Toll Brothers started from scratch when it came to Chicago in 1999, as opposed to buying an already established local player. After slowly building up mass in the market, the company sold 227 homes in 2005, followed by 491 sales in 2006.
Then, as it did for many other builders in many other markets, the bottom dropped out. Toll's year-to-date sales had fallen to 175 homes as of June 2007. Still, considering the climate across the country, Toll brass don't regret their decision to build in the Windy City.
Toll's timing of entry into the Chicago market was no rarity. A glance at the top 20 list of builders in Chicago from Hanley Wood Market Intelligence (HWMI) shows a who's who among national builders: D.R. Horton through its Cambridge Homes brand, Lennar Homes, Centex, Ryland Homes, Kimball Hill Homes, Pulte Homes and its Del Webb brand, and KB Home. Large regional builders such as Neumann Homes, Pasquinelli and Portrait Homes, MCL Companies, and Montalbano Homes also call Chicago a core market.
Competition is tight throughout the Chicagoland area. Overall, sales fell 21.4 percent from the second quarter of 2006 to the second quarter of 2007, but it doesn't look like any national builders will pull out of the market. While the city's Midwestern neighbors including Detroit, Cleveland, and Cincinnati have fallen upon hard times economically, the Windy City continues to produce a variety of jobs at a stable pace. This leads builders to believe better days lie ahead.
Chicago's broad shoulders carry a lot of industry and have done so since the Industrial Revolution. The only areas with a higher gross metropolitan product (GMP) than Chicago's $422 billion are Los Angeles and New York, according to the U.S. Conference of Mayors.
"It's no longer the meat packaging center; it's a service area," says Alan Lev, president and COO of the Belgravia Group, a builder in the Chicago market. "There are a lot of professional jobs. There's Boeing, Walgreens, the state and the city, and lots of law and accounting firms. It's incredibly diverse."
In fact, Moody's points to the Second City as the most diversified economy in the country. "It has a huge advertising base. It's a transportation hub. It has a strong financial district, even though some of that has moved to New York and Western Europe," says Peter Tremulis, principal of Deerfield, Ill.-based Sunesta Resort Communities and former national head of acquisitions for Pulte Homes. "Chicago continues to be a strong economic engine for the Midwest."
The services industry leads job growth, producing 35,800 new jobs in the first quarter of 2007–a 1.9 percent increase over last year. "We're adding financial services, but we're not adding construction jobs," says Lance Ramella, senior managing director for HWMI. "Commercial is doing OK, but it's offset by the loss of residential [building] jobs. That's happening everywhere."
Although manufacturing is no longer Chicago's bread and butter, it's still a factor. "Chicago businesses do better in producing manufacturing jobs," Tremulis says. "They're not as auto-dependent as Detroit, Cleveland, and Cincinnati."
But to think Chicago has escaped the automotive industry's woes would be shortsighted, according to Tracy Cross, president of Tracy Cross and Associates, a real estate analysis and consulting firm in Schaumburg, Ill. "No one wants to admit that Detroit has an effect on Chicago, but it does," Cross says.
Fortunately, Chicago is big enough to absorb losses in other industries. "The employment shifts around to professional services and transportation–all of those other industry sectors," Cross adds.
The city recently drew 165 corporate facility projects totaling more than $5 billion in capital investment, according to the Conway Data New Plant database. That's putting a lot of upper level jobs in the market.
Despite this broad and expanding base, however, Chicago's job growth hasn't been spectacular. Lately, the city has seen growth at a clip of approximately 1.0 percent. This year, HWMI expects Chicago to add 49,720 jobs, which would be a 1.1 percent increase compared with 2006.
"Chicago is not growing as fast as the nation, but our workforce is older," Cross says. "A new worker may replace someone that's retired. That leads to zero job growth, technically, but the employed workforce does change dramatically."
Out of Whack
Although Chicago's job growth has grown steadily over the past few years, there's nothing modest in its new-home sales story. In 2007, HWMI expects 32,500 new-home sales in Chicago–a 5 percent decrease from 2006. In 2005, the market recorded 42,236 home sales.
As a result, builders have put the brakes on their construction pace. HWMI expects 34,980 building permits to be issued this year, compared with 41,858 and 47,495 in 2006 and 2005 respectively. Between 1988 and 2007, Chicago has averaged 39,033 permits per year.
In the first quarter of 2007, there were 2,054 active new projects, which was an increase of 321 projects from the same period last year. Contributing to an additional supply could be foreclosures; in 2007, HWMI expects between 30,000 and 36,000 foreclosures in Cook County alone. That could eat demand all by itself, as HWMI says there's demand in the market for 31,000 units this year.
