Chicago Office Market Report Year End 2009
Jack O'Brien
Vice President-Leasing
At year end 2009, the total supply of office space in the Chicago area office market measured 231,972,000 rentable square feet (RSF), breaking down into two statistical categories: Chicago's Central Business District (CBD) and Chicago's Suburban markets. The CBD totals 125,158,000 RSF while the suburban market totals slightly less at 106,814,000 RSF. The growth in the size of the Chicago markets has been dramatic over the past development cycle. In the past 24 months alone, mixed-use developments and build-to-suits have added just over 6.2 million RSF of inventory, 76% of which was delivered to the CBD, including such trophy towers as 300 North LaSalle (developed by Hines), 155 North Wacker (developed by The John Buck Co.) and 351 North Clark (developed by Mesirow Financial).
Chicago CBD -
In light of the recession, 2009 was a difficult year for the office market. The vacancy rate in the CBD at year end was 16.1%, consisting of 13.8% of direct vacancy and 2.3% of actively marketed sublease space, representing an inventory of 20.1 million square feet of vacant space. By comparison, the inventory of available space in the CBD at the end of 2008 (including sublease space) was 13.2 million RSF. Some of this vacancy increase is attributable to new deliveries, but much of the surge in available space was driven by the contraction of space requirements, which naturally follows from a shrinking jobs market.
The Central and West Loop Submarkets (the two largest submarkets comprising almost 70% of the total CBD) tracked very closely with the overall market vacancy. The third largest segment, the East Loop, is burdened by an even higher vacancy rate, which is generally attributable to the submarket's distance from the commuter train stations in the West Loop, as well as City Hall and the Chicago court systems in the Central Loop.
With supply increasing and demand for space anemic at best, gross asking rents declined for the sixth straight consecutive quarter. Overall, average gross asking rents dropped $1.02 per RSF over the course of the year, ending at $31.80 per RSF. The Class A market averaged $37.23 per RSF gross, the Class B market averaged $31.77 per RSF gross and the Class C market averaged $23.89 per RSF gross. Real estate taxes and operating expenses will represent, on average, $15-$19 per RSF for Class A and $14-$16 per RSF for Class B properties. More telling is the fact that actual rents for completed transactions were up to 10% less than quoted asking rents, depending on the total concession package, lease term and credit of the entity signing the lease.
In order to protect rental rates, Landlords offered more generous tenant concession packages, in the form of richer tenant improvement allowances, longer rent abatement periods and/or more lucrative broker commissions. However, as demand continued to plummet, these one-time marketing "specials" quickly became the norm, as Landlords tried to adjust to the unusually low level of leasing activity. Today, a new ten year lease would likely demand a gross rent abatement of 12 months and a tenant improvement allowance of as high as $70 per RSF (depending on the credit quality of the prospective tenant). Bonus commissions (above $1.25 per RSF per year) are now offered by approximately 35% of Landlords leasing Class A and Class B product in the CBD.
From peak employment in 2007 to year-end 2009, approximately 8 million jobs were lost. At year end 2009, our national employment level matched that of 2001, representing zero growth for the past 8 years. The Chicago market suffered its proportionate share of job losses as well. During each quarter in 2009, Chicago's unemployment rate stood at 25 - 75 basis points higher then the nation's average.
Looking Ahead -
Fortunately, the pace of job losses in the US has slowed substantially. In fact, the chart below shows, on a national basis, how the job outlook can quickly swing positive. In 2011, this projection shows an increase of approximately 3.5 million jobs to almost 135 million employed. In 2012, nearly 5 million jobs are projected to be added setting a ‘high water mark' for the number of people employed at almost 140 million - the previous jobs record set in 2007 was 138 million. Chicago, with its diverse employment base of legal, consulting, banking and manufacturing will benefit from the anticipated recovery.
Total Employment Growth & Forecast
The total market supply in Chicago will peak in 2010 when the last new building from this development cycle is delivered to the market. 300 East Randolph (expansion space for Blue Cross Blue Shield and the future home for Baker & McKenzie) will bring 900,000 RSF of new Class A space to the East Loop. Fortunately, no new office deliveries are currently planned for Chicago.
Office Deliveries by Year-%
The chart above (Source: CoStar) shows, on a national basis, the record low level of office deliveries in 2010. It is projected that new office space inventory in 2010 will add less than a half of one percent to the total market, representing the least amount of new space delivered to the market in over 40 years. Similarly, office building deliveries for 2011 and 2012 are currently projected to set new record lows. With regard to Chicago's CBD market, a Hines executive opined during a recent real estate market panel discussion that Chicago's CBD will not see a new office building delivered to the market until 2017 and that, he said, was an optimistic view. If this holds true, the current inventory of vacant space will certainly be absorbed more rapidly and effective rental rates, i.e. the combined effect of higher rental rates and lower tenant concessions, will correspondingly begin to increase.
Requirements for Success in 2010 -
In addition to the obvious, i.e. offering proposals that feature aggressive effective rental rates, it will often be the intangibles that will give some Landlords a competitive edge in an exceptionally difficult market. Landlords would be well advised to be diligent about maintaining professional looking properties that have clean lobbies, healthy planters, attentive guards, watchful security officers, etc. Available suites being marketed for lease should always be in "market ready" condition - in fact, some Landlords are wisely building out vacant suites on a speculative basis in anticipation of leasing interest from some space users who got off to a late start looking for office space alternatives. Landlords are likely to be rewarded with high tenant retention ratios if they proactively explore lease renewal opportunities with their tenants by customizing lease proposals to anticipate specific tenant needs. Finally, communicating with tenant brokers through a quality marketing campaign that creates awareness of leasing opportunities offered by Landlords who are ready, willing and able to offer market competitive proposals is absolutely critical in 2010. In a market that offers countless opportunities to prospective tenants, it does not take long for a building that is either unwilling or unable to offer market competitive terms, to be stigmatized with the dreaded "zombie" classification by a very shrewd, "cut-to-the chase" tenant representative community.