Living on the Loop

Around midday on December 28, 2000, Chicago residents were stunned by the announcement that Montgomery Ward’s–a 128-year-old chain of department stores–was shutting its doors. With the company gone, its 1970s-era corporate headquarters in downtown Chicago became an empty, 28-story reminder of the retailer’s demise.

Because of the flight of companies like Montgomery Ward’s and staff reductions at others, downtown Chicago now suffers from a fifteen percent commercial vacancy rate. A recent flurry of office building construction has further exacerbated the city’s oversupply. Laurence Msall, president of the Civic Federation, a Chicago government and tax watchdog group, observes that the commercial market “is a renter’s market–right now there is plenty of space.” The recent transformation of the Ward’s building exemplifies Chicago developers’ most popular strategy for dealing with the glut: converting aged office buildings to highly coveted condominiums. Chicago-based Centrum Properties, a leader in the conversion market, is transforming the Ward’s building into 249 condo units, meeting Chicagoans’ growing demands for centrally-located residential space. 

Commercial Conversions: A New, and Growing, Trend

Michael Moran, vice president of a young advocacy organization called Preservation Chicago, describes the conversion wave as coming from a “synergy between the abandonment of class C office space and the fortuitous arrival of new customers: empty-nesters from the suburbs and young singles.”

One-third of all condominium units introduced to the Chicago market since 1994 were in former commercial buildings–a total of 9,450 units in 91 buildings. According to Chicago-based Appraisal Research Counselors, a real estate market research firm, last year the city saw more downtown condos converted from older commercial uses than in any of the previous ten years, with 1,703 units in eleven projects offered for sale. Gail Lissner, a vice president for Appraisal Research Counselors, predicts growth to continue through 2005. While office rental prices in downtown Chicago have fallen for the past three years, according to Studley, a New York-based commercial real estate tenant services firm, sales prices for downtown condominiums have risen sharply, breaking $500-per-square foot in 2004.

About five years ago, Louis D’Angelo, president of the development company Metropolitan Properties of Chicago, began converting office buildings to residential condos in the Loop, Chicago’s traditional downtown commercial and government hub.

“[Conversions] are terrific for all those involved,” D’Angelo said, since they transform “the use from obsolete office to vibrant, exciting residential use [and] in many cases dramatically increase the tax revenue for the city and the county, which in turn funds the parks and city services.” The roots of the conversion wave, however, may go deeper. Jim Costello, a senior economist for Boston-based Torto Wheaton Research, suggests that Chicago’s pattern of development has contributed to changing market demand within different segments of downtown. In the 19th and early-20th centuries, wealthy corporate executives lived closer to downtown and arrived by train on Michigan Avenue, the East Loop corridor where many other early corporate headquarters lie. Now those executives are more likely to live in the western suburbs and ride to work on the Chicago area commuter rail line Metra, exiting at a downtown station in the West Loop. For convenience, they favor the West Loop as the home for new corporate towers, giving life to Joel Garreau’s maxim that “the headquarters is put as close to the home of [the] chief executive officer as is physically possible without lowering his personal property values.” Responding to these preferences and available space, the city’s 2003 Central Area Plan prioritizes the development of the West Loop as the new center of class “A” office towers.

Meanwhile, the East Loop has seen the improvement of Grant Park, the 200-acre open-space separating East Loop skyscrapers from Lake Michigan, with the 2004 opening of Millennium Park. The park’s 24 acres border Michigan Avenue and house a Frank Gehry-designed music pavilion, public gardens, and massive public art. The park has made the East Loop desirable residential space, according to Moran. “The corporation likes being around the Metra train, the busses, the heavy congestion, whereas residents would rather be away. Residents want to be next to a large park.”

Strategies to Promote Conversions

Other cities have seen similar changes in demand, driving conversion of underutilized or abandoned commercial buildings. In Lower Manhattan, Jim Costello conducted a 2003 study that found that, on average, “older, pre-war [office] buildings were selling for under $200 per square foot. [But] condos were selling for $500 per foot.” In Los Angeles, the city has made conversions city policy, through a 1999 Adaptive Reuse Ordinance. The ordinance loosens zoning restrictions and streamlines the conversion process. It also frees developers of downtown conversions from open space, density, and floor-to-area ratio requirements. Hamid Behdad, L.A.’s Director of Adaptive Reuse Projects, said that the city is creating over 10,000 housing units from abandoned or underutilized office buildings.

While Chicago has not established as focused an ordinance as Los Angeles’, it similarly uses city policy to proactively promote commercial space conversion, through long-range planning, landmarking ordinances, and tax policy. The city’s 2003 Central Area Plan stated: “The City of Chicago is committed to preserving the area’s historic buildings and districts by encouraging creative adaptive reuse. Residential, cultural, educational and business uses will occupy historic buildings.”

