grubb & Ellis' Rosemont office. "Overall activity in 1999 will neither erase the record highs established in the mid- to late-1990s, nor will it fall to record lows achieved in the early 1990s," he says.

At the end of 1998, Rosemont, Ill.-based Colliers, Bennett & Kahnweiler Inc. reported the overall industrial vacancy rate at 6.94%. This compares to 7.61% at the close of 1997. Net absorption for 1998 was 2.6 million sq. ft. out of a total inventory of 817,567,857 sq. ft. Net absorption in 1997 totaled 4.87 million sq. ft.

According to CB Richard Ellis, the warehousing sector accounted for 71% of 1998 absorption. The most active users were third-party distribution companies and companies expanding and consolidating their distribution operations into centralized sites.

Not surprisingly, new construction continues to be dominated by high-cube warehousing space, says Doug Reed, managing director with CB Richard Ellis. However, he notes there was an increase in construction of large properties divisible by 20,000 sq. ft. to 60,000 sq. ft. in order to accommodate demand for spaces that size.

New construction starts for the year totalled 14.6 million sq. ft., compared to 13.1 million sq. ft. in 1997, according to a year-end report from CB Richard Ellis. For the fourth consecutive year, there was a moderate increase in speculative development, which topped 9.9 million sq. ft. The largest concentrations of new starts during 1998 were in DuPage County (2.7 million sq. ft.), followed by Will County (2.1 million sq. ft.), Lake County (1.1 million sq. ft.) and Kane County (640,000 sq. ft.).

Jacob Kiferbaum, president of Lincolnshire, Ill.-based Kiferbaum Construction Corp., hasn't seen a slowdown yet. "We thought spec construction would slow," he says. "But we have been building more distribution space for developers and REITs. We are fully booked through the spring."

Build-to-suit projects increased 261% during the first half of 1998, according to a report from The Alter Group, Lincolnwood, Ill. Of the six-county area's total 4.7 million sq. ft. of build-to-suits, the industrial sector accounted for 2.6 million sq. ft., or 54%, of total activity. DuPage County had the most build-to-suits, totaling 2.3 million sq. ft., which include some office buildings. That figure represents 52% of the metro area's total build-to-suit activity.

Rents have increased slightly to about $4.50 per sq. ft. for larger buildings in markets with little development, according to a 1998 year-end report from CB Richard Ellis. By comparison, rents in growth areas where new product is coming on line declined to about $3.30 to $4.25 per sq. ft. Similar price differences were seen in smaller properties with less than 50,000 sq. ft. Those in mature markets had rents ranging from $5 to $6 per sq. ft. In growth areas, rents in small buildings ranged from $4.50 to $5.50 per sq. ft.

For investors, according to Grubb & Ellis, prices have increased an average $7 per sq. ft. Rates for the suburban submarkets average $42.60 per sq. ft. In areas such as the I-88 south DuPage county, prices are approximately $10 per sq. ft. higher than in 1998. Since there is a lack of buildings for sale, prices are not expected to change much in the next six months. Lease prices will continue to have a greater disparity. Grubb & Ellis pegs industrial rents at $2.80-$5.25 per sq. ft., with an overall Metro average of $4.25 per sq. ft.

In the O'Hare market, building prices have remained strong despite reduced interest from REITs and other institutional owners, according to a report from David Bercu and Ronald Behm of Colliers, Bennett & Kahnweiler. They feel users may become more important buyers this year.

Duke Realty Investments Inc. acquired a portion of the mixed-use Meridian Business Campus in Aurora. The property included 155 acres of the 660-acre site. Included in the sale were six buildings totaling 400,000 sq. ft. and the Michael Jordan Golf Center. The property was owned by Chicago, Ill.-based The RREEF Funds.

Business park development has continued with a big new project being planned, along with additions to other parks. Northwest suburban Algonquin in Kane County will be the site of a 1,000-acre office and industrial park. Though plans are still at an early stage, the village intends to assemble the land and then sell parcels to developers.

