Winter 2007 Newsletter

Office Supply and Demand

Even the Midwest, with its perennially slow economic growth and subdued office development profile, has participated in the recent nationwide trend of increased office construction. Although its 16 markets account for only 11.2% of space presently being built throughout the U.S., the 21.0 million square feet under construction are up 11.5% from only a quarter earlier and are up 6.7% year over year. Supply and demand numbers for the latest quarter are favorable: 2.3 million square feet delivered, 3.7 million absorbed net. All but two regional metros enjoyed positive absorption during the latest quarter and all but one recorded plus-side volume for the last six months. While Chicago is the six-month absorption leader, other cities were not far behind. With respect to space under construction, however, Chicago has no rival: space underway in this market accounts for nearly 40% of the Midwestern total.

· Chicago’s construction boom continues. More than 8.1 million square feet were underway at quarter’s end, up 12.2% for the period, up 25.4% year over year. The 909,000 square feet delivered over the past six months were accompanied by net absorption at more than 1.8 million. Demand will need to stay strong if the market is to maintain its favorable profile.

· Kansas City and Minneapolis each follow with 1.7 million square feet under construction. Detroit and Cincinnati claim 1.6 million and 1.5 million, respectively. Six-month net absorption exceeded same-term deliveries in all four markets.

· Cincinnati, leading the latest quarter with net absorption at 1.1 million square feet, followed Chicago with 1.7 million over the last six months. Kansas City and Columbus were next with 1.4 million and 1.3 million.

Office Vacancy

While the overall Midwestern vacancy rate remains the highest in the nation, this region out-performed all others in rate of improvement with a 20-basis point decline to 13.0%. Vacancy a year earlier, however, also was 13.0%. Only three of the region’s markets saw their rates rise during the quarter. Nine enjoyed declines while four held steady. Ten markets, however, have rates higher now than a year ago. And only two markets—Oklahoma City and Madison, WI—have rates below 10.0%.

· The robust Cincinnati market saw its rate shed 120 bps during the latest quarter to close the period at 14.2%. Kansas City’s 150-point decline, to 12.5%, was the best year-over-year performance.

· After falling during second quarter, vacancy in Chicago held steady at 13.4% during the latest. The rate is down 50 bps over 12 months and is down 190 over 24.

· A 310-bps increase during the quarter drove the rate in Tulsa to 17.5%, highest in the U.S. Detroit, with its troubled economy, claims a rate of 17.1%, down 20 bps for the period but up 30 points year on year.

Office Rents

Slow rent growth is a chief characteristic of the Midwestern marketplace. The 1.3% increase in the asking lease rates achieved during third quarter tied the region with the South for the period’s smallest growth rate. And the 1.6% increase recorded year over year put the region in a distant last place over the longer term. Moreover, the 5.3% loss recorded over two years, puts the region in a class by itself. The U.S. average, by way of contrast (including the Midwestern decline) increased 10.9% over the last 24 months. Six Midwestern markets now have average rents lower than in third quarter 2006. Five lost ground during third quarter.

· With new space continuing to arrive on line, rents in Chicago continue to make progress. Third quarter’s $24.01 psf, highest in the region, is up 0.9% for the quarter and 3.1% over 12 months.

· Solid year-over-year increases at 6.0%, 3.4% and 3.2% are indicated for Indianapolis, Kansas City and Columbus. Respective latest quarter averages were $17.26, $17.41 and $16.14 psf.

· The lack of decline in Detroit—a city with a one-cent increase to $20.23 psf—may be construed as a good sign for this beleaguered market. Current rents here are down 1.0% year over year.

Office Investment Sales

Real Capital Analytics (RCA) reports total Midwest office investment sales volume 2007 at $13.47 billion for the first nine months, with 70.0% of the activity tied to the Chicago area market. As in many areas, activity in the Midwest was elevated by Blackstone Group’s recent acquisition of the massive, $39 billion Equity Office Properties (EOP) portfolio and subsequent related sales, as referenced below. Now, with the nationwide tightening of credit, declining sales volume can be expected for the coming term.

· Tishman Speyer’s August acquisition, primarily from Blackstone, of $1.7 billion of six former EOP properties in downtown Chicago (one of which subsequently flipped to Hines Interests) is described by Chicago Business as the largest real estate deal in the history of the city.

· Sales volume in Chicago through September is reported by RCA at $9.42 billion in 125 transactions. The average sales price was $191 psf, the regional high. The average cap rate was 7.1%. Caps in Minneapolis and St. Louis averaged 6.8% and 6.9%.

