From Boom to Bubble From Boom to Bubble How Finance Built the New Chicago rachel weber The University of Chicago Press Chicago and London Rachel Weber is associate professor in the Urban Planning and Policy Department and a faculty fellow in the Great Cities Institute at the University of Illinois at Chicago. The University of Chicago Press, Chicago 60637 The University of Chicago Press, Ltd., London © 2015 by The University of Chicago All rights reserved. Published 2015. Printed in the United States of America 24 23 22 21 20 19 18 17 16 15 1 2 3 4 5 isbn- 13: 978- 0- 226- 29448- 3 (cloth) isbn- 13: 978- 0- 226- 29451- 3 (e- book) doi: 10.7208/chicago/9780226294513.001.0001 Library of Congress Cataloging-in-Publication Data Weber, Rachel, author. From boom to bubble : how fi nance built the new Chicago / Rachel Weber. pages ; cm Includes bibliographical references and index. isbn 978-0-226-29448-3 (cloth : alk. paper) — isbn 978-0-226-29451-3 (ebook) 1. Urban renewal—Illinois—Chicago. 2. Real estate development—Illinois— Chicago—Finance—History. 3. City planning—Illinois—Chicago. 4. Creative destruction—Illinois—Chicago. I. Title. ht177.c4w43 2015 307.3′4160977311—dc23 2015004406 This paper meets the requirements of ansi/niso z39.48- 1992 (Permanence of Paper). Contents Introduction: Why We Overbuild 1 part 1 Real Estate Speculations 1 The Rhythm of Urban Redevelopment 15 2 Fast Money Builds the Speculative City 38 3 Out with the Old: How Professional Practices Construct the Desire for New Construction 63 part 2 Chicago in the 2000s 4 Downtown Chicago’s Millennial Boom 91 5 Who Overbuilt Chicago? 126 6 Making the Market for Chicago’s New Skyscrapers 156 part 3 Building the Future 7 The Slow Build 187 Epilogue: Why We Will Continue to Overbuild 210 Appendix 215 Acknowledgments 217 Notes 221 Index 273 Introduction: Why We Overbuild The speed of the cycles of prosperity and desolation is an extraordinary challenge to historians and prophets. saul bellow, “Chicago: The City That Was, The City That Is,” 19861 LaSalle Street bisects the Loop, the heart of Chicago’s central business dis- trict, and has served as the city’s fi nancial services artery since the 1920s, when it was known as the “Wall Street of Chicago.” A canyon whose steep walls are carved out of vintage offi ce buildings and ornamented with symbols of the modern industrial economy, the street terminates on the south in the imposing Art Deco Board of Trade building (fi g. 0.1). A few blocks north sits City Hall. Viewed as a whole, the street has come to symbolize the solidity and durability of the City That Works. Cameos of this classic vista have ap- peared in movies such as The Dark Knight, The Road to Perdition, and The Untouchables. In 2006 the City of Chicago declared the area to be “blighted,” noting that the buildings on LaSalle Street were “obsolete.”2 Tenants, it argued, were rejecting their outmoded structures for the new emerald- glass and steel sky- scrapers springing up just blocks away along the western perimeter of the Loop. It was true: law fi rms and corporate headquarters had rushed to re- locate to the millions of square feet of new offi ce space built since 1998. The buildings they vacated had a diffi cult time staying solvent. Some deteriorated, others were converted to new uses such as hotels, and a few were demolished. The wrecking balls and construction machinery signaled yet another round of what Joseph Schumpeter in 1942 famously termed “creative destruction”— capitalism’s habit of rendering old products obsolete and destroying them so that it can invent new ones.3 In this book I explore three aspects of creative destruction in the built environment that are underappreciated by scholars and practitioners in the fi elds of real estate and urban planning. First, creative destruction has a histo- ricity; innovation and annihilation tend to occur together in time, and certain 2 introduction figure 0.1. Chicago Board of Trade building, 2011. Photograph courtesy of Kevin Dickert. periods experience a disproportionate amount of both. At these times the de- velopment industry, fi nancial markets, and public planners all race to erect new structures and demolish older ones. Spectacular changes are made to the urban fabric. In the following chapters I take apart these dizzying “build- ing booms” to determine what sets them off, what sustains them, and what cuts them off. Looking specifi cally at the case of Chicago during the early years of the twenty-fi rst century, I argue that developers there acted as they did not because potential occupants demanded new buildings, but because fi nancial markets were making more capital available. The new offi ce towers that pulled tenants from LaSalle Street were fi nanced by investors speculating on future sale prices, prices infl ated by the use of derivatives and other com- plex fi nancial instruments. Under the circumstances, it made more sense for them to build, buy, and “fl ip” buildings than to invest in other kinds of assets. Second, creative destruction is subject to social and political forces that infl uence what Schumpeter called its “perennial gale.”4 In addition to their drive to maximize profi t, capitalists are motivated by professional norms— such as the pursuit of status and peer imitation. Political incentives and reg- ulations also structure and harmonize their behavior. Individual capitalists receive guidance in interpreting their markets from intermediaries, such as brokers, who play a critical role in propagating ideas about the right times to invest and the right buildings in which to invest. Tenants abandoned their why we overbuild 3 older premises on LaSalle Street because, like developers and investors, they too operated within status hierarchies that placed a premium on the most modern construction. They too were subsidized, either through concessions offered by the landlords of these new buildings or through the City of Chi- cago’s economic development policies. Moreover, they too depended on the advice of intermediaries whose commission and fee structures rewarded mo- bility and short-d istance relocations. Such professional advice helps industry actors make decisions under uncertainty, but can also lead to collectively ir- rational results. Construction in downtown Chicago, for example, continued unabated during the 2000s despite the fact that employment growth was fl at. Third, during a boom, the actors engaged in creative destruction often misread demand, miscalculating the nature and amount of new products the market is willing to bear as well as underestimating the strength of attach- ments to the older products that are destroyed. The pull to abide by domi- nant professional norms is often so strong that it distracts attention from actual occupant demand and results in substantial oversupply. Asset bubbles occur when the market for space comes unhinged from underlying economic activity and prices bear little resemblance to operating incomes. Once burst, bubbles leave behind an overhang of unused space. Vacancy rates spike, par- ticularly in those marginally older buildings whose tenants have fl ocked to the new stock. On a broader scale, building and lending to excess can bring down the banking system and capital markets, threatening macroeconomic stability. In exploring these three aspects of creative destruction, some central ques- tions emerge. What caused Chicago and so many other North American cit- ies to boom during the 2000s? What explains the dramatic and rapid changes in urban form witnessed during construction booms, when some areas are built up and out while others are thinned and de-d ensifi ed? Why do develop- ers seem to get ahead of themselves during these periods, producing more space than is needed by local businesses and households? And what accounts for the fact that some of the historic buildings in older submarkets, such as LaSalle Street, maintain their status and hold their value while others are torn down to make way for new construction during the boom? Rebuilding is usu- ally erratic and incomplete, leaving in its wake, as construction booms do, an assortment of old and new— shiny glass exoskeletons poking out from the bricks and mortar. How does this happen? To address these questions and contribute to a richer understanding of these periodic booms, their bubble phases, and subsequent busts, I care- fully dismantle the urban development process. This process is a mixture of continuity and change, building and unbuilding—d ualities more accurately