Even with the office sector’s struggles, vacancy rates are solid in Chicago’s Tier 1 office properties, newer office buildings in the city’s downtown core that boast strong amenity packages.
This isn’t surprising: The flight to quality is real. Companies are looking for high-end, well-located office space as they try to bring their employees back into the office more often. Modern class-A office properties in downtown Chicago located near restaurants, bars, theaters, retail and services fit that description.
But what about Tier 2 office properties, those buildings that, while still boasting high-quality construction and amenities, might be a little older? Or maybe they’re located on the farther edges of the city’s CBD? Is demand increasing for these spaces?
It might be, according to a new study from JLL. According to JLL, as vacancy rates in Tier 1 office spaces stabilize by the year 2028, demand is expected to spill into Tier 2 properties.
To better understand this trend, we spoke to Edgar Leon, senior manager of Chicago research for JLL, about the shift of tenants to Tier 2 properties as space becomes more difficult to find in Chicago’s downtown trophy properties.
Here is what he had to say.
What is the difference between a Tier 1 and Tier 2 office property in Chicago?
Edgar Leon: What is a Tier 1 asset? It’s any kind of office property in the downtown market that is of the latest generation of space. It is the trophy assets. Tier 2 is the generation of downtown product before that. They are good, high-quality assets, state-of-the-art assets. I’m thinking of places like 151 N. Wacker and 500 W. Madison. They are buildings that have often gone through a high-quality renovation. They are often well-located. But they are last year’s model. Tier 1 properties are like the new model Corvette. Tier 2 is like last year’s design. They are still high-quality spaces, but they’re a bit older.
Why would tenants choose a Tier 2 property instead of a Tier 1 office property?
Leon: Vacancy rates in Tier 1 properties are lower. When you look at the tenants in the market that we work with, 95% are looking for office space in Tier 1 and Tier 2 assets. Those assets make up maybe about 30% of the total office space in downtown Chicago. This means that most tenants are looking in just a third of the Chicago office market.
There is that spillover effect. The average tenant in the downtown Chicago office market is looking for about 30,000 square feet. The vacancy in Tier 1 space that can accommodate that demand becomes even less. Because of this, many tenants must consider Tier 2 space because they can’t find what they want in Tier 1 space.
There are also cost savings associated with Tier 2 space. You can be in a quality building up the river perhaps that has all the amenities you want. You can get a high-quality space while paying less than you would for a Tier 1 space.
The flight to quality is still happening in the Chicago office market, right?
Leon: Absolutely. It is about the amenities and quality of the office building. There is a reason why so many tenants are looking at Tier 1 and Tier 2 spaces. They have the highest quality of amenities. Some Tier 3 properties might have good amenities here and there. But the level of amenities that people want is usually found in Tier 1 and Tier 2 buildings.
Is it easier for employers to get their workers back into the office if they locate in a Tier 1 or Tier 2 office building?
Leon: I think it is. Those buildings are well-located. They will be near transit options, both CTA and Metra. Tier 2 asses in the West Loop, for instance, have done very well as we see more employees coming back to the office. The urge to work in a transit-oriented building is a big factor. It has pushed more leasing into traditional office markets such as the West Loop and River North where there are quality transit options. These properties are also located near social amenities, something else that is appealing to workers returning to the office.
What about in the Chicago suburbs? Do you expect to see more demand for Tier 2 office properties in the suburbs as space tightens in suburban Tier 1 office buildings?
Leon: There are some differences in the suburbs. In the city, a Tier 1 asset is partially based on when it was built. In the suburbs, we do not see many new office properties being built. Tier 1 in the suburbs, then, are the crème-de-la-crème properties. That is where we see most of the demand in the suburbs.
Most tenants in the suburbs are flocking to quality, well-located office buildings. Being located near O’Hare or within proximity to major highways is important, too.
What about in other cities in the Midwest? Are you seeing demand rising for Tier 2 office properties in these areas, too?
Leon: This trend does repeat itself in other larger cities and metros. Cities like Los Angeles, New York and other larger cities tend to mimic each other when it comes to this trend. We are hoping to study other Midwest cities such as Minneapolis and Indianapolis. I do think we’ll see that the trend is very similar in these cities, too: The highest-quality office asses perform the best.
Underwhelming Class-B and Class-C buildings might be repositioned into other asset types or in the suburbs demolished for industrial.
Conversions of older office space are going to be important for the market. This can be difficult, though. Converting office to multifamily is very difficult. Many of these buildings that are obsolete for office use are not a natural fit for multifamily. You need a creative developer to think outside the box. In the suburbs it’s easier. You can take a building off the highway, get approval from the city and build a warehouse or industrial complex on that site.