Cantera, another large development, remains an investor favorite with 650 acres in west suburban Warrenville. In this same development, Scottsdale, Ariz.-based Globe Corp. purchased Diehl Center One and Two. Each multi-tenant building has about 100,000 sq. ft. of space. "The strength and momentum of this market provides Globe with the opportunity to purchase institutional quality, net-leased industrial facilities," says Bert A. Getz Jr., vice president of Globe.

Two new business parks -Bloomingdale Business Center, a 100-acre park developed by Bloomingdale, Ill.-based Security Capital Industrial Trust and Carol Stream Corporate Center, a 60-acre park in Carol Stream developed by Atlanta-based Industrial Developments International - are due for completion this spring.

Wispark Corp., the subsidiary of Milwaukee, Wis.-based Wisconsin Energy Corp., which has managed to lure industrial companies just across the state line into its Wisconsin business park, has a new 150-acre business park underway in Elgin, Ill. The park, called NorthWest Corporate Park, already has two warehouse/ manufacturing facilities.

Retail Grocery-anchored shopping centers are the hottest retail property type in the Chicago area. Of the 34 new retail developments underway, 20 are anchored by grocery stores, according to a report by Oakbrook Terrace, Ill.-based Mid-America Real Estate Corp. Grocery anchors include Dominick's Supermarkets Inc., which was recently acquired by Safeway Inc. of Calif., and Jewel Food Stores owned by American Stores Co. of Utah which recently merged with Boise, Idaho-based Albertson's Inc. The report also says a total of 5.6 million sq. ft. of retail space was added during 1998, a 54% increase over 1997.

Mid-America predicts that 1999 will be another strong year with about 8.1 million sq. ft. of development. More than 20% of the new retail space is in the city, a 15% increase in building compared to the early 1990s.

A year-end report from CB Richard Ellis notes that vacancies in community/neighborhood centers fell during the year from 9.9% to 8.4% in 1997. Vacancies in power centers checked in at 1.8%, down from 2.5% at the same time last year.

By contrast, vacancies jumped from 11.7% to 12.6% in strip shopping centers. "Without the lure of an anchor tenant, these shopping centers remain at a competitive disadvantage," says Todd Caruso, managing director with CB Richard Ellis.

In the suburbs, empty big boxes remain a concern especially since home-improvement retailer Builders Square recently announced plans to close its Chicago-area stores. Real estate brokers say the number of empty big boxes had been dropping as the buildings were reconfigured or razed. For example, Highland Park, Ill.-based Tucker Development Corp. is redeveloping a former Handy Andy site in south suburban Chicago Heights. Upon completion, the 101,500 sq. ft. project will be renamed Lincoln Crossing and will consist of a 91,500 sq. ft. Dominick's food store and 10,000 sq. ft. of additional retail GLA.

Surprisingly, Chicago's Michigan Avenue has shown some weakness lately. Viacom closed its doors at 600 N. Michigan Ave. because sales did not meet expectations. Men's clothier Bigsby & Kruthers vacated 16,000 sq. ft. at 605 N. Michigan Ave., while Henri Bendel closed its five-level 45,000 sq. ft. store at 900 N. Michigan Ave. There also are rumors that Escada at 750 N. Michigan Ave. would like to sublease its store, about 17,000 sq. ft.

Bruce Kaplan, president of Chicago-based Northern Realty Group Ltd., says demand remains strong for first-floor space. "Street-level spaces are hot," he notes, adding that second- and third-level spaces are not performing quite as well and that landlords may have to strip off upper-level space for other uses. "Not everyone can do multi-level retailing," he says.

On the plus side, Planet Hollywood is moving its restaurant to 555 N. Michigan Ave. It will occupy part of the first floor and all of the second floor in the three-story building. The remainder of the first floor will be subleased to a retail tenant.

A recent survey from Northern Realty reports that only 1.3% of the retail space along Michigan Avenue is vacant. However, average asking rents dropped by 2.8% from $62.82 in 1997 to $61.09 in 1998.

The biggest change for the shopping district has been the start of work on the 14-story landmark McGraw-Hill Building where the John Buck Co. is constructing a new retail and hotel complex. After a lengthy battle with preservationists, Buck was allowed to construct a new building at 520 N. Michigan Ave., with the old building's art deco facade attached to the face of the new structure.