· Recent notable deals include GE Pension Trust’s $114.3 million ($208 psf) acquisition from the John Buck Company-McMorgan & Company joint venture of the 1974-built, 550,000 square foot 200 W. Monroe building in Chicago’s West Loop. This was but one of a number of significant sales occurring recently in downtown Chicago.

RETAIL

· Absorption narrowed the gap with new supply during the quarter, arresting for the moment the upward movement in the vacancy rate. Construction volume, meanwhile, continues to grow.

· Regional investment sales trends feature the nation’s lowest average sales price and highest average capitalization rate. Pockets of strength are noted, however.

The balance of supply and demand improved during the latest quarter as the delivery of 3.57 million square feet paired with 3.24 million square feet of net absorption, leaving only a small gap. This, however, does not remove the market’s soft spots. Last quarter’s gap was considerably larger, vacancy is up significantly year over year (see below) and the volume of space under construction continues to rise. The 34.6 million square feet being built at the end of third quarter represented respective increases of 2.4% since mid-year and a whopping 39.3% since third quarter 2006. Ten of the region’s 16 markets have more product under construction now than a year ago. The performance of absorption, meanwhile, is mixed. While six markets suffered occupancy losses during the quarter, a number of others recorded large gains.

· Cleveland led the quarter in construction completions and net absorption with respective market-friendly totals of 1.7 million and 1.8 million square feet. Recent completions here include the 1 million square foot Steelyard Commons in the central area. Another 6.8 million square feet remain under construction.

· Over the last six months, Chicago maintained its balance, completing 3.3 million square feet and absorbing 3.5 million, respectively. This market leads the region in current construction with 10.4 million square feet underway, up about a half million for the quarter.

· Volumes ranging from 2.2 million to 2.9 million square feet are under construction in Kansas City, Indianapolis and Detroit.

With the latest quarter showing a better balance of supply and demand, the escalation of the regional rate vacancy took a breather, repeating second quarter’s 8.3%. Still, this vacancy level equates to the nation’s highest regional rate, and the 70-basis point year-over-year increase is the nation’s largest for that period. Six markets posted rates decreases during third quarter while eight recorded gains. All but four markets, however—Kansas City, Columbus, Dayton and Cincinnati—have rates higher now than a year ago.

· Cleveland, with all its activity, records third quarter vacancy at 10.0%, down 30 bps for the period, but up 40 bps year over year.

· Chicago’s 7.1% is down 20 basis points since mid-year and up 50 bps since third quarter 2006.

· Lowest vacancies are indicated for Madison and Minneapolis at 4.6% and 4.9%. Respective year-over-year increases of 80 bps and 110 bps are indicated. Columbus’s 60-bps decline, to 9.5%, was the latest quarter’s largest.

Improved absorption during the latest quarter did little to help rent growth. With a 0.7% decline to $13.66 psf, the Midwest was alone among U.S. regions to suffer a loss in its asking rents which, in addition, stands as the nation’s lowest. The year-over-year performance is a little better. But the 3.3% gain recorded for the period was again the nation’s smallest. Half of the region’s 16 markets witnessed declines in rents during third quarter; one posted no change.

· Rent growth was weak in Chicago and Cleveland, the busiest builders of retail space at the moment. Chicago’s rents of $17.87 psf remained unchanged since mid-year; rent growth here, however, is 6.3% year over year. Cleveland’s rents fell 2.1% to $11.59 psf during the quarter.

· The 6.4% increase in Indianapolis, lifting the average to $13.14 psf, was the best performance in the quarter. Its 8.2% topped the year-over-year column as well.

· Kansas City’s $12.95 psf average was up 2.9% since second quarter. Dayton was next with a 2.4% gain to $9.30 psf, one of the nation’s lowest average rents.

A marked slowdown in retail investment sales nationwide is indicated by RCA, a result of ailing capital markets. Capitalization rate increases exceeding 25 basis points have surfaced for the Midwest (and for the Southwest as well). Meanwhile, numerous so-called secondary markets around the U.S., including Cleveland and Milwaukee are “showing positive momentum.” RCA reports total retail investment sales in Midwestern markets of through $7.09 billion involving 496 transactions over the course of nine months in 2007. Average sales price and capitalization rate register at $123 psf, lowest among the nation’s regions, and 7.0%, the national high.

