Chicago’s commercial real estate market has faced both significant challenges and opportunities throughout the past cycle, and its office sector is no different. Investment brokerage firm Savills released its first-quarter report on the Windy City’s downtown office market, and while signs show an overall solidifying of fundamentals, the overall picture is a bit more nuanced.
Fulton Market sign. Image from Google Street View.
Chicago as an office market has long been attractive for major companies. As the largest city in the Midwest, the metro’s large talent pool available to fill office jobs has been second to none, and leasing rates have historically been far below pricier coastal population hubs like New York or San Francisco.
And yet, Chicago’s office market is really more like two — each with very different dynamics and quality. High-quality assets in the Loop and nearby growing neighborhoods like Fulton Market have been sought after by tenants looking for the best space Chicago has to offer, similar to the flight to quality seen in most major markets. Yet, older Class A properties, and nearly all Class B and C properties, remain plagued by heightened vacancies amid reduced leasing activity.
Distressed Office Buildings
Reports of distressed office assets are on the rise across the city, with one of the largest — Brookfield Asset Management’s 1.4 million-square-foot skyscraper at 175 W. Jackson Blvd. — being taken over by LNR Partners, the tower’s $258 million CMBS loan’s special servicer, BisNow reported in March. Finance analytics firm Trepp reported the office building’s occupancy was 65% just last year.
Overall, the Savills report shows that vacancy in the first quarter for Class A assets was 19.3%, compared to 28.2% for Class B and C properties. This is significantly higher than the national vacancy rate of 15.7% reported in March by data provider Yardi Matrix.
Despite the higher vacancy, office rents have climbed significantly since last year, averaging $42.42 per square foot, compared to $40.48 in the first quarter last year, an increase of 4.8% over the year. At the same time, concessions — even for high-end space in Fulton Market and in the West Loop — are growing. Though trophy assets in these submarkets have enjoyed high demand, office deliveries slated for this year are likely to boost any potential tenant’s position in finding new space.
Tax Troubles Dampen Chicago’s Office Real Estate Growth
Further impacting the office market are rising taxes for the city over the past couple of years. New real estate assessment practices have taken effect in recent years, combined with growing tax rates to cover both the city’s and the state’s budgetary shortfalls. Today, property taxes are assessed at 25% of a commercial building’s value, compared to 10.7% in New York City.
This hasn’t yet resulted in significant rent growth, even for the trophy office assets that might be better positioned to command increases. Long term, however, landlords will need to boost asking rates or risk cutting into operating margins significantly.
Chicago Remains a Tenant-Favorable Office Market
Even with these headwinds, Chicago as an office market continues to be desirable for tenants. As vacancy remains high — especially considering the pace of workers returning to physical office space — tenants find themselves in an incredibly advantageous position, with landlords competing to fill buildings. Though some of the highest-demand Chicago neighborhoods may remain pricey and office assets may remain filled, any tenant seeking space in a Class A building outside the West Loop’s borders — or even within a Class B property in the heart of the city — should have no shortage of good opportunities.