My kind of town

AvalonBay Communities' Chicago area portfolio has dozed through most of the decade since the REIT was created, with around 1,000 units in the suburbs, give or take a few hundred, prompting one analyst to ask, during the REIT's Q4 2007 earnings call, if AvalonBay was thinking of exiting that market.

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“We’ve been growing our concentration in that market through acquisition activity. It’s a small market for us and will remain a relatively small component of our overall portfolio, but we have no plans to exit,” Bryce Blair, CEO of the company that owns or has an interest in nearly 53,000 apartments in its mostly bi-coastal portfolio, told the analyst in February.

In fact, the company’s first ground-up development in Chicago is expected to start in about a year on 3.5 acres in the Windy City’s burgeoning South Loop neighborhood.

“We did a lot of analysis before making the decision to go there and our first bet is a pretty big one on the development side of this.

So, we’re wed to making this market work for us,” said Jon Cox, AvalonBay Senior VP of development in the Midwest and Mid-Atlantic regions, of the REIT’s plan to build a $295 million, 1,000-unit apartment community in two or three 42-story towers on Clark Street in the South Loop.

“The primary reason for the decision is that Chicago’s economy is so large. It generally has somewhat stable growth. It does go through fluctuations because it has a manufacturing base, but it mirrors the U.S. economy. And, in the bulk of our markets, which are on the coasts, the highs are higher and the lows are lower and we really looked at it as a way to even out our portfolio performance over time. That will take time because it’s a very small part of our portfolio,” Cox said in March, echoing Blair’s comments of the month before.

“We’re heavily invested on both coasts and Chicago now is going to be the fulcrum,” agreed Walt Rebenson, AvalonBay VP of Development for the Midwest, who has been scouring the city and its suburbs since the summer of 2005, when he joined the REIT to open its first Chicago area development office in the close-in northwestern suburb of Arlington Heights.

“There have been very few new units delivered to the six-county region in the suburbs since 2002 and even those delivered in 2002 were in planning back in 1998. So, really since 1998, there’s been a dearth of new product, with deliveries at historical lows,” Rebenson said.

“Downtown’s a little different story. It’s not as difficult to get zoning, but, again, there was a lot of competition for land from condo developers, so the bulk of the desirable sites were being bought at record prices that would render an apartment use unfeasible. And, combined with record conversions, up until the end of 2006, the rental supply Downtown has been almost cut in half,” he said.

“If we look back to 1990, there were just about 21,000 rental units, which represents about 72 percent of the overall Downtown housing supply. And, if we add the almost 6,000 units either already delivered or to be delivered through 2012, we’ll be at 20,000 rental units,” said Rebenson, explaining AvalonBay’s enthusiasm for the market and desire to begin developing there.

That opportunity finally presented itself last summer, when AvalonBay cashed in on the cooling condo market with the $23 million acquisition of an already-entitled site, which currently serves as a service parking lot at the corner of Clark and Polk Streets, from a joint venture of home builder Lennar Corp. and two former principals of Concord Homes.

Lennar acquired Concord in August 2002 and had planned to build three condo towers on the property, but the disintegration of the single- family home market took the wind out of the sales plans, prompting the disposition of the property that is just a few blocks from the Sears Tower, close to three of the “L” stations that provide train transport throughout the city, immediately south of One Financial Place–home of the Chicago Board of Trade–and a block from a brand new Target store at Clark and Roosevelt.

Unlike the rest of the Concord portfolio, prior to the sale to Lennar, the Clark Street site was owned solely by Concord Homes’

Principals Rob Benach and Wayne Moretti. Benach, a legend in the Chicago for-sale residential industry and founder of three home building companies in the Midwest, reintroduced Lexington Homes to the Chicago market in 2006 and is underway on four for-sale projects on Windy City infill sites. Wayne Moretti is president of the relaunched Lexington Homes. The Clark Street site was the only deal outside of the Concord-owned portfolio purchased by Lennar,

which owned it in JV with Benach and Moretti, Rebenson explained.

“So, it made sense for them to dispose of it, since they already had one other condo community under construction and another site up further north in the River North sub-market that they already had approved for condos, so they had to get rid of some of their pipeline,” he said.

But the JV, which had between $18 million and $19 million invested in the property, wasn’t forced to take a loss on the site, as many erstwhile single-family home and condo builders have had to do to get out from under deals for which debt, investors and buyers have vanished since the subprime disaster hit last summer, and lenders are calling about land loans with which many less well-capitalized developers financed their deals.

“What happens is most of the land loans have shorter maturities, so I’m sure a lot of the lenders are calling and saying, ‘Your land loan’s coming due in six months and, with all the new pressures and devaluations, you have to write a check if you want an extension.’ And some of them may not have the capacity to do that, so we’ll start getting calls from their lenders at some point when they file foreclosure,” predicted Rebenson.

“We initially started out scouring the suburbs for development opportunities, but in the end, we determined that our best opportunity to create value now was Downtown,” Cox explained, adding that the search for infill development sites continues in suburbs close to the city. “It’s very difficult to make suburban deals work.

