Understanding the Top 7 Trends in Chicago Office Investments

1. Increase in Available Office Space: Chicago’s office market has reached a historical high of 102 million SF of available space, a 27 million SF increase since Q1 2020, with sublet availability at a record 2.4%.
2. Declining Lease Renewals: Many employers are letting their lease obligations expire without considering relocating, contributing to a rising vacancy rate, now at a record high of 15.8%.
3. Corporate Relocations and Expansions: Despite high vacancy rates, Chicago led the nation in corporate relocations and expansions for the 10th consecutive year, with 448 projects.
4. New Supply and Construction: Chicago’s office market is nearing the end of its largest supply wave in over a decade, with 1.7 million SF under construction and new deliveries below the 10-year average.
5. Life Sciences Growth: Chicago is emerging as a significant life sciences hub, with notable projects like the 28,000 SF Chan Zuckerberg Biohub and several other major life science buildings under development.
6. Increased Rent Allowances: Market rents remain flat, but tenant improvement packages and rent allowances are increasing. Tenant improvement costs exceed $100/SF, and representation commissions are at $1.50/SF per year.
7. Incentives for Existing Tenants: Landlords are highly motivated to retain existing tenants, often providing substantial incentives and allowances to keep them in place.

Increase in Available Office Space

Chicago’s office market has reached a historical high of 102 million SF of available space, a 27 million SF increase since Q1 2020. The sublet availability rate has also hit a record 2.4%. Tenants are still determining their future office needs, driving this trend.

Declining Lease Renewals

Many employers are letting their lease obligations expire without considering relocation. This behavior contributes to a rising vacancy rate, now at a record high of 15.8%. Move-outs are outpacing move-ins, recording -3.8 million SF of negative absorption in the past year. This signals a need for more confidence in long-term office space needs.

Corporate Relocations and Expansions

Despite high vacancy rates, Chicago led the nation in corporate relocations and expansions for the 10th consecutive year, with 448 projects. However, the overall leasing velocity is still not at pre-pandemic levels. The West Loop submarket, the largest in the region, recorded only 40% of the leasing volume of 2019 over the past year.

New Supply and Construction

Chicago’s office market is nearing the end of its largest supply wave in over a decade, with 1.7 million SF under construction. New deliveries are below the 10-year average. Notable new buildings include the Salesforce Tower and various life sciences projects, reshaping market dynamics.

Life Sciences Growth

With projects like the 28,000-SF Chan Zuckerberg Biohub and several other major developments, Chicago is emerging as a significant life sciences hub. These include two new life science buildings near the University of Chicago and Northwestern University. The life sciences sector attracts companies due to Chicago’s diverse talent pool and research network.

Increased Rent Allowances

Market rents remain flat, but tenant improvement packages and rent allowances are increasing. Tenant improvement costs now exceed $100/SF. Representation commissions are commonly at $1.50/SF per year. Landlords are highly motivated to retain existing tenants, providing substantial incentives.

Incentives for Existing Tenants

Landlords are offering generous rent allowances to keep tenants in place. This includes setting aside exclusive outdoor spaces and other amenities. Despite a weakened demand environment, these strategies aim to maintain occupancy and stabilize the market.

Persisting Uncertainties and Leasing Velocity

Long-term utilization patterns remain uncertain, keeping tenants and investors cautious. Leasing velocity is still below pre-pandemic levels. The West Loop submarket recorded only 40% of the 2019 leasing volume, showing a significant impact.

Major Deals and Submarket Performance

The largest deals recently involved renewals, such as Chicago Trading Company’s 266,000 SF renewal in the Central Loop. Law firm Katten Muchin Rosenman and insurance company Chubb also renewed leases with reduced square footage. These renewals indicate a trend of downsizing rather than expansion.

Expansions and Suburban Transactions

The market is seeing some expansions. For example, Molson Coors is increasing its space to 84,000 SF in the West Loop’s BMO Tower. In the suburbs, CF Industries inked a 78,000-SF lease in Northbrook. These transactions reflect a mixed pattern of contractions and expansions across different areas.

