Downtown Office Market Puts Together Another Solid Quarter, But Long-Term Outlook Stays Hazy

After putting up some solid numbers in 2018, Chicago’s downtown office market started the new year with robust activity in several of its submarkets, according to first-quarter data produced by Newmark Knight Frank.

Buoyed by several key lease renewals by big-name corporate players, along with the continued migration of suburban firms into the Central Business District, and the growing demand for coworking space, downtown office tenants absorbed another 466K SF, while the vacancy rate sank from 13.3% to 13.1%.

Still, even though experts are not exactly sounding the alarm, some worry the healthy demand may not match the amount of new office space hitting the market over the next few years. 

"The economy is so robust, but we have been on a 10-year run," Newmark Knight Frank Vice Chairman Bob Chodos said.

Last February, when the firm surveyed the city's downtown market, it found that tenants looking for space were collectively seeking about 8M SF. In its latest survey, finished early this year, the amount of space sought by tenants shrunk to 5.9M SF.

That decline could mean the market is slowing down, Chodos said, although other tenants could come forward during the next few months and join the competition for space.

The downtown market received a few needed shots in the arm during the first quarter. 

At 550 West Adams in the West Loop, USG decided to keep its 220K SF, and United Airlines, one of the market’s largest tenants, kept its 850K SF on the 16 lower floors of Willis Tower, where owner Blackstone is in the midst of a $500M renovation.

"United poked around the market pretty vigorously, and was out looking at all kinds of space, including Lincoln Yards and in Fulton Market, but Blackstone made it very attractive for them to stay," Chodos said. 

Many other downtown landlords are also in the midst of upgrading their properties, and he expects many will be successful in retaining their most important tenants.

Outside Chicago’s downtown, conditions seem less favorable.

“The suburbs continue to fight an uphill battle against aging building stock, a lack of access to public transportation, and the persistent trend of companies moving downtown,” the NKF report said.

Certain Class-A suburban properties now have little trouble attracting tenants that pay healthy rents, especially ones near O'Hare Airport, in Oak Brook and in several other locations, but NKF found the overall suburban vacancy rate rose 50 basis points in the first quarter to 21.5%, and average rents stayed roughly flat at $22.97.

Overall, the city should continue acting as a magnet for companies and jobs. Chodos said the total cost of doing business in Chicago is still much cheaper than in San Francisco and New York City, and most importantly, the labor pool will stay deep for a long time.

"Within a 200-mile radius, there are about 220,000 graduates coming out of some of the best schools in the country every year, and that has been driving the demand side of our market," he said.

That is one reason new buildings such as 110 North Wacker have filled up so fast. Developed by The Howard Hughes Corp. and Riverside Investment & Development, the 1.5M SF tower will open late this year, and its current tenant roster includes Bank of America, the first anchor tenant, which leased 530K SF, Lincoln International and many law firms.  

The 2.8M SF Old Main Post Office building, the nation's largest adaptive reuse project, will also begin welcoming tenants such as Walgreens later this year, and in the first quarter, Abelson Taylor, Home Chef and other firms kept the momentum up by leasing 215K SF.

This activity helped average downtown rent rise for the past two years at a 3.6% pace, and it now stands at $36.35, according to NKF's first-quarter report, but Chodos expects it will most likely level off this year due to tenants' many new options.

The expansion of coworking also helped downtown landlords. In the first quarter, coworking firms signed deals totaling 300K SF, according to NKF, including for Convene’s two new locations at Sterling Bay’s 333 North Green in Fulton Market and 311 West Monroe in the Loop. It looks like that pace will continue.

According to NKF, coworking providers, which already occupy more than 2.2M SF in Chicago, will grow to about 3M SF by the end of the year.

“Although coworking started as a suitable option for small or independent businesses and technology startups, it has gained more conventional users in the past few years, driving the need for larger facilities.”

Fulton Market was the standout among the downtown submarkets, accounting for nearly half the first quarter's total absorption, NKF found. Developers don't believe activity in the burgeoning area will slow down. 

McCaffery Interests Senior Managing Director Clayton McCaffery said an entire new generation — Generation Z — just began arriving in the workplace, a national trend that will drive demand for new nontraditional offices in neighborhoods like Fulton Market for years.

"We see Fulton Markets developing in almost every city in North America," he said.  

His company recently completed its first Fulton Market project, an adaptive reuse of a brick-and-timber chicken processing plant built in 1900. Arete Wealth Management just agreed to occupy 4K SF on the third floor, and will move from its current West Loop headquarters later this year. Galley Group Food Hall will occupy 13K SF on the first floor, and offer fully built-out kitchens, communal seating, a wine bar, event spaces and other features.

Most of the buildings in the neighborhood are just as small, McCaffery said, usually less than 80K SF, and now that tenants fill most of these adaptive reuse spaces, developers have begun constructing new office towers.

Sterling Bay, which recently completed McDonald's new 490K SF Fulton Market headquarters, has also started construction on a 200K SF building at 210 North Carpenter, where Google agreed to occupy more than half the space, as well as the 19-story 333 North Green St. 

"Honestly, Fulton Market is just getting started," McCaffery said. 

Developers in far more mature submarkets also see the potential for growth.  

North Wells Capital, the investment management affiliate of Chicago-based Urban Innovations, just acquired a surface parking lot at 320 West Huron St., one of the few remaining large land sites in River North, where Urban Innovations began renovating industrial buildings in the 1980s. Even though it is entitled for residential, CEO Jim Fox envisions other possibilities.

"We are definitely going to consider a new office development," he said.

He said River North is one of the tightest submarkets, but with Fulton Market filling up, it may offer an alternative, mainly because the North Side's growing millennial and Gen Z workforce will find it easier to get there on the CTA's Red and Brown lines. 

"A lot of people question River North as an office location because traditionally, it's been a market for small tenants," he said. 

North Wells Capital has two other sites in River North, at 308 West Erie and 301 West Huron, where it also envisions new offices that may provide the large blocks of space needed by many users.

"We are going to start canvassing the brokerage community to find out what the level of interest might be," he said.   

The real test for Chicago's market will come when developers start opening up the next generation of office towers, Chodos said. This will include Riverside Development's 3M SF mixed-use redevelopment of Union Station, including a 50-story office tower. And Hines plans to break ground next year on its 1.2M SF Salesforce Tower on Wolf Point, after getting a commitment from San Francisco-based tech giant Salesforce to lease 500K SF.

Chodos takes the Salesforce lease, along with recent expansions by Google, Facebook and other growing tech firms, as a good sign the market still has legs, but there are some worrying signs.

The government recently revised gross domestic product figures downward, and a tremendous amount of uncertainty afflicts trade relations between China and Mexico, he said. Locally, new Cook County Assessor Fritz Kaegi will soon unveil plans to restructure how commercial real estate taxes are calculated, and downtown landlords can expect a hit to their bottom lines. In addition, both the city and state may seek additional tax revenue to help solve their own financial difficulties.

"Combine all that, and we could be looking at a perfect storm that will make demand more tepid," Chodos said. "I've been through three business cycles in the past 30 years, and when things take a turn, it usually happens fast."