A common question Chicago office brokers are hearing from clients these days is, “When is the best time to start negotiating with my landlord?” In fact, it is also a question brokers are asking themselves, contemplating when they should advise their clients to get into the market. The truth is: 1) it’s very hard to say, and 2) it depends on the situation.
Let’s explore what we do know. This is a historically tenant-favorable office market. Vacancy rates have increased from 13.8 percent to start 2021 up to 17.7 percent currently. Concessions are far over-weighted with construction allowances and free rent packages 20 to 30 percent higher than they were pre-pandemic, and landlords are being more flexible on term lengths allowing tenants three- or five-year leases despite offering full buildouts.
Corby Marx, Colliers Chicago
On the other side of the coin, gross rental rates (base rent plus real estate taxes and building operating expenses) have not declined. In fact, in the last quarter they increased from $42.34 to $42.57 per square foot. The trends and market conditions surrounding concession packages and rental rates haven’t really changed in the last 12 months or so.
The above touches on what the market is doing, but what are tenants doing? Possibly the biggest difference between 2020 and 2021 in the Chicago office real estate market is that many companies are finally making decisions. However, most of those who are signing leases have reduced their respective footprints.
Total net absorption (the amount of space leased compared to what has been vacated) has reported four consecutive quarters of negativity, coming in at just over 1.2 million square feet of negative absorption. Total year-to-date net absorption has reached over 3.96 million feet — a record high in negative net absorption activity in one year. Since the end of March 2020, the onset of the health crises, 9.1 million square feet has been vacated in the central business district.
What we don’t know is whether the gross rental rates will eventually break or if the high concession packages have buoyed landlords through the worst of times. That is where a tenant’s individual business situation comes into play.
Traditional users of office space such as legal, sales, insurance and financial services are not dramatically changing their layouts and therefore can commit to their office with greater confidence. This is especially true for smaller and mid-sized companies in those sectors — the sector responsible for a majority of market activity. Those types and sizes of companies can take advantage of the concessions and lock in the tenant-favorable market for many years to come.
On the other hand, companies in tech, association/nonprofit and consulting industries are looking for ways to change their spaces to accommodate the new workplace strategies that are being adopted. Those firms are left in the difficult position of not being ready to act because they still don’t know what their future office needs will look and feel like yet. But many of them are worried about missing out on a great opportunity.
The firms in the former scenario have grabbed hold of what the landlords are offering and locked it in for the long term. The good news is that firms that can’t make that commitment or look that far into the future still have opportunities.
We are now in an interesting, and somewhat unprecedented, market balance: 1) activity is high from companies that put their decisions on hold last year, 2) companies’ natural expiration dates are now coming due, and 3) opportunistic companies are looking to take advantage of the situation. Yet the office market remains soft because so many of the leases being signed are for less space. Even though tenants are signing leases again, landlords are still losing occupancy.
The economy is still quite healthy and for most industry sectors, business is good. In most downturns, tenants are looking to save money through occupancy costs to help offset their decreased revenue. In this cycle, leadership is downsizing because they aren’t using the office as much as they used to. Subsequently, we are seeing a flight to quality. The tenants mentioned above are looking to upgrade office space and/or location while maintaining current occupancy costs.
The appetite for well-located space with good views in a high-quality building is still very healthy and far different from that for low floors of a Class B building. Other than the trophy class buildings, we see the rental rates holding steady and concessions remaining high for the next two or even three years.
So, the answer to your question about when the best time is to start negotiating…it depends.
Corby Marx is a senior vice president with Colliers Chicago. This article originally ran in the October 2021 issue of Heartland Real Estate Business magazine.