Sublet Space and Negative Absorption

The direct availability rate in Chicago is 17.6%, with 12.5 million SF of available sublet space. This sublet availability rate of 2.4% has been at record-breaking heights since 2020. Companies like Zurich North America and Follett have significantly reduced their footprints, contributing to the rising sublet space.

Demand Decline and Vacancy Rates

Move-outs and space consolidations are pushing demand lower by -3.8 million SF. This marks the most significant decline in office demand since 2009. The market has recorded over 10 million SF of negative absorption since 2020. This shift in demand is more severe than the 7.9 million SF lost during the 2008-2009 recession.

Geographic Demand Shifts

Demand is following new developments in areas like Fulton Market, River North, and the medical district of Central North. In contrast, traditional office markets like the Central Business District are significantly declining. The gross vacancy rate is now at 15.8%, the highest in over 25 years.

Investment Strategies and Market Outlook

Investors need to navigate the complex landscape of Chicago’s office market carefully. The focus should be on partnering with strategic partners and capital groups. Understanding the dynamics of real estate private equity will be crucial. Despite challenges, opportunities exist in high-demand submarkets and emerging sectors like life sciences.

Flat Asking Rents Amid Rising Inventory

Year over year, asking rents across Chicago remain flat despite new trophy properties. Available 4 & 5 Star space rose to a record high of 66.9 million SF, representing 27.9% of the market’s overall inventory. With increased inventory and uncertainties, landlords offer generous concession packages. This strategy helps stabilize occupancy and preserve asset value during sales.

High Concession Packages

Some concession packages are very steep, raising concerns about landlord profitability. In Fulton Market and River North, base rents range from $28/SF to $40/SF net. Tenants can secure improvement packages up to $135/SF for a 10-year lease. High downtown tax bills add $30 to $40 per SF to the tenant’s net price.

Aggressive Lease Renewals

Reported renewals involve aggressive negotiations. Tenants can negotiate rents similar to those from three or four years ago. This cancels out 2%-3% rent escalations in initial contracts. Landlords may also offer costly build-outs, as seen with Tishman Speyer’s efforts to retain Katten Muchin Rosenman.

Competitive Affordability in Lab Space

Chicago’s affordability is a strength, especially for lab space occupiers. Venture capitalists advise biolab companies to manage capital expenditures, with real estate costs being significant. Chicago’s Bio Safety Lab and Good Manufacturing Practices facilities offer rent at half the rates in San Francisco and Boston. This cost-saving attracts tenants to Chicago.

High Demand for Premium Locations

Lab space occupiers seek highly amenitized buildings in top submarkets. Fulton Market is a prime draw due to its amenities. Dan Lyne from CBRE confirms that tenants come to Chicago to save money but prefer prime locations. They avoid taking risks with less desirable properties.

Canal Station’s Unique Offering

Canal Station, is asking $45/SF for its renovated space. The former Northern Trust HQ offers double-sized windows, private terraces, and 400 parking spaces. Despite its remote location, the 601W Companies hope tenants will be attracted by the building’s reconfiguration. Currently, the 592,000 SF building is entirely available.

Persistent Market Challenges

Chicago’s office market faces significant challenges. The total available office space is at an all-time high, and developers and the sublease market are increasing competition. Office rents are expected to remain under pressure for the foreseeable future, necessitating strategic partnerships and innovative solutions.

Increasing Demolitions in Chicago

Demolitions are reshaping Chicago’s office development landscape. Over 1 million SF is projected to be removed this year. Despite this, new office products continue to emerge. The 1.2 million SF Salesforce Tower in River North contributes significantly to this new inventory.

