The residential development trends in downtown Chicago are undergoing a transformation, as record numbers of new condominium units are completing construction and few new buildings are breaking ground.

Downtown Chicago is nearing the end of a four-year construction boom period, which has resulted in the completion of 18,500 new condominium units, a record number of condominium deliveries for the downtown Chicago market.

Starting in 2006 with 4,200 units completed, an additional 4,800 units were completed in 2007, along with 4,900 units in 2008, and another 4,600 units which will be completed during 2009. Currently, 75 percent of the units being completed in 2008 have already been sold, and 60 percent of the 2009 deliveries are also reported to be under contract.

However, the construction pipeline for new condominium buildings in now suddenly empty after 2009. Only three new downtown buildings totaling less than 500 units have obtained construction loans in 2008 and started construction this year. Thus, there will be little new inventory of condominium units delivered to the market in 2010 and 2011, and likely into 2012.

Because of the weakness in the housing market, developers are postponing or cancelling their plans for potential new projects. During 2008, 11 proposed condominium projects were cancelled, with developers closing their sales centers and refunding deposits to the buyers. With the problems in the housing market along with the financial markets, these projects were not gaining adequate pre-sales in order to obtain construction loans. In addition, developers are finding that construction financing is extremely difficult to obtain with lenders also requiring substantial equity, another hurdle in an already near-impossible scenario.

What does this mean? Certainly, the lack of new condominium product will help the unsold inventory situation, allowing the market to absorb what is currently delivered or delivering within the year. With little new product being developed, buyers will find that their choices will start to thin out.

Currently, prospective buyers have a multitude of new construction housing choices. However, as these units sellout and few new buildings start construction, the new construction alternatives in 2010 and 2011 will be extremely limited, consisting of a lesser number of unsold units along with resale properties. Thus, the most desirable units will have already been purchased, leaving the tougher units in the unsold inventory pool.

With so many potential buyers now putting their own decisions to purchase on hold, we expect to see evidence again of pent-up demand again in the market, once the nation’s economic conditions improve. Yes - it will take a time to work through the current unsold inventory, given the sluggish sales pace seen in 2008. However, once there are some positive signs of the market rebounding, both buyers and developers will move off the sidelines and reenter the housing market arena.

The strongest markets are historically affected least by market downturns and do recover first, and downtown Chicago has certainly proven itself to be one of the strongest housing markets in the metropolitan area.

Gail Lissner, CRE, SRA, is co-author of Appraisal Research Counselors’ quarterly Downtown Chicago Residential Benchmark Report. This in-depth analysis of the downtown Chicago housing market tracks development activity and helps people investing in residential real estate make informed decisions.

Buyers are continuing to wait on the sidelines so far in 2008, although there are some very enticing opportunities for buyers with good credit. A decrease in the number of potential buyers actively shopping the market along with attractive interest rates and a record number of building completions this year will provide some excellent buying opportunities. However, with the uncertainty in the financial markets and slower resale market, many buyers are taking a “wait and see” attitude and deferring purchase decisions.

As reflected in our weekly survey of new-construction condominium developments located throughout the city of Chicago, fewer potential buyers are visiting sales offices in 2008 and even fewer are deciding to purchase. Overall, the number of potential buyers visiting new condominium developments each week in 2008 to date has declined 25 percent from the first half of 2007, with sales volume down more than 65 percent from the first half of 2007. Thus, while a smaller number of potential buyers are looking at their alternatives in the market, even fewer are ready to commit to a purchase.

The large drop-off in sales volume and potential buyer traffic occurred in August of last year, coinciding with the public awareness of the turmoil in the sub-prime and credit markets. At this point, market activity has not yet returned to its pre-August 2007 levels.

In 2008 and 2009, developers will complete construction on a record number of downtown Chicago condominium buildings, many of which started their marketing programs during the robust market conditions of 2005 and early 2006. While a total of 10,000 units are projected for completion in 2008 and 2009, 70 percent of the 2008 units and 55 percent of the 2009 units are already under contract to individual owners. Thus, the focus of the developers with 2008 building completions is to sell the inventory that is not yet under contract.