A strong historic preservation movement has focused this general planning language. Between 1996 and 2003 Chicago designated three landmark districts in the Loop, which added scores of buildings to the over 40 structures in the downtown area that were already individually landmarked. The landmark designation in most cases prevents demolition of the protected building. Owners of underutilized buildings then must either maintain the current use or find a better use within the existing structure. In the current market, the most valuable choice is often residential condominiums.

Louis D’Angelo, who is currently converting a 1923 office building within what is now the Michigan Avenue landmark district, worries that landmark designation may not be the economic engine it was touted to be. “It is not a victory to have an empty museum on Michigan Avenue,” he said. “The landmark has not proven to be good or bad; the jury is still out. Michigan Avenue needs a win.” Then he added, with a developer’s characteristic immodesty, “I think Metropolitan Tower will be its first win.”

Chicago has also helped finance projects that promote residential living downtown through a powerful– and controversial– tool called tax increment financing (TIF). When the city designates a neighborhood for a TIF, it dedicates any future increases in property tax revenue from that neighborhood to a separate fund to be spent on public and private projects in that neighborhood only. A TIF-designation can potentially leverage hundreds of millions of dollars by stimulating private redevelopment in anticipation of future public spending on the district. Designated areas in Chicago that have seen large increases in property values now have enormous TIF funds available. One such district is the Central Loop TIF, which contributed $95 million as part of the total $475 million in public and private dollars spent to build Millennium Park. The Central Loop TIF also spent several million dollars on the construction of student housing in the Loop. Developers generally support the TIFs as an effective tool for economic growth. Many community advocates, however, complain that TIFs take money away from traditional citywide services, such as schools and sanitation, and instead dedicate it narrowly to particular neighborhoods.

Critics of Conversions

Criticism of the city’s support for commercial conversion reaches beyond questioning specific policies like TIFs to general questions about whether such conversions make sense. Albert Hanna, senior vice president of the Chicago-based real estate company Draper and Kramer, calls the conversions “sophisticated abandonment.” Planners are being short-sighted in their goals, he warns: “No one in city planning is thinking about ten to twenty years out–it is all done on what the voters want done today. A key question is whether we should be reducing the available office building space in the Loop, thereby reducing potential employment in another thirty to fifty years.”

Hanna has misgivings about any project that would diminish Chicago’s commercial density. He prefers a traditional, unified commercial district downtown, free of most residential structures. Ironically, one of his firm’s largest current projects involves converting the landmarked 1929 Art Deco Palmolive Building on North Michigan Avenue–originally an office tower–into condominiums. Hanna emphasized, however, that the Palmolive Building was located in a heavily residential area north of the Loop. Since this area is predominately residential, the conversion does not impact commercial density as a similar conversion might in the Loop. Long-time alderman Burton Natarus of downtown’s 42nd Ward also remains skeptical of the recent trend toward conversion, citing potential tax revenue losses. “We have to have a balance. You have to realize that when you convert to residential, you cap property taxes,” he said, referring to a 2004 state law that temporarily limits the increase in homeowner taxes. He also noted that in Cook County, residential taxpayers pay approximately half the rate of commercial owners.

Already, the city increasingly depends on residential tax revenues. In 1999 residential taxpayers paid 62 percent of the total city real estate tax bill, but as Laurence Msall points out, that figure jumped to 68 percent in 2003 and is expected to climb in the coming years–just as the state law limits the city’s ability to raise taxes on homeowners. Msall, however, is not concerned with the change: “The Civic Federation strongly supports property owners to have the right to the best and highest use for their property.”

A Downtown You Would Want to Set Foot In

Despite Natarus’ point that the city halves the tax rate on a property by conversion to residential property, the city makes very little money on abandoned or underutilized commercial space; substandard spaces have low property value and generate little business activity. Tax revenues from the reuse of the older buildings have thus already expanded the city’s coffers. “What happened along Michigan Avenue É is that older structures that are economically obsolete have been converted to residential and often their net tax is higher to the city and county,” said Louis D’Angelo. Michael Moran notes that people spend more of their money closer to home, so this residential infusion of cash also helps the city towards its dream of a 24-hour downtown.

If Los Angeles is a good indicator, the social and economic upturn from conversions could prove remarkable. Planner Hamid Behdad said of his city’s transformation: “Our downtown was pretty much desolate a few years ago–a disaster. You wouldn’t step out of your car” for fear of drug dealing and prostitution being conducted in the empty buildings. Now the raw buildings fetch $85 to $200 per square foot, and the rehabbed condos are selling for $500 to $750 per foot. D’Angelo echoed those comments while discussing Chicago. He called the changes he has seen in recent years “extraordinary.” “In the ’70s, you wouldn’t want to step foot in Grant Park. Now you can get people living there, and they become stakeholders in the community, in the park, and in the lakefront.”