Why Suburban Chicago Multifamily Sales Outperform City

Suburban Chicago multifamily sales are outperforming the city even as strong rent growth continues in both the urban core and the greater metro area.

Politics could be the difference.

“The only risk is our real estate taxes and protecting your margins,” Berkadia’s Pete Evans said. “That’s the biggest challenge in multifamily in general today.”

It’s a particular challenge within the city limits of Chicago and the first-ring suburbs that fall under the jurisdiction of Cook County Tax Assessor Fritz Kaegi. Kaegi has increased the share of the property tax burden for commercial and multifamily properties in recent years, leading to a more stark disconnect between his assessments and post-appeal rulings by the Cook County board of review. His penchant for reconsidering tax policy — a process that is ongoing in the city and leading to higher-than-expected assessments for commercial properties — and the general political tumult at Chicago’s City Hall over the same period have more investors eyeing collar counties for multifamily deals.

The Real Deal’s analysis of deals for 27 recent multifamily properties that sold for more than $10 million in the Chicago metro area found 17 sold at a markup from their last sale price.

Suburban markets accounted for 11 of the 17 winners in the bunch, with sellers marking up their purchase price from $4 million to $10 million. The deals within Chicago’s city limits included six markups and 8 that traded for less than prior sales.

The suburbs appear to have found an edge with an annual jump of 4 percent for rents, to an average of $2.06 per square foot, according to a mid-year report from Integra Realty Resources. Indeed, the suburban counties of Chicago saw the greatest demand among residential renters in the country, according to a September study from RentCafe, which showed the area tied with Miami.

While the ranking drew attention to the suburbs, including those in Cook County, Chicago proper wasn’t far behind, taking the fifth spot among 20 markets listed by RentCafe.

There is a clear tie between the urban core and outer suburbs — many of the jobs that underpin the suburban rental market are based in the city. Class A apartment rents in the city’s center averaged $3.61 per square foot in the third quarter, a 2.3 percent increase from the same period in last year, the report from Integra found.

But those fundamentals appear to be hampered by the city’s property tax regimen and the underlying uncertainty of its current political environment.

Politics as usual

Some recent, high-profile losses signal that urban sellers may have bought at the top of the pre-pandemic market, Andy Friedman of the Kiser Group said. He points to JPMorgan Asset Management’s sale of 850 North Lake Shore Drive. The bank’s investment arm bought the 19-story, 198-unit building for $140 million, or $707,000 per unit, in 2016. This year, JP Morgan sold it to Crescent Heights for $80 million or about $404,000 per unit.

Of the multifamily deals in the city reviewed by The Real Deal, gains were modest, in the $7 million to $21 million range, while losses stretched from $5 million to $60 million with most hovering near $20 million.

That’s a comedown from the mid-2010s, when investors perceived Chicago as a safer, more fiscally sound, business-friendly city than they do today, Friedman said.

“There was a lot of bullishness on Chicago,” Friedman said. “In those 2016, 2017 and 2018 purchases, people were underwriting pretty high rent growth rates that actually might have caught up the last couple years but in the first few years of ownership didn’t really happen.”

Political shake ups in the years following Mayor Rahm Emanuel’s exit in 2019 have put the city on shaky ground with institutional investors, he said. Any typical political upheaval expected in a change of leadership was supercharged by the pandemic, bouts of social unrest and ongoing concerns over crime that have led Chicago voters to replace their mayor not once but twice in five years.

Despite strong fundamentals like a limited development pipeline and a reliable job market, adjusting to Cook County Tax Assessor Fritz Kaegi, who took office in 2019, has given some investors pause. Plus, Chicago’s City Council just enacted a rule that gives tenants in certain gentrifying neighborhoods the right of first refusal to buy multifamily buildings — without having to show proof of funding — and it has sent some real estate players into panic.

Amid a pandemic-ravaged office market reset, Kaegi has changed how certain mixed-use commercial buildings are taxed and he came under fire recently for miss-assessing $444 million in value from 620 properties last year.

Kaegi declined to be interviewed for this story.

Meanwhile, Mayor Brandon Johnson proposed a real estate transfer tax that was defeated at the ballot box with opposition from real estate lobbying groups. He’s now mulling a 4 percent property tax hike that was met with criticism from city council members.

Some brokers have taken note of those headwinds and used it to attract buyers to suburban properties.

CBRE marketing materials for The Westlyn in Warrenville note that “investors can easier handicap current and future tax liability,” because the property is located in DuPage County rather than neighboring Cook County.

As multifamily players get more familiar with the assessor’s methods, confidence in the market could improve, Kiser Group’s Friedman said.

“If it’s an older neighborhood walkup, your taxes are likely somewhere between 12 and 15 percent of gross (profit),” he said. “If you have a new high rise or you’re in Fulton Market, you’re probably north of 20 percent gross. So there’s still uncertainty, but I think less than the first go around (of assessments).”

Looking ahead

New supply will be top of mind in the suburbs and the city next year.

Like most of the country, the region’s pipeline is limited by high interest rates and construction costs, but Chicago and its suburbs face unique additional barriers to development.

A patchwork of local government officials and ordinances dictate what does and does not get built, and some local leaders are more open to multifamily development than others.

In September, commercial real estate firm Bradford Allen secured $17.8 million in tax increment financing to assist with a $130 million residential and retail redevelopment of a shopping center in the northwest suburb Arlington Heights. The recently approved TIF will go toward the construction of a 301-unit apartment complex with 26,000 square feet of ground floor retail.

Meanwhile, an entirely different saga is playing out at a shopping mall in western suburb St. Charles.

Two developers have walked away from plans to repurpose the defunct Charlestowne Mall. Mixed -se development proposals from developers SR Jacobson and Urban Street Group included multifamily components that drew backlash from residents and city officials. As a result, city leaders are back to the drawing board and the town’s multifamily pipeline remains limited.

Chicago, on the other hand, lacks opportunities for development because of a low supply of available land and laborious zoning regulations, Friedman said.

“I think it’s impossible for Chicago to become over-supplied, absent real population loss. First of all, there’s only so much dirt. Go find somewhere in Lincoln Park and Lake View where you can put up 200 units. If you do find it, you’re going to be stuck in zoning forever,” he said. “In the city you do not need to worry about oversupply.”

The constricted pipeline throughout Chicago and the suburbs could bode well for today’s buyers even as they grapple with uncertainty on taxes and politics.

“This is the best time to buy multifamily real estate, probably in my career,” Evans said. “Rent growth is going to be well above historical averages, and your returns are going to be very, very strong … I think you have to try hard to not make decent returns if you invest in multifamily today, anywhere.”