· Chicago led the region in sales volume through September at $1.84 billion involving 101 sold properties. Average price and cap rate were $167 psf and 6.8%. Average selling prices were highest in Kansas City and Cincinnati at $224 and $207 psf.

· The lowest average cap rate was Columbus’s 6.5%. Cap rates for properties on the market as of September averaged 7.5%.

· Significant recent deals include the $47.3 million ($328 psf) purchase by BlackRock Realty (SSR) of the 144,000 square foot Calhoun Square strip center in Minneapolis. The American Properties-Principal Global Investors joint venture was the seller.

· Supply and demand dynamics are favorable with absorption moving well ahead of new supply amid slowing construction.

· The vacancy rate shed 20 basis points during the quarter. Overall rent growth remains weak, however.

· The investment sales profile features the nation’s highest average capitalization rate and lowest average selling price.

Industrial Supply and Demand

Demand ran ahead of new supply for the past two quarters with the gap widening during the latest as delivery of 6.4 million square feet met with net absorption at 14.4 million. The volume of space under construction, meanwhile, has been decreasing. The 25.6 million square feet underway at quarter’s end were down 2.3% since mid-year and 10.5% from four quarters prior. Overall, these numbers represent the nation’s most favorable supply and demand dynamics. Looking more closely, however, the quarter’s increase in absorption can be attributed to dramatic gains in a small handful of markets, including Chicago and Detroit. Several markets with positive second quarter totals have since fallen into negative territory.

· Chicago’s 5.21 million square feet of net absorption nearly doubled the previous quarter’s total (2.85 million) and more than doubled third quarter deliveries (2.58 million). The volume of space under construction rose 18.7% to 11.1 million square feet.

· Net absorption in Detroit this quarter grew more than five-fold to 2.6 million square feet. West Michigan and Cincinnati rose from negative territory to 2.7 million and 1.6 million square feet.

· There are 2.9 million square feet under construction in both Columbus and Indianapolis. Net absorption in the latter fell sharply negative to minus 1.1 million square feet during the quarter. Columbus was strong at plus 1.3 million.

Industrial Vacancy

Midwestern vacancy decreased 20 basis points, to 9.4%, during third quarter. The 20-point year-over-year decline was the nation’s best for the period. Performances among individual markets were mixed. Eight saw their rates decline during the quarter, six suffered increases, and two remained unchanged. Nine markets were down year over year, four of which experienced declines in the range of 110 to 200 basis points.

· The quarter’s best performances belonged to neighbor markets Cincinnati and Dayton. The 90-bps declines in each resulted in respective vacancies at 7.9% and 9.6%.

· Milwaukee’s 7.8% vacancy remained fixed for the quarter but was down 200 bps year over year. Chicago’s 9.5% was down 30 bps for the quarter and 70 bps year over year.

· Lowest vacancies are indicated for Madison (6.5%), Kansas City (7.0%) and Oklahoma City (7.6%). Changes for the quarter were minimal to non-existent in these markets.

Industrial Rents

The favorable turn in the dynamics of supply and demand and the improvement in Midwestern occupancy did little to boost rent growth. Asking rents of $4.55 psf, lowest by far among the nation’s regions, was down a penny from a quarter earlier and was up only two cents (0.5%) from the comparable period of 2006. Only three of the region’s markets posted rent hikes during third quarter, and only Madison’s increase was substantial. Eight markets suffered losses while five showed no change.

Madison led in third quarter and year-over-year rent growth with respective increases of 6.7% and 12.3%. The latest quarter’s rent was $4.92 psf.

· While no change was recorded for Kansas City, the Twin Cities or Indianapolis for third quarter, year-over-year increases were substantial at 4.9%, 4.4% and 3.3%. Respective latest quarter rents are $4.32, $6.14 and $4.05 psf.

· While Oklahoma City and St. Louis suffered third quarter losses of 2.7% and 2.9%, year-over-year rent changes remained positive at 0.8% and 1.7%. Their respective rents are reported at $3.64 and $4.76 psf.

Industrial Investment Sales

Industrial investment sales in the Midwest registered at $5.39 billion during the first nine months of the year according to RCA. At $54 psf and 7.5%, average sales price and capitalization rate were lowest and highest, respectively, nationwide. As of September, newly offered assets were averaging $55 psf and 8.0%, again the national extremes. Chicago leads in sales activity among the region’s combined tertiary markets. Only Milwaukee and Chicago among regional markets are cited by RCA for substantial growth in prices.