Still, Chicago builders continue to produce homes. The number of active detached projects in March 2007 was 880, which is a 13.5 percent increase from the same time period last year. Attached projects numbered 1,174, a 22.5 percent increase over March 2006.
But HWMI believes Chicago could actually improve in late 2007. "I think we're kind of plateauing on the bottom," Ramella says. "We're starting to get close to where we were at this time last year. We've dropped a little over last year, but it's not like where we were. We're not 30 percent below last August; we're 10 [percent] to 15 percent below last August."
Sales numbers vary drastically, depending on product type. Builders sold approximately 2,297 detached homes in the first quarter of 2007, a 4 percent increase from the previous quarter, according to HWMI. Attached sales fell to 4,336 for a 12.5 percent decline. The median sales price for attached homes rose 8.9 percent, while detached prices rose 4.8 percent.
Location has a lot to do with this difference. "We've gone back to more infill, closer-in locations," Ramella says. "This is a heavily attached market, with most of the attached being concentrated in the city of Chicago. Some infill condo projects that are well located are doing OK. If they're near train stations and priced appropriately, they're doing fine."
And with so many big companies centrally located in Chicago's downtown, the appeal of urban locales is easy to understand. "This market is heavily dependent on downtown, where over 50 percent of the jobs are located," Ramella says. "Downtown Chicago is so dominant it creates a commuting nightmare."
But commute times aren't the only factor contributing to downtown Chicago's popularity. "[Mayor Richard Daley] is committed to the city and [its] growth," says Christina Noelle, president of MCZ Development, a Chicago-based company specializing in adaptive reuse projects and high-density urban infill. "He's done some wonderful things to make the city world class for people who want to live [in] and visit [it]."
The city's popularity has helped the Belgravia Group's 600 N. Lake Shore Drive and 565 Quincy projects, which sell approximately six units and five units per month respectively. "Townhomes are doing pretty well," Belgravia's Lev says, adding that those that are most successful feature "a special niche or location."
Another unique success story is The Glen, a former Naval base that was converted to a master planned community with a town center, schools, office space, big box retail, a golf course, and a train station. Yearley saw this success firsthand when 40 people camped out the night before Toll Brothers was scheduled to release condos in the development. "We sold out that morning," Yearley says.
However, just because a condominium project is located downtown or near transit, that doesn't mean it will sell. HWMI says there are currently 5,164 unsold condo units in active projects downtown, with an additional 6,352 condo units in the entitlement process. "Downtown is overbuilt," Yearley notes.
Because of that, even downtown developers will offer concessions to move inventory. Units priced from $250,000 to $299,000 seem to be moving best, accounting for 23 percent of attached sales.
With the exception of Lennar, Chicago's big builders avoid building inside the city. "It's broken between the city and suburbs," says Christopher Shaxted, executive vice president for Hoffman Estates, Ill.-based Lakewood Homes. "For the most part, inner-city and suburban builders are segregated."
The bad news: Outlying areas are doing a lot worse than the city. "The suburbs saw a pretty good drop last year," Shaxted says. "We're continuing to see that drop."
Things are moving better at the top of the market, but it's still not great. HWMI reports that homes in the $300,000 to $399,000 range are the best sellers in the detached market, constituting 31 percent of sales. But as Shaxted points out, "There's a lot of product in the $300,000-plus range."
"The Midwestern mentality is conservative; we've learned that from Detroit, Minnesota, and Chicago," Yearley says. "When there is bad news, the Midwestern mentality is to not buy. As [we see] more press about housing being off and the mortgage crisis, that buyer is conservative and will wait until there are clear signs of improvement."
Chicago's builders seem to be getting the most traction out of financing programs. Lakewood Homes has seen success by offering down-payment assistance of 3 percent for its buyers (allowing them to qualify for more favorable interest rates than a true zero-down mortgage), and it also uses two-to-one buy-downs off of a permanent buy-down. "What we are focused on, being involved with the first-time buyer and move-up buyer, is to look at monthly payments and focus on financing products that can help out the buyer," Shaxted says.
Pulte also tries to help its buyers with financing and closing costs. "Our team is developing relationships and [the ability] to dive in and ask a lot of questions about how people want things structured and what their financing situation is," says Brian M. Brunhofer, Illinois division president for Pulte Homes. "They get a lot of input and can point them in the direction of a program that makes the most sense."
Cross sees the public builders taking the lead with concessions. "The top five builders are public, but that comes at a cost," he says. "They're doing OK because they applied strong incentives to liquidate inventory and apply incentives to houses yet to be built."
HWMI's Ramella foresees a day when things will move in Chicago without incentives. Although the sales of 2004 and 2005 are only distant memories, HWMI projects a positive turnaround for Chicago in late 2007–that's much better than many of the markets around the country.
Learn more about markets featured in this article: Chicago, IL.