The project, North Bridge, will be anchored by Nordstrom and will front Michigan Avenue, stretching west for two blocks. The four-level Nordstrom will be accessible through a five-level arcade, complete with 30 additional stores.

State Street, the other big downtown shopping district, has experienced some dramatic changes too. Northern Realty pegs vacancies there at about 1.8%. Plans are not final yet for State Street's Block 37, the notorious vacant lot, which has been turned into an ice skating rink. A deal with Macy's fell through after failure of an agreement with the city over concessions. Reports now say retailer Lord & Taylor is looking at the site.

Multifamily Investors want to own Chicago-area multi-family properties, but few purchasing opportunities exist. William E. Montana, vice president of investment property services for Chicago-based Draper and Kramer Inc., writes that properties that go up for sale are typically flooded with interest. "One property got 26 offers," he says.

Montana says occupancies are holding at about 98%. The only exception is the Aurora/Naperville market, where he reports that there has been a fair amount of building. Approximately 4,000 units in 17 new developments are either underway or planned in the area.

Downtown rents are increasing about 6% to 7%, according to a year-end study by Draper and Kramer. Montana figures rents in Class-A properties are up 3.3% over the past six months. He also says rents are rising because of a number of condominium conversions in the downtown area which has decreased the supply of rental units. About 1,800 units are going condo by summer.

One Superior Place is the only new apartment project that has broken ground downtown. The 52-story, 809-unit building is slated for completion later this year. Montana says downtown projects make economic sense only if they include first-floor commercial space. One Superior Place, for example, will have a 46,000 sq. ft. Whole Foods Grocery store.

Rents are being curbed by low interest rates and a wave of residential development in the city which has turned potential renters into home buyers. "Renters are becoming homeowners," says Greg A. Moyer, first vice president and regional manager for Marcus & Millichap Real Estate Investment Brokerage Co., Chicago. "Rent increases would be stronger if there weren't this leakage to the condo market."

The only exception to strong suburban rent increases is in Aurora/ Naperville, where rents have gone up only 2% because of new projects. Developers say tough local approval processes mean only high-end projects are getting built.

According to Draper and Kramer, there were 18 sales of multifamily projects of 100 units or more in 1998, down from 30 sales in 1997. Cap rates on Class-A properties are running approximately 8 1/2%. Class-B and Class-C properties have cap rates of 9% to 9 1/2%.

Notable transactions for the year include:

* Amli Residential purchased Ascot Glen, a 600-unit apartment development in west suburban Wheaton, for $48.8 million.

* The RREEF Funds purchased Forest Pointe/Deer Valley, a 460-unit apartment complex in north suburban Lake Bluff, for $39 million.

Hotels The lodging sector has been the most erratic in the real estate industry, according to a 1999 investment report from Chicago-based LaSalle Advisors Capital Management Inc. The report says strength is seen at the high and low ends of the market. However, Chicago gets singled out as a market where supply growth has been unrestrained, raising questions about the viability of recently announced projects.

"The market should be able to absorb a substantial portion of these new rooms, but the supply increase may suppress occupancy growth," says Scott Steilen, senior manager at Chicago-based E&Y Kenneth Leventhal Real Estate Group.

A report from E&Y Kenneth Leventhal says approximately 8,000 to 9,000 rooms are either proposed or under construction downtown. The majority of these units would come on line between 1999 and 2001; the addition of even half of these rooms represents an 18% increase in the downtown supply. "There was a minor decline in occupancy but that didn't hurt the average daily rate," says Steilen. Average daily rates in 1998 were $109.50 marketwide. Occupancies were 71%, according to E&Y.

Kapila Anand, national director of hospitality for New York-based KPMG, says, "The discussion is now centered on whether construction is a viable option or if it should not be done at all."

By the end of 1998, five hotels opened adding 1,400 rooms. A 143-room Crowne Plaza opened at 10 S. Wabash Ave., the former Silversmith Jewelry building; a 230-room Hampton Inn & Suites River North opened at 33 W. Illinois St.; and the former Bismarck Hotel, at 171 W. Randolph St., reopened as the Allegro Hotel.

