For Chicago Office, The Way Back Might Be A Long One

Millbrook Properties Executive Director Jen Sweeney sums up the doldrums of Chicagoland’s office market in an anecdote involving blue gift bags filled with candy bars, pens and other goodies meant to welcome tenants back to the office in June 2020.

The bags were left in conference rooms in suburban Chicago and across the Midwest a few months after the pandemic hit in a gesture of solidarity and hopefulness the business world would soon return to rights.

“Now here we are two years later, and we still have a whole bunch of those blue bags left and we've had to throw away those candy bars. They've gone stale,” Sweeney said.

Although the market is hitting its stride in places like Fulton Market, River North and some suburban submarkets, vacancy is sky-high, leasing dropped to its lowest level in more than a year in the third quarter and a wave of distress is likely in the cards.

Today, offices are about half full, at least midweek, as hybrid schedules take root, panelists at Bisnow’s Chicago Office Summit held Sept. 29 at Riverview at Roscoe said.

But as the city battles headwinds from crime to persistent slow growth that have led to record office vacancy, the way back is slow and uneven, with many tenants renewing leases that are as much as 35% smaller than before, even as others expand in neighborhoods like the city’s thriving Fulton Market.

“We're seeing a little bit of everything,” Tishman Speyer Managing Director of Leasing Adam Mitchell said, adding that large global occupiers might be shedding about a third of their space, but 320 North Sangamon St., a 270K SF building his company delivered in Fulton Market just last year, has only 24K SF remaining.

Mitchell said professional and financial services firms are signing leases, with many tenants utilizing space differently, often doubling the amount of square footage dedicated to hospitality. That partially compensates for a reduction in dedicated seats at offices, he said.

Smaller tenants in legacy properties, however, are going even smaller.

"In the older brick-and-timber lofts, I would say we're probably seeing more tenants downsize than upsize,” said North Wells Capital co-founder and CEO James Fox, adding that those properties are suffering from a stampede of office tenants toward newer, highly amenitized properties.

“The market today is really an interesting dichotomy because you've got increasing vacancy and increasing sublease space, and yet, lease deals that are getting done are in the more expensive buildings, the new developments," Fox said.

That has led to feast and famine for Chicago office, with older properties and Class-B and C properties going hungry. Where once tenants were attracted to locations and addresses, panelists said they’re now sifting by product type and whether buildings are situated in live-work-play neighborhoods with large employee bases from which to draw.

That’s as true in the suburbs as it is downtown. Sweeney said landlords that failed to upgrade and add amenities to older buildings are unlikely to make it.

“When you look at the suburban market, that's where everybody is going, and quite honestly, the A buildings can afford to drop the rate, the B and the C buildings can't necessarily,” she said. “So those buildings are going to start looking at adaptive reuse and we've seen that in the suburbs. There are still even maybe a Class-A building or two in the suburbs that are not going to make it because they're not in that live-work-play area, and they're going to have to start looking at what is the highest and best use.”

Even so, a plan announced last week by Chicago Mayor Lori Lightfoot to do just that by incentivizing developers to turn aging but historic office properties into apartments and condos along the city’s hollowed-out LaSalle Street corridor drew a mixed reaction.

Panel moderator Molly Phelan, a partner with Siegel Jennings, noted the area is home to “a ton of Class-C properties that in a million years, you can't turn into Class-A property.”

And while Fox called the initiative great, in theory, he advised allowing the free market to decide how to repurpose LaSalle Street’s more than 5M SF of mostly empty office space.

“Let the developers figure out what's best,” he said. “I do think some of those buildings are so functionally obsolete — the giant floor plates, the light corridors, you know, frankly, suck because they're building-to-building … The smaller [buildings] probably can be adapted to multifamily, hotel or other uses, but the big ones, some of those are in real trouble.”

On the other hand, Mitchell said that with Google’s announcement it would purchase the iconic James R. Thompson Center in a $105M deal many hope will transform the Central Loop, he could easily envision the corridor becoming a haven for young professionals.

“I'd love to see some of these buildings turn into apartments on top and coworking on the bottom,” he said. “If people are going to go in two to three days a week and I was 25 again … I'd love to have an apartment on the 26th floor and head down to kind of a cool collaborative workspace.”

Mitchell said Google could be a major catalyst for growth regardless of the city’s plans to reinvent it as a residential hub.

“That's going to be a big, big thing and it's going to drive a lot of investment to it,” he said. “Who knows who's going to come out of the cracks and leverage that investment for their own benefit.”

For now, though, panelists advised the CRE community to pick its shots carefully amid rising interest rates, foundering interest in the Chicago market and a potential wave of distress as loans on troubled properties come due and banks hike loan-to-value ratios.

“Some of those owners are going to just hand back the keys,” Sweeney said.

In the past month alone, two LaSalle Street office properties saw their loans transferred to special servicers in a sign they are in danger of defaulting on their loans. Shrinking office requirements have cut into profits, pushing some landlords into foreclosure and dropping property values to the extent refinancing loans is tricky and often impossible.

That could mean opportunities — eventually.

“The distress [Sweeney] was talking about is real and it hasn't even really started,” Fox said. “I think you're gonna see plenty of distress. And I believe that for the next couple of years, there's going to be some good things if you really pick through all of it. But by and large, it hasn't gotten beat down enough for it to really be that big macro opportunity.”