While slower sales velocities are affecting the ability of developers to sell out their projects, it is also affecting the pipeline of new potential condominium developments. As a result, only one new condominium project in downtown Chicago has started a marketing program to date during 2008, and no other major announcements are expected. The lone addition to the downtown market in 2008 is the highest-profile project in Chicago, the 1,194-unit Chicago Spire, which is being marketed both locally and internationally. In contrast, during the first half of 2007, 13 projects in downtown Chicago had already started marketing programs, although four of these proposed projects have already been canceled after a slow initial start.

During the remainder of 2008 and into 2009, we expect that developers will continue to market their units in ongoing projects and will hold off announcements of new projects until market conditions strengthen. Thus, while 2008 and 2009 will have large numbers of units being completed, there will be little ground-breaking occurring during this period, which means that there will be few completions of buildings in 2010 and into 2011.

With the downturn in sales activity in the condo market, we are seeing condominium developers looking at other development opportunities, with many contemplating rental development. Already, 2008 and 2009 will be at record levels for rental unit completions, with more than 4,000 new rental units being completed in downtown Chicago within this two year period. We are also tracking a large pipeline of potential rental developments being proposed, although we expect that few of these proposed developments will actually break ground due to the limited sources of equity and debt in the market.

The “shadow” rental market will also continue to offer additional rental competition, as individual condo unit owners offer their units for rent, continuing a trend that has been present in the downtown Chicago market for the past 30 years.

Gail Lissner, CRE, SRA, is co-author of Appraisal Research Counselors’ quarterly Downtown Chicago Residential Benchmark Report. This in-depth analysis of the downtown Chicago housing market tracks development activity and helps people investing in residential real estate make informed decisions.

By Gail Lissner

Home pricing in the Chicago market has been holding up well through November 2007, based on the S&P Case-Shiller Home Price Index, which tracks changes in values of existing homes in 20 major markets throughout the United States.

According to this study, existing home prices in Chicago have been growing annually at a rate of 6.9 percent per year since 2000 and have lost only 4.1 percent in value from their peak. This is a far different story from what is occurring in many other parts of the United States, where pricing climbed quickly and then fell fast. Thus, the prognosis is rather good for Chicago in comparison to many other markets across the nation.

Locally, a survey of resale prices in 10 major high-rise condominiums developed in downtown Chicago during the last five to seven years indicated that prices have been generally flat for the past three years, with one building outperforming the market and one building underperforming the market. Stable pricing is certainly preferable to declining pricing, and the market is weathering the changes in market conditions relatively well. Buildings with strong views or great locations can often outperform the more generic product that is also available in the market. In addition, buildings with lots of investors may perform poorly, particularly when large numbers of owners have short holding periods and offer large numbers of units for resale at the same time. These buildings can be more prone to fluctuations in price.

The volume of 2007 sales in new developments in downtown Chicago decreased 36 percent from 2006 levels. Historically low interest rates have been strong drivers for demand along with hopes of future price appreciation; however, the recent problems in the subprime market, diminished expectations for immediate price appreciation and surplus inventory of housing units are affecting sales levels both nationally and locally.

This visible shift in buyer confidence and less speculator activity taking place has moderated the sales levels for 2007. Buyers have been more hesitant about making decisions, sitting on the sidelines and waiting out the market. Thus, discretionary buyers have not been making purchases, and contributing to the slower sales velocities.

At the same time, large numbers of new construction units are being completed and will be delivered in 2008, adding nearly 6,000 new units to the market. At the present time, nearly 80 percent of these units are already under contract. In addition, nearly 5,000 units are also expected to be completed in 2009, making 2008 and 2009 a record period for deliveries of new condominium units in the downtown market.

Despite the slowing in sales, approximately 4,300 new units started marketing programs during 2007, including new construction units and a small number of conversions. These new projects are situated throughout the downtown market, with price levels ranging from approximately $300 per square foot to more than $900 per square foot. Unlike 2006, where the majority of the newly announced projects were situated in the South Loop, the development activity in 2007 was much more diverse, both in terms of location and price level.

While there is still a large pipeline of potential development sites in the downtown area, we do not expect 2008 to be a major year for new project announcements. Rather, this will be a year to sell out projects currently under development. Once the pace of sales picks up, we anticipate that 2009 could be the year for renewed activity in terms of new project announcements.

Gail Lissner is co-author of Appraisal Research Counselors’ Downtown Chicago Residential Benchmark Report, an in-depth quarterly publication that tracks development and sales activity in downtown Chicago.

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