The downtown office market continues to recover at an impressive rate, with the first half of 2011 reporting the strongest numbers since 2007. Unfortunately, the dynamics working in its favor seem to be working against the suburban market as its office supply continues to struggle, according to Transwestern‘s second quarter outlook.
Net absorption of office space in the CBD hit 986,000 square feet in the second quarter, bringing the total to 1.3 million square-feet for the year-to-date, reports Transwestern.
This is quite a jump for the market, recording more positive absorption in six months than any full year since 2007. The surge in activity brought the overall vacancy rate in Chicago’s CBD down to 12.5 percent in the 2nd quarter of 2011, from 13.3 percent in the 1st quarter and a cyclical high of 14.1 percent a year ago.
Transwestern’s reports typically show vacancy rates 2-3 percent lower than most other industry reports, because the firm includes data from buildings less than 15,000 square feet, single tenant, and owner occupied facilities. All told, the report includes 50 million square-feet more than if it tracked multi-tenant alone.
This is done in efforts to show correlation between job growth and occupancy of inventory, and, because owner occupied space often does become competitive space. The addition of Blue Cross Blue Shield’s space at 300 E. Randolph is a prime example. It added 800,000 square feet to its facility that was supposed to be all owner-occupied. It eventually offered half of it for sublease. If an owner does not offer up space for sublease, the facility is recorded as 100 percent occupied.
The downtown market activity is being driven by a number of reasons; chief among them is the desire for firms to locate nearer to talent. Within the last year, companies like United Airlines have announced large-scale moves to the CBD. Motorola and GE Capital have announced major expansions and hot start-ups like Groupon have grown to take on several large blocks of space. As a result, employment growth in Chicago has picked up. The metro Chicago economy recorded a 12- month job growth of 37,100 during the 12 months ending April 2011. The unemployment rate declined to 8.7 percent in April 2011, from 9.5 percent in January, and 10.7 percent a year ago. While this activity may be positive, it is still below the average annual gains of 47,000 from 2005-2007.
Still, the latest numbers have professionals more optimistic about the future.
“It feels like it is back to business,” says Tamara Kos, executive vice president with Transwestern. “It is not the same level of demand as in 2007, but dynamics are returning. We are seeing job growth and I expect that to continue.”
Kos points out that since newly elected Mayor Rahm Emanuel has taken office, multiple firms, such as the aforementioned GE Capital and Motorola, among others, have pledged new hiring to the tune of 4,000 jobs.
“Companies are coming to Chicago for its location and proximity to a young, talented workforce,” says Tamara Kos, executive vice president with Transwestern. “The cache is there now, unlike 15 years ago when firms were moving to the suburbs.”
Today, workers tend to value living and working near public transportation. Chicago has the ability to draw public transit commuters from urban and suburban locations into a central area. Conversely, many suburban locals suffer from the inability to connect public transportation and work centers.
Yet, while some large firms are pledging job growth in the future, recent real estate expansion has been led by the small-to-medium sized firms that are taking advantage of still favorable rental rates, says Kos.
“Class A asking rents in the CBD edged down 0.4 percent in the first half of 2011,” says Kos. “Rates haven’t moved much. Statistically, we hit bottom last year. As absorption continues, eventually, rates will increase and concessions will decrease.”
The market still faces numerous challenges. One of the bigger leases last quarter was by McKinsey and Company, which leased 100,000 square feet at 300 E. Randolph. The firm is vacating a 150,000-square-foot space. Large firms are becoming more efficient with space and finding ways to maximize their square-footage allowance.
“We are seeing employee growth, but big firms are driving down square footage per employee,” says Kos. “The McKinsey deal was not based on job loss, but efficiency.”
Wells Fargo took the largest lease in the second quarter with 300,000 square feet at 30 S. Wacker Drive, followed by Bankers Life & Casualty taking 135,000 square feet at 111 E. Wacker.
Numerous big firms are still looking, with Citadel in the market for 400,000-square-feet, but big floor plates for large scale deals are becoming scarce.
“If you are a 20,000-square-foot tenant you have hundreds of choices,” says Kos. “If you are looking for 100,000-square-feet you have a few choices and there are only a couple sites that can accommodate 300,000-square-feet and above.”
This has fueled speculation for new construction in the downtown market, but with an earliest estimated delivery of 2014, many firms may end up renewing where they are.
Suburban market
The suburban market has not fared as well, experiencing 37,000 square feet of negative absorption, bringing the year-to-date total to negative 385,000 square feet. The overall Suburban Chicago office vacancy rate jumped to 17.0 percent in the second quarter of 2011, from 16.4 percent in the first quarter and 16.8 percent a year ago.
While owners and landlords are beginning to find equilibrium in the downtown market, the suburban market is still decidedly in the tenants favor. Suburban asking rents for all classes of space declined 2.9 percent in the first half of 2011; Class A asking rents dropped 4.4 percent.
Many areas have been particularly hard hit as they are heavily reliant on specific industries.
“The northwest corridor was hit hard by the struggles of the mortgage industry and the East-West Corridor was very reliant on the technology industry,” says Kos. “Those markets have suffered. They will need to find new industries and diversify their base.”
There is 877,800 square feet of office space under construction or renovation in suburban Chicago at mid-year 2011, up from 768,250 square feet in the first quarter and 696,000 square feet a year ago. Astellas Pharma is building a 416,000-square-foot U.S. headquarters in Northbrook. Suburban office space under construction is 84 percent pre-leased. Three office buildings, totaling 140,000 square feet, were delivered in the first half of 2011. These buildings were 100 percent leased upon delivery.
Investment sales
The investment market has continued to recover and the first half of 2011 has seen improved activity. The market recorded investment sales of $827 million in metro Chicago during the first half of 2011, compared to $322 million in the first half of 2010. Sales volume in the second quarter of 2011 totaled $413 million in metro Chicago.
The largest sale of the second quarter took place in the East Loop, where CommonWealth REIT purchased 233 N. Michigan Avenue from Parkway Properties for $162.2 million.
Cap rates on core offices declined to 6.9 percent, down from a high of 9.3 percent in the spring of 2010. The report suggests that cap rates on core, long-term-leased CBD assets should stabilize in the low-to-mid-6 percent range. In the suburbs, core stabilized product will price in the high-6 percent to mid-7 percent range.
The emerging trend is that value-add assets are now finding their way to the market. Previously, investors were only interested in taking on core deals, but as the number of core deals available shrinks, many now are considering taking on buildings that may be a little older and come with some leasing required.
“Value-add investors are now willing to buy more vacancy and do it at a discount,” says Kos. “A year or two ago you couldn’t finance a value-add deal. It’s really amazing compared to where we were two years ago.”
Delta Associates, the research affiliate of Transwestern, complies the information for its quarterly reports.