Strong Tenant Demand Continues to Propel Chicago’s Office Market

In spite of the ongoing fiscal woes of the State of Illinois and City of Chicago, the downtown office market in the Windy City continues to experience solid growth in demand for quality office space. The first quarter of 2017 saw net absorption of 374,000 square feet, a 54 percent increase from the 243,000 square feet of net absorption recorded during the first quarter of 2016.

This comes on the heels of a spike in supply in the central business district (CBD) of Chicago, with the opening of two new Class A office towers during the past two quarters: 150 North Riverside Plaza and 444 West Lake Street, developed by Riverside Investment & Development Co. and Hines Interests, respectively. These trophy assets added 2.4 million square feet of office space to the CBD.

Bob Chodos, Newmark Grubb Knight Frank

Bob Chodos, Newmark Grubb Knight Frank

With these additions, Chicago’s office inventory in the CBD expanded from 132.6 million square feet in the first quarter of 2016 to 135 million square feet in the first quarter of 2017. Two additional towers under construction now at 151 N. Franklin Street and 625 W. Adams Street will open in the next 12 months, adding an additional 1.3 million square feet to the supply and bringing that total to more than 136 million square feet.

Who’s absorbing the space? 

Demand is coming from a diverse cross section of industries including professional and business services, healthcare, education, hospitality, food, transportation, consumer goods and technology. Chicago is one of the world’s largest and most diversified economies with more than 400 major corporations headquartered here, including 31 Fortune 500 companies.

Chicago’s newest buildings are opening with major lease commitments from Hyatt Corp., William Blair & Co., McDermott Will & Emery, DLA Piper, Mead Johnson Nutrition, CNA Insurance and Navigant to name a few. Companies such as Outcome Health, formerly Context Media and Motorola Solutions Inc., have recently backfilled large blocks of existing Class A space.

Outcome Health recently leased 385,000 square feet of space vacated at 515 N. State Street by the American Medical Association in 2013. The tech incubator known as 1871 now boasts more than 180,000 square feet of space at the Merchandise Mart, with over 400 start-up operations currently in place, employing over 6,000 people, busily working to create the next tech success story.

So, stay tuned for more tech startups to become major enterprises in Chicago.

Motorola Mobility shocked the market in 2013 when it leased over 600,000 square feet at the Merchandise Mart. Motorola Mobility was then sold to Google and subsequently to Lenovo in 2014-15.

On the heels of that move, Motorola Solutions signed a lease in 2015 to occupy 160,000 square feet at 500 W. Monroe St. and has since expanded its space to more than 200,000 square feet.

CBD is a corporate magnet

Suburban migration of companies into Chicago’s CBD remains a big story. This has been one of the key drivers of demand in the market. Since 2012, over 4.8 million square feet of space has been leased by companies moving their headquarters, or portions of their operations, into the CBD. These include but are not limited to:

• United Airlines, with over 839,000 square feet at the Willis Tower;

• McDonald’s Corp., with its new 485,000-square-foot global headquarters under construction at 1045 W. Randolph St.;

• Kraft Heinz, which leased over 170,000 square feet at Aon Center for its headquarters operations (the company relocated from Northfield, Ill., in 2015);

• Nielsen Corp., which recently expanded its office lease to 212,000 square feet at 200 W. Jackson St. and is relocating operations from Evanston and Schaumburg, Ill.

Those events, coupled with over 5.3 million square feet of leases signed in the CBD in the past 12 months, bodes well for the future of Chicago office absorption

What does future demand for office space look like in Chicago?

My team tracks tenants we know to be actively reviewing their space needs in the market now. Tenants that have a lease expiration occurring within the next five to seven years, or are involved in some other business event that could generate a need to do something with their lease well in advance of its expiration, are evaluating their options today.

Our list contains over 8.9 million square feet of active prospects — a very healthy inventory of potential transactions owners will have to make in the coming years. The demand pipeline looks to be quite strong for Chicago’s CBD.

Long lead times

Many ask, “Why do these businesses consider their space needs with so much time left on a lease?”

For large leases of 200,000 square feet and up, the lead time for negotiating to be an anchor tenant in a new development can be upwards of five years. It often takes up to three years to build a new office building and a year or more to design, entitle, price and finance it prior to the start of construction. A lease has to be negotiated, after a market process that can take a year or more to complete. So, lead times can be very long in the real estate space.

Office landlords with large tenant leases in place — but with less than five to seven years remaining on those leases — are confronted with a dilemma. How do they predict, with some reasonable certainty, the ongoing cash flow from that property that will justify asset valuations owners rely upon to finance and operate their buildings? The cost to carry and re-lease a space vacated by a tenant is an event all landlords try to avoid.

Today’s market is both technology-
focused and design intensive. For both landlords and tenants, moving from one office building to another is most always an expensive proposition. All-in costs to design, build, furnish and equip new workspace in Chicago can exceed $200 per square foot. So, capital demands on both sides of the equation are challenging.

Because of these dynamics, larger tenants enter the market far earlier today than market observers would expect, and landlords negotiate well in advance of lease expirations in order to keep their properties full.

The top 10 leases signed in Chicago in the past 12 months total 3.1 million square feet. Six were early lease restructures totaling 1.86 million square feet. This means that 60 percent of this top segment of transaction activity in the market is attributed to early lease restructuring.

Rents a relative bargain

What does this all mean for Chicago’s CBD? Compared with other major office markets on the coasts like New York, Boston, San Francisco and Los Angeles, Chicago’s rents are a bargain.

Top rents in our market for premier office space can approach $60 per square foot full-service. That would be for the top floors in the best of the newest buildings in the market. Comparable spaces in New York or San Francisco could be north of $125 to $150 per square foot.

Companies seeking Class A space in Chicago can still secure leases with full-service rents in a range of $40 to $50 per square foot. For Class B and C space, these full-service rents can fall into the mid and sometimes low $30s per square foot. Quality space at a good value, compared with other major U.S. markets, can be found in Chicago.

What companies really treasure in Chicago is the access they gain to a dynamic, expanding and well-
educated workforce. The number of graduates from major colleges and universities in the region that move to Chicago is growing annually. That dynamic, coupled with proximity to a large international airport and a high-quality lifestyle, bodes well for Chicago’s future.

Oh, and did I mention access to fresh water? Many say that “fresh water will be the next oil.” The Great Lakes basin is one of the largest fresh water resources on the planet. Lake Michigan is the front door of Chicago. In coming decades, this water resource will likely be one of Chicago’s greatest assets.

The future for Chicago’s CBD and metro area in general is bright. If our state and city can get their fiscal houses in order, there will be no stopping Chicago as a great place to live, work and invest.

—By Bob Chodos, SIOR, Vice Chairman, Newmark Grubb Knight Frank. This article first appeared in the June 2017 issue of Heartland Real Estate Business magazine.

Content Partners
‣ Arbor Realty Trust
‣ Bohler
‣ Lee & Associates
‣ Lument
‣ NAI Global
‣ Northmarq
‣ Walker & Dunlop

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