Rents are incredibly low and housing is very affordable. I’m not saying we won’t do it. It’s just going to be very difficult.”

And Downtown Chicago is where most of the job growth is–at least the growth of jobs for young, upscale professionals, who are the target tenants for AvalonBay’s high-end Downtown apartments, he said.

“We like both Downtown and the suburbs and there are probably about 30 close-in suburbs we would really like to develop in and they’re all going to be infill,” said Rebenson, agreeing with Cox that the strongest job base is Downtown, where Mayor Richard M. Daley, he said, has done a phenomenal job of revitalizing the city that 20 or 30 years ago many expected to go the way of other Rust Belt cities like Detroit, Cleveland, Cincinnati and Indianapolis.

“In fact, the opposite has happened in Chicago,” he said. “The move-backs to Downtown have been exponential. Back in 1990, there were approximately 48,000 total units in the core of Downtown, both rental and for-sale. By the end of this year, we’ll have 108,000 units, so there’s been a huge influx of residents and we’ve reached a critical mass, where more and more people want to live and work Downtown. And then you have the growing number of baby boomers selling that big barn out in the suburbs and moving to the city.”

AvalonBay’s Midwestern presence dates back to just prior to the 1998 merger of East Coast-focused Avalon Properties, Inc., a REIT that was structured in 1993 by parent company Trammell Crow Residential (TCR), and West Coast-focused Bay Communities, which became a REIT a year later. In December 1997, Avalon Properties acquired a portion of TCR’s Midwest portfolio that included assets in Minneapolis, Indianapolis, Detroit, Cincinnati and Chicago, and the merger that created AvalonBay was finalized in June 1998.

However, the company that is well-known for its development expertise and currently has a $6 billion pipeline of projects either underway or in planning on both sides of the country, never has turned so much as a shovelful of dirt in the Windy City area.

Shortly after the acquisition of TCR’s Midwest assets, the merchant builder’s development partner in the Chicago office retired and the newly created AvalonBay closed the development office. Over the next few years, the REIT disposed of most of the Midwest assets acquired in 1997, keeping a couple of properties in the Chicago suburbs–the 295-unit Avalon at Danada Farms in Wheaton and the 192-unit Avalon at Stratford Green in Bloomingdale, both of which were completed by TCR in 1997, and adding the 400-unit Avalon at West Grove in Westmont, a deal that came out of an aborted transaction with another REIT, about a year later.

The market that historically has generated around two percent of the REIT’s overall NOI, didn’t see much AvalonBay activity until the REIT created the AvalonBay Value Added Fund LP in March 2005, through which it acquired the 204-unit Avalon Lakeside in Wheaton, followed by the 196-unit Avalon at Poplar Creek in Schaumburg in 2005 and the 256-unit The Covington in Lombard about a year later. The fund–a private, discretionary investment vehicle, in which the company holds an equity interest of approximately 15 percent–had invested $779,318,000 as of the end of January, with an additional expected net investment of $39 million to redevelop the 4,229 units in the 20 assets acquired since its launch three years ago, at which time the fund will become fully invested.

Now, after 10 years in the market, the REIT believes the time has come to increase its investment in the area exponentially. The 1,000 unit Avalon South Clark represents a 50 percent increase in AvalonBay’s total unit count in the Chicago area, where Rebenson, who has offers out on several sites both Downtown and in the suburbs, also hopes to win the opportunity to build a mixed-use project on village-owned property in Oak Park, a suburb located just on the other side of the western border of the city and five or six miles south of O’Hare International Airport.

AvalonBay’s proposal for the 81,000 sq. ft. site in the heart of the village includes about 268 units and around 35,000 sq. ft. of retail and the corresponding parking for those uses. “We have a partner, Clark Street Development, that would actually own and develop the retail component,” said Rebenson. Final proposals were presented to the Oak Park village board on March 31, with selection of the winning proposal expected sometime in April or early May.

AvalonBay and Mid-America Development Partners LLC, a seven-year-old full-service real estate development firm headquartered in the Chicago suburb of Oak Brook, are the two finalists in the contest. A third finalist, Centrum Properties, Inc., the 25-year-old Chicago- based real estate development company that submitted a proposal that included condos, has since withdrawn from the competition that was initiated by the village six or seven months ago.

“The condo boom has been more particular to Downtown,” Rebenson explained. “You don’t see a lot of condos in the suburbs. It’s more town home or duplex product and there’s a high barrier to entry to get zoning for apartments. Certainly, if you’re anything short of luxury product, if you’re affordable, good luck. You won’t get zoning,” said Rebenson, who has nearly 30 years of real estate experience and is no stranger to the Chicago real estate development scene, having spent ten years with 20-year-old Fordham Company, a developer of luxury residential product, where he oversaw more than $600 million of for- sale residential and retail development prior to joining AvalonBay.

