The Office Market Isn't Dead. It's Just Resting

Next year is going to be a confusing one for anyone in the office market. The coronavirus pandemic emptied out most offices throughout much of the past year, and everyone from entry-level workers to CEOs found Zoom calls and other technologies made it possible to work from home. But the possibility of vaccinations and increased safety won’t end uncertainty and leaves both landlords and tenants with a dilemma: How do you negotiate leases when it’s impossible to know how many employees will return to the office, how many will stay home and how much space will be needed?

New leases for significant amounts of space were rare throughout summer and fall as most tenants took a wait-and-see attitude. Q3 activity in Chicago was mostly confined to sublease deals and renewals, according to a Colliers International report. Year-to-date absorption was negative 146K SF, and about 2M SF became available for sublease. The average rental rate was essentially unchanged in the past year, standing at $42.13 per SF in Q3, just 2 cents below where it was in Q3 2019.

But behind the scenes, some negotiations are taking place, and big changes could be afoot.

“Truth be told, rental rates are dropping. It’s just not been published,” Savills Vice Chairman Lisa Davidson said.

After years of record-breaking new construction and leasing activity, especially in a burgeoning downtown market where rental rates kept increasing, landlords are no longer confident in their ability to secure tenants.

“When I get proposals now, I get rental rates lower than last year and substantially more concessions,” Davidson said. “I also get unsolicited offers, and that’s a function of there not being much demand.”  

The results of these negotiations won’t be officially reflected in commercial real estate data until the parties actually sign the deals. That could take months.

“Landlords are also trying to maintain a wait-and-see attitude as long as possible; nobody wants to commit to giving lower rental rates until they have to,” Davidson said.

It’s possible the combination of vaccines and pent-up demand will transform how people see the office market, she added. If companies that put off planned expansions when the pandemic hit begin seeing offices as safe, there could be a scramble for spaces sometime next year. Such competition would help landlords avoid having to sign all the deals currently sitting on the table that would push down rental rates.

Before making commitments, tenants will need to decide how to blend work-from-home strategies with traditional ways of running offices, Davidson said. If half the workforce stays home on any given day, many could decide that fewer workers need a permanent desk, decreasing the need for space. On the other hand, lingering fears of COVID-19 could also mean office users will not want to simply pack their employees into smaller offices. Only when those strategies are thought through will the direction of the office market come into focus.

“That’s what we’re waiting for, for these transactions to happen so we can get the comps,” Davidson said. “I think at the earliest that will be in the second half of next year.”

A burst of demand may not happen until 2022, she added, because some office users are being very conservative. Google, Uber, Slack, Microsoft, Ford Motor Co. and others have already announced they will not reopen their offices this winter or spring.  

But that doesn’t mean the office market is dead. Some tenants recently decided this is the perfect time to check out some possibilities.

“It goes without saying that we are in one of the most challenging, if not the most challenging, office market in our history, but we’ve seen some tenants circulating in the last, call it 90 days, and an uptick in tours,” Thor Equities Senior Vice President Peter McEneaney said Dec. 17 during Bisnow’s Chicago Deep Dish: State of the Office webinar.

Some showed interest in 800 West Fulton Market, a 19-story mixed-use building that Thor and joint venture partner QuadReal broke ground on in October 2019. The company plans on opening the building in the spring.

“We’re starting to see tenants see the light at the end of the tunnel potentially in terms of rolling out the vaccine and when people can start emerging and come back,” he said.

When tenants do return, the office market may not look the same.

“This pandemic has made people reconsider their priorities and what’s really important to them,” Knickpoint Ventures Managing Partner Zain Koita said during the Dec. 17 webinar.

More companies want to locate outside of the dense urban cores and occupy spaces where employees can avoid public transportation, he added. Knickpoint has also seen more tenants looking for space, especially at nontraditional properties such as The Fields on the Northwest Side of Chicago, a redeveloped former Marshall Field warehouse that Knickpoint bought in 2018. And for such nontraditional buildings, demand has been strong enough to sustain rental rates.   

“We haven’t seen a big change in lease terms,” he said.

Davidson said in response to these changing tastes and in preparation for when tenant demand returns, a lot of landlords are starting to create spec suites complete with cafes and open collaborative areas.  

“Spec suites were somewhat popular before COVID, and they’re more popular now,” she said.   

That is also because many downtown and suburban companies cut their capital budgets during the economic crisis and won’t be willing to spend scarce dollars remaking an office after signing a lease deal, GlenStar Properties Managing Principal Michael Klein told Bisnow.

“Being able to move into rent-ready spaces is going to be important,” he said. “It happened after the last recession, and we believe it will happen again.”

Klein’s Chicago-based firm owns and operates office properties in the suburbs and Chicago’s Central Business District, including the 911K SF Continental Towers in Palatine, the 1M SF Schaumburg Corporate Center and the Chicago Board of Trade building in the Central Loop.

Even with all the turmoil and sky-high unemployment, Klein isn’t sure the office market will fundamentally change. He pointed out that although sectors such as hospitality and restaurants were eviscerated by the pandemic, the work-from-home option preserved office work.

“From an office perspective, a lot of companies are still doing relatively well, and a number of companies have even hired during the pandemic," he said. "So, will there be a massive, wholesale shift in how we do business? I think it’s unlikely. But I don’t think we’re going to know for the next six months how things are going to shake out.”