The Windy City’s industrial sector could face market headwinds in 2024

Author: Chris Mergenthaler, DarwinPW Realty/CORFAC International

The Windy City, as Chicago is often called, has long been an important center of commerce and industry. With 19 intermodal facilities served by six Class I railroads, 15 of the world’s largest cargo airports, and located at the confluence of seven interstate highways that allow freight to reach 25 to 30 percent of the U.S. population within a single day’s journey, Chicago makes that Chicago is a central location and a key logistics and transportation hub.

According to the U.S. Bureau of Labor Statistics’ first quarter 2024 report, a robust workforce of more than 4.7 million nonfarm workers, combined with Chicago’s location and infrastructure, underpins a fundamentally strong industrial market.

While the long-term outlook for Chicago’s industrial space market remains positive, the Windy City faces some headwinds as the market expands through 2024. Uncertainty, whether positive or negative, has been a common theme in the Chicago industrial space market since early 2023 as the market responds to changing macroeconomic and geopolitical factors.

Uncertainty in the global supply chain, trade relationships with other countries, as well as one of the longest freight recessions in recent history have led to an increase in market space available for direct and sublease. Tenants who had previously expanded their space in anticipation of continued pandemic-related demand conditions are now looking to right-size their operations and reduce costs.

Additionally, while landlords have insisted on lease terms of seven to 10 years with minimal opposition from tenants, short-term direct leases are now beginning to appear on the market as tenants seek to remain flexible with the changing market. The overall vacancy rate in the Chicago market has increased to just over 5 percent, which is still a historically low level.

Higher interest rates have significantly slowed down speculative housing starts and the overall sales activity of investors and users in the market. Many developers, uncertain about future market conditions, continue to refrain from speculative investments, instead looking for build-to-suit solutions to reduce risk.

Subjectively, there still appears to be a wide range of asking prices between buyers and sellers in the market. However, in contrast to the slowdown in momentum, there were several notable sales in the last quarter that showed little or no decline in average sales prices per square foot. Still, the sales transaction cycle has slowed significantly over the past year, with both tenants and their lenders acting with greater caution and diligence.

Investor demand for real estate remains fairly stable compared to the end of 2023, as new capital enters the market. Investor demand for industrial outdoor warehousing (IOS), which covers a wide range of low-coverage properties, remains high despite a short-term decline in demand from some users of these spaces due to the aforementioned freight recession.

Focusing on Chicago’s O’Hare submarket, heavily occupied by transportation and logistics users, we saw a slight increase in vacancy rates, hovering around just over 4 percent, with a slight increase in sublease availability of about 50 basis points to about 1.1 percent.

Still, rent growth in O’Hare continues to rise, especially among older generations and smaller spaces. Over the past few years, a lack of development land in the submarket and favorable market conditions have made developers more willing to build smaller, functionally outdated industrial spaces and single- and multi-tenant business parks in the O’Hare market, consequently reducing space availability and forcing growth rents for the remaining available space.

Additionally, due to its power infrastructure and data connectivity, the O’Hare market has become a desirable location for data center developers. Because developers are willing to pay much more for a plot of land than the typical industrial user, this has reduced the availability of traditional industrial space on the market. This also affected the available power, in some cases limiting the power available to other industrial users. At last count, there were more than 10 data center facilities proposed or under construction in the O’Hare market.

While the Chicago market may experience some near-term turbulence, Chicago’s location, infrastructure and resilience make it well-positioned to limit the extent of any market declines and rebound fairly quickly.

Chris Mergenthaler is Vice President at DarwinPW Realty/CORFAC International. This article originally appeared in the June 2024 issue of Heartland Real Estate Business magazine.