Downtown, a number of other new projects and renovations are underway. Marriott announced plans to renovate the Blackstone Hotel at 636 S. Michigan Ave. The company will spend $65 million on the 89-year-old landmark property. Another hotel getting landmark status and a $40 million makeover is the Allerton Hotel, 701 N. Michigan Ave., a project being built by Chicago-based Pepper Construction.

Last May, a new 33-story, 800-room Hyatt Regency Hotel opened at McCormick Place which has doubled its exhibition space. Other new projects include:

* A 500-room Wyndham Hotel will occupy 16 floors of an office tower at 633 St. Clair St.

* A new, 205-room Park Hyatt Hotel, part of a mixed-use development, is being built at Michigan and Chicago avenues.

* The building at 36 S. State St. is being converted into a mid-priced hotel operated by Red Roof Inns.

* John Buck's new Michigan Avenue project, North Bridge, will include a 12-story luxury hotel.

The 424-room River North Westin, at 320 N. Dearborn Ave., was sold for $91 million to Lend Lease Real Estate Investments. Also reported to be for sale are the Ritz-Carlton, at Water Tower; Four Seasons Hotel at 900 N. Michigan Ave.; and the Marriott Hotel at 540 N. Michigan Ave.

In the suburbs, construction has been active though most of the new supply is limited service hotels, such as Extended Stay America, Amerisuites and Fairfield Inn. For example, Atlanta-based Homestead Village Inc. acquired a 3.1-acre parcel in the Corporate Woods Business Park in north suburban Vernon Hills for an extended stay hotel.

Near O'Hare International Airport, a new, 360-suite hotel will be developed at 8550 W. Bryn Mawr Ave. Rand Diamond, head of the partnership developing the project, says O'Hare hotels enjoy the highest occupancies and room rates in the suburbs. The $80 million project will also include a six-level parking garage.

A report from E&Y Kenneth Leventhal says O'Hare area hotels had the highest occupancy in 1997 checking in at 75%. Average daily room rates increased approximately 8% to $80.

Senior Housing The number of reported seniors housing properties under construction nationwide was 41% higher in 1998 than in 1997, according to the American Seniors Housing Association, Washington, D.C. Illinois had 10 new projects underway, of which eight were in the Chicago metro area. The most popular housing types were the assisted living facilities or the combination congregate care and assisted living projects.

Developers are focusing on high-end properties, mostly in the suburbs, where land is more plentiful. There are some affordable senior apartments under construction, but these are mostly confined to the city.

Another area getting attention is the active adult community. Phoenix-based Del Webb Corp. has begun selling lots in its Sun City development in Huntley, a northwest suburb. Chicago-based Brookdale Living Communities Inc. acquired an 8-acre parcel, part of the Chicago-based Del Webb project, for an independent and assisted living facility. Phase I, with 175 units, breaks ground this year. Carillon announced plans for a north suburban version, in Grayslake, of its successful southwest suburban project, Cambridge-at-Carillon in Plainfield.

Chicago based-Senior Lifestyles Corp., has completed four seniors-only buildings. The company has two others underway, plus a new seniors complex in suburban Olympia Fields: The Breakers at Olympia Fields, which opens this month, includes congregate, assisted living and villa units.

Other new senior housing projects include:

* Churchill Estate of Clarendon Hills was co-developed by The Birches Senior Services Inc., Clarendon Hills, Ill. and Roseville, Minn.-based Rosewood Estates. The three-story, long-term care facility has 82 residential units and opens in July.

* Carriage Oaks in west suburban St. Charles, an independent senior living community with 65 apartments, was developed by Omaha, Neb.-based Essex Corp. and is due to open in July.

* The Village at Victory Lakes on 68 acres in Lindenhurst has a nursing home, 100 apartments, 60 assisted living suites and 40 cottages, has just opened. The developer is Waukegan, Ill.-based Victory Health Services.

Although demand for senior housing is strong, developers say municipal approvals for new projects are hard to obtain. Local residents often object to large, dense projects saying they generate too much traffic and congestion.

The attitude in the Chicago real estate industry is optimistic. Vacancy rates have dropped, rents have risen, the industrial market remains steady and new construction is underway, despite the underlying suspicion that the economy is eventually going to change. The Chicago and U.S. real estate industries hope it is not just a short term attitude, but instead, a long-term reality.