The Office Market May Not Be As Robust As Other Asset Classes, But 'It's Not Dead'

The Chicago market doesn’t get rave reviews these days, with one neighborhood being a notable exception.

“When we look at Chicago, it’s hard to underwrite projects, except in Fulton Market,” LG Development Group Chief Investment Officer Daniel Haughney said Thursday at Bisnow's Chicago 2022 Forecast event.

Developers began creating millions of SF in new office space in the former meatpacking district just before the pandemic hit, and even though most of these buildings opened vacant, 2021 saw relatively strong leasing. And with young professionals continuing to show interest in the neighborhood, apartment developers have also continued to launch new towers there.

That activity also brought a lot of life back to its streets, according to Cushman & Wakefield Managing Principal Vicki Noonan.

“There are more restaurants opening every day, and they are thriving and succeeding,” she said.

But it is hard to see similar dynamism at work elsewhere in the city, Haughney said. There is a litany of concerns that make new investments into Chicago properties seem dicey, from worries over the fiscal health of the state and municipal governments to perceptions about crime and the city’s stringent rules about including affordable housing in many new developments.

Cities around the U.S. have the same challenges, he added. But many of those places also show much stronger rent increases than Chicago, a city known for slow and steady growth.

Multifamily opportunities do exist in Chicago if you look hard enough, even outside Fulton Market, according to Inland Bank & Trust’s Chris Metcalf. His group does a lot of rehab deals valued between $2M to $15M and has found that such deals will pencil.

“You get a decent basis when you’re not building ground-up,” he said.

Metcalf still struck a note of caution when it comes to Chicago investing, adding that it takes more to do a deal than having the numbers work.

“We also ask, ‘Who are the people behind a project, and do we believe in them?’” he said.

Noonan said the coronavirus makes it difficult, at least in the short term, to see the strengths of Chicago neighborhoods outside of Fulton Market. The in-person occupancy of downtown offices remains below the national average, and how well these buildings will perform isn't yet clear. But she is optimistic that a return to the office is inevitable.

“What we’ve learned is that a hybrid work environment can work, but it doesn’t help the next generation to grow. In-person is needed,” she said.

The key, she added, will be for landlords and tenants to make offices as attractive as possible, with full suites of amenities and ways to provide younger employees the opportunity to interact with all the colleagues they may only have met through Zoom calls.

“You have to ask, ‘What can we do to make sure people come in?’” Noonan said.

Haughney said his firm is now seeing in-person office occupancy of between 75% and 80%. That is a big improvement from one year ago, and with the new hybrid work schedules, it may be as high as it is ever going to be.

“We’ve landed where we think we’ll be moving forward,” he said.

And that level of occupancy doesn't necessarily mean huge cuts in the amounts leased, Noonan said. Prior to the pandemic, trendy office designs emphasized strategies such as benching, which shrank the amounts allotted to each person. In the years since, many tenants said they took that strategy too far and were now looking to boost the amounts leased by including more collaboration spaces, moves that should give hope to many owners.

“Office is definitely not as robust as other asset classes right now,” Noonan said. “But it’s not dead.”      

Haughney said he also expects the rest of Chicago’s downtown outside of Fulton Market will bounce back.

“In the short term, there’s going to be some pain, and ultimately Fulton Market will be a winner,” he said.

But at some point, he added, Fulton Market will run low on available inventory and other submarkets will start attracting their share of new tenants.

Evanston Mayor Daniel Biss said one of the chief problems facing both Illinois and Chicago was one of perceptions. The region looks great whenever it is compared to other metros in the Midwest, especially as a mecca for talent, but longstanding opinions about its fiscal stability mean it suffers when compared to places such as the Bay Area.

"There is the perception that the Midwest is a declining region," he said.

But those attitudes sometimes haven't kept pace with reality. Biss said there have been real improvements in the state's fiscal health in just the past five years.

The bond rating agency S&P Global, for example, issued a report on the state one year ago titled Is Fiscal Stabilization on the Horizon for Illinois? Soon after, the agency moved its Illinois outlook to stable.

Haughney said the region has other strengths as an investment market that are sometimes not recognized. It is less risky for multifamily investors to park their money here because new inventory typically amounts to only 1% of the total, whereas in a hot city like Nashville, Tennessee, where growth and returns can be much higher, new inventory can be up to 15% of the market. 

He added that he talks up the benefits of investing in Chicago wherever he goes.

"It's important to get the word out, and the tide is turning," he said.