New Office Developments Continue

The Salesforce Tower’s tenants include Salesforce, which has 500,000 SF, and Kirkland Ellis, which has nearly 600,000 SF. Salesforce subleased 119,000 SF. 1.7 million SF of office space is currently under construction in Chicago, with a direct availability rate of around 35%.

Construction Beyond the Central Business District

Only a third of the pipeline projects are in the central business district, but over half of the square footage is in Fulton Market. Investors are confident despite rising vacancy rates, Fulton Market speculators are building properties for tenants drawn to trendy locations.

Growth in Medical and Life Sciences

About 800,000 SF of new construction is for medical office and life science laboratories. This development spans North Branch/Goose Island, South Chicago, and Near North. Sterling Bay’s 285,000-SF Ally Lincoln Yards and North Wells Capital’s 153,000-SF office tower are notable projects.

Future Construction Proposals

Approximately 17 million SF is in proposal and final planning stages, aiming for delivery by 2026. Most are in Fulton Market, West Loop, Goose Island, and South Chicago. The 78-master plan includes 13 million SF of office, residential, and commercial space as part of a transit-oriented development (TOD).

High Availability and Pre-Leasing

These new assets have an availability rate of roughly 77%. However, 18% of this supply is already 100% pre-leased. This pre-leasing indicates strong demand and suggests space cannibalism in Chicago’s market.

Canal Station Development

The 601W Companies, known for the 99%-occupied Old Post Office redevelopment, is opening Canal Station. The 592,000-SF former Northern Trust HQ, marketed by the Telos Group, aims to leverage the Post Office District’s success. The development sits just a half-mile north of the Old Post Office.

Elevated Leasing Uncertainty and High Vacancy Rates

Leasing uncertainty remains high in Chicago, with available space at record levels. Federal interest rate spikes add to the pressure. Office investment has been declining since mid-2022. Sales volume is only $539 million, the lowest in over a decade.

Dominant Investment Strategies

Current office sales focus on three main strategies. Investors target high-vacancy properties for repurposing, owner-occupied spaces, and long-term, stable investments. Institutional investors are cautious, reducing their presence.

Repurposing Office Spaces

Several deals exemplify the trend of repurposing. Aligned Data Centers acquired 519,000 SF in Elk Grove Village for $79 million. They plan to convert these properties into hyperscale data centers. Tucker Development bought a 457,000 SF office in Skokie for $13.3 million, planning a mixed-use project.

High-Value Transactions

On the high end, mHUB bought an 80,000-square-foot former HQ for $32.5 million. The developers will transform this property into a manufacturing and cleantech innovation space. Despite the high price per square foot, the use aligns with the rising demand for lab space.

Small Deal Dominance

Most transactions involve properties smaller than 20,000 SF. These typically include 100%-occupied medical office spaces. These properties sold for an average of $108/SF at an 8.7% cap rate.

Declining Price Per SF

Rising interest rates and softening tenant demand are driving down prices. The price per SF for office space has decreased since Q4 2021. This trend, reflecting challenging market conditions, is expected to continue through 2025.

Increasing Distress in Office Properties

Chicago’s office market is seeing more mortgage defaults and distressed assets. Vacancies in for-sale properties rose to over 40%. The Central Business District (CBD) is mainly affected by high East and Central Loop vacancy rates.

Urgent Sales of Distressed Assets

Distressed assets are not limited to downtown Chicago. Alissa Adler of Colliers advises quick auctions for troubled properties. Franklin Partners bought land under a vacant 516,000-SF office building in April for $4.8 million. They plan to repurpose the site for light industrial use.

Future Sales Activity

Given leasing uncertainties and persistent inflation, sales will likely focus on low-risk deals. Investors prefer properties with stable cash flows or redevelopment potential. This trend will continue to shape Chicago’s office investment landscape.

Closing Thoughts

Chicago’s office market faces significant challenges, including high vacancy rates and leasing uncertainty. Strategic investments and repurposing are key opportunities. Investors should focus on stable cash flows and redevelopment potential. Contact Lumicre for your investment needs.