Fordham’s most recently delivered Downtown Chicago condo communities– 49-story Pinnacle and the 50-story Fordham –epitomize the company’s luxury high-rise product. “Certainly, one of the reasons AvalonBay recruited me is my high-rise experience, but I’m not unique to the company,” said Rebenson, explaining that the REIT, which has long been recognized for its upscale garden-style development expertise and, in the past, has frequently brought in third-party general contractors and construction managers for development of its high- rise communities, is growing its in-house vertical development team.

“We’re building a lot of high-rise product in cities like New York, Seattle, San Francisco, Los Angeles and San Diego. So a big component of our development is more vertical, but we still build two-story and three-story wood-built in suburban locations. If you look at our total pipeline and how much of the capital is in high-rise development, it’s a big percentage,” he said. “And many of the people who have been hired over the last five years, either on the construction side of the business or property management, have a long history of vertical development and operations.”

For the Avalon South Clark deal, AvalonBay will act as the general contractor and will hire a third-party general contractor as construction manager, Cox said. “Essentially, we are renting that third-party’s employees and their buying power, but they don’t take any risk on construction. That way, we get their local expertise and their local management skills and we actually over-staff the job. We cover it with additional AvalonBay people to make sure it’s getting built the way we like it to be built,” he said.

Rebenson has been working with Walsh Construction on pre-construction and design issues for the South Clark project and also has worked on suburban pursuits with McShane Construction Corp. He expects one of those two will take on the construction management for the 1,000-unit development. Chicago-based FitzGerald Associates Architects is the architect for the project for which AvalonBay currently is seeking a legislative amendment to the previously approved planned development.

“It was approved with 1,000 units in three towers. Lennar had planned to have two towers that were very similar, flanking an above-grade parking garage and a park, with a third tower at the corner of Clark and Polk with its own parking garage,” said Cox. “We are attempting to change it to just two towers flanking a 1.7-acre park and a parking garage. The park will run along Clark between the two towers– one tower on the north end and one on the south end–with the parking garage in the back, connected to the two buildings on each end and shielding the site from the Metra rail tracks behind it.”

Rebenson expects to get the final word on the proposed change to the planned development by the end of April, and, if the legislative amendment is not approved, he’ll just go forward with the currently approved three-tower plan, but only build two towers. “We’ll hold the third and either later decide to build it as apartments or, at that point, sell it to a condominium developer. Because we will build these towers sequentially, we would start the first tower under either plan and, about 20 months after we start the first tower, we would start the second,” he said. Ground-breaking for the first tower is expected in early 2009.

Since it will take around 27 months to build each of the first two high-rise buildings, the third tower site won’t be an issue for nearly five years. “So, we’ve got plenty of time to make that decision. At this point, we don’t care which plan the city wants to go forward with. When you buy land with the existing zoning in place, you have to be prepared to go forward with that plan without any changes. We just thought the two-tower plan was a better plan, but we’ve underwritten both,” said Rebenson.

Around 250 of the units at Avalon South Clark will be studios and convertibles, a unit type that is peculiar to Chicago and is a bit larger than a studio. Another 36 percent of the apartments will be one-bedrooms, nine percent will be one-bedroom/dens and the remaining 300 units will be two-bedrooms, said Cox, adding that rents are underwritten at $2.39/sq. ft. for the apartments that will range in size from 560 sq. ft. to 1,074 sq. ft. and are expected to lease up at an average of 25 units a month.

“We will be doing green roofs with plantings on both towers and we’re putting our pool on the ground on the edge of the park and we’ll have high-end finishes in the units, like granite counter tops. These are fairly modern-looking buildings, so there’s a lot of glass on the first floor and very open common areas. Instead of dedicating the top floor to a penthouse, that space will become a party room facing east over Lake Michigan,” said Cox.

Rebenson expects the nearly two-acre park will be outfitted with dog recreation areas, gaming areas for bocci or chess tables and a small gazebo for live entertainment on the weekends, providing a unique amenity in the city’s Downtown.

“And then you’re a short walk to Grant Park and the whole lakefront.

You’re only about five blocks to the west of the lake and, in our 42-story buildings, above the 20th floor you have unimpeded views of not only the lake, but also the whole Downtown cityscape,” he said.

Looking forward, Rebenson said, “I see Chicago continuing to draw in more people than it loses over the next five to ten to 15 years,” thanks to the growth of retail and entertainment venues in the city that he believes is to the Midwest markets what New York is to the world capital markets.

The real wild card for the Windy City is whether it’s going to be selected for the 2016 Olympics. “That selection will be done by the fall of 2009 and would bring in a huge infusion of fresh investment to Chicago leading up to and around the Olympics,” he said, adding that the most dramatic impact would be in the South Loop and further south to the Washington Park area and the University of Chicago, where most of the venues and housing would be built for the athletes.

But, even without the Olympics, he expects the South Loop will continue to grow, eventually matching the quality and number of residents at income levels found in the upscale Gold Coast, River North and Lincoln Park neighborhoods today.

“A lot of our predecessors have come and gone already and we do not intend to be that way in Chicago. We’re not plodders, but we’re not going to do anything rash either. We’re going to figure out the way to make money in that market and we’ll make it happen,” said Cox.