The metro Chicago office market experienced mixed performance in the third quarter, with the CBD outperforming the suburbs, according to a Chicago office market report by Transwestern and its research affiliate, Delta Associates.
The overall vacancy rate in Chicago’s CBD declined to 11.6 percent in the third quarter of 2013, down slightly from a revised 11.7 percent at mid-year, but up from 11.4 percent a year ago, according to Transwestern. This compares to a cyclical high of 14.1 percent in the third quarter of 2010. Transwestern expects vacancy to edge downward through the fourth quarter of 2013 and into 2014, in concert with steady job growth and renewed interest from potential tenants looking to take advantage of relatively low rental rates.
Transwestern notes that the direct vacancy rate in the CBD declined to 10.8 percent at third quarter 2013, from 11.0 percent at mid-year, but is up from 10.5 percent at the third quarter of 2012.
Net absorption of office space totaled positive 200,000 square feet in Chicago’s CBD in the third quarter of 2013, according to Transwestern. A handful of significant lease transactions boosted net absorption during the past three months.
“I feel confident about activity. I just don’t know how that is ultimately going to be measured in terms of absorption because the deals that will be getting done are a lot smaller,” said Tony Smaniotto, executive vice president in Colliers International’s Investment Services Group. “So it feels good. There’s a lot of activity. It just might not add up to those big historical absorption numbers.”
With steady job growth in the professional/business services and financial activities sectors, Transwestern expects absorption to remain positive for the remainder of the year for the CBD, but growth may not be robust enough to fully offset the 354,000 square feet of space vacated year-to-date. The window of opportunity for prospective tenants to obtain high quality space in the CBD remains open due to consolidation earlier in 2013, but the market is gaining traction.
“There is a transformation, in effect, going on in Chicago,” Smaniotto said. “There’s obviously an incredible amount of energy and momentum occurring due to the growth in Chicago of technology firms such as Google and others.
“We’ve seen a lot of activity with the big one-off transactions and we’re seeing a lot of the corporate service demand chipping away,” he added. “We haven’t seen a lot in between and we’ve got to get a lot of those small and mid-sized office space users to get rolling before we really get back to a healthy office market.”
No new projects broke ground during the third quarter of 2013. The two projects under construction in the CBD — 444 W. Lake St. and 1000 W. Fulton St. — total 1.8 million square feet and are 40 percent pre-leased, according to Transwestern. The conversion of 1000 W. Fulton to office space is scheduled for a January 2014 delivery, and the 444 W. Lake St. property should be completed in early 2017. There were no office deliveries in the CBD in the third quarter of 2013.
Meanwhile, asking rents have risen 0.2 percent for all classes of office space in the CBD since year-end 2012, while Class A asking rents in the CBD have declined 3.3 percent, according to the Transwestern report. Class A rents are experiencing “subtraction by addition,” as available space hits the market at lower rates, bringing down the average. Transwestern expects this slide to correct in the near term, as consistent job growth drives demand for office space and pushes vacancy downward. Better buildings with strong, well-capitalized ownership will outperform market-wide averages, the report notes.
In general, tenants remain cautious about future growth and, in many cases, are filling space to accommodate only their current needs.
“Interest rates have affected decisions again because corporate America rode out the recession and forestalled big transactions, instead opting to do short-term leases,” Smaniotto said. “Most of the big companies downtown have made their deals and taken advantage of the low rates.”
However, Transwestern points out that if job growth continues at a steady rate, rents are likely to rise further in 2014 given the limited pipeline of new construction.
Suburban office
The overall office vacancy rate in suburban Chicago rose to 15.3 percent at third quarter 2013, from 15.1 percent at mid-year, but vacancy is well below its cyclical high of 16.9 percent in the third quarter of 2010. The overall vacancy rate is unchanged from a year ago, according to the Transwestern report.
The report goes on to state that the suburban Chicago office market experienced 477,000 square feet of negative absorption during the third quarter of 2013; the year-to-date total absorption is positive 74,000 square feet. Move-outs more than offset leasing activity during the third quarter. In particular, the East-West Corridor submarket dragged down absorption during the third quarter, at negative 297,000 square feet, though it remains positive for the year-to-date.
“The East-West Corridor is doing OK, but I think that as you move farther west in the East-West Corridor, they’re still having some issues,” said Eric Myers, principal at Avison Young.
There is 320,400 square feet of office space under construction in suburban Chicago at third quarter 2013, compared to 623,000 square feet at the third quarter of 2012, according to Transwestern. Suburban office space under construction is 98 percent pre-leased. There are five properties under construction, but only one is larger than 100,000 square feet, the report states. The suburbs’ limited pipeline, which is equal to just 0.1 percent of the suburban Chicago inventory, will help to promote the market’s recovery during the balance of 2013 and into 2014. New construction remains largely build-to-suit.
There were no deliveries in the suburban Chicago office market during the third quarter of 2013. Transwestern notes that year-to-date, 287,000 square feet of new space has been delivered to the suburban Chicago office market at 85 percent leased upon delivery.
Suburban asking rents for all classes of office space have fallen 2.0 percent year-to-date during 2013, though rents quietly rose 0.4 percent during the third quarter, according to Transwestern’s report. Class A asking rents are down 2.8 percent year-to-date, though up 0.6 percent during the third quarter. Of note, better-located product is outperforming this trend. As tenants continue to reduce requirements for space in an effort to become more efficient and reduce occupancy costs, landlords have reduced asking rents in order to boost occupancy, according to Transwestern.
With the market favoring tenants, predominantly due to large amounts of vacant space, Transwestern predicts that concessions will remain steady through the rest of the year and that landlords will renew leases at lower rates to secure occupancy.
“It’s challenging for suburban office landlords right now,” Myers said. “Rents have been really depressed. Vacancy has risen. A lot of the office product that was bought in 2006 and 2007 has either gone back to the lenders or they’ve had to reconstitute their notes with the banking institutions. It’s tough. It’s pretty depressing to hear what landlords have to do to keep tenants and attract new tenants.”
However, Transwestern expects suburban asking rents to stabilize during the balance of 2013, with demand picking up in early 2014 and rents gradually following suit.