Research & Forecast Report DOWNTOWN CHICAGO | OFFICE Fourth Quarter 2018 Demand Rift Widens Will Goldstick Research Analyst | Downtown Chicago Chicago’s Central Business District Market Indicators Q4 2017 Q3 2018 CURRENT reported 3,496 square feet of negative VACANCY 12.5% 12.8% 12.9% net absorption in the fourth quarter 381,592 179,450 (3,496) and ended the year with 1,365,000 QTR ABSORPTION YTD ABSORPTION 1,202,213 1,368,496 1,365,000 square feet of positive net absorption. RENTAL RATE $39.37 $40.74 $41.19 Although there was minimal negative net absorption in the fourth quarter, the delivery of 210 N. Carpenter with in Chicago. Google will expand its Chicago footprint by 132,000 square feet, bringing the company to 570,000 square feet in Google’s space still vacant was a factor total across Chicago. Facebook announced it would move into in the vacancy rate increasing by 10 151 N. Franklin for 263,000 square feet. Lastly, Salesforce plans on occupying 500,000 square feet in Salesforce Tower, or Wolf basis points to 12.9 percent. Point South, which is expected to begin construction sometime in 2020. Overall, 895,000 square feet will be absorbed due to Year-to-date, Chicago’s central business district vacancy rate coastal migration over the next couple of years. increased by 40 basis points with six new office buildings delivering. Chicago’s CBD delivered over 5.2 million square feet Tenant demand for quality space in modern assets with best of office space since 2015. Of the six buildings that delivered in in class amenities and transit-oriented locations has created 2018 (2,099,388 SF in total), 86 percent of such space had been a deep divide in performance between such assets and older either preleased or occupied at the end of the year. assets in suboptimal locations throughout the CBD. Including new supply that delivered preleased in 2018, Class A assets reported Throughout 2018, Chicago’s CBD displayed three types of 2,112,598 of positive net absorption year-to-date, while Class B demand: suburban migration, coastal migration, and the need for assets reported 631,036 of negative net absorption—a difference efficient space. Five suburban companies: Walgreens (200,000 of 2,743,634 square feet. Professional service firms continue SF), Ferrara Candy (77,000 SF), McGraw-Hill (65,000 SF), FTD firms continued the trend of densification, or shedding space (40,000 SF), and One Span (11,800 SF) signed leases throughout without reducing headcount, in relocations to desirable assets 2018, and will bring 393,800 square feet in total of positive gross and growing technology firms continue to cite their office spaces absorption to Chicago’s CBD over the next twelve months. The as key tools for recruitment and retention purposes. Landlords biggest suburban migrator will be Walgreens, which announced of modern assets with tenant amenity packages in vogue with plans to bring 1,300 employees from its Deerfield HQ into the occupiers continue to hold record high rental rates in place, city as it opens a new 200,000 square foot office at the Old Main while Landlords of older Class B assets that have yet to properly Post Redevelopment (433 W. Van Buren) upon the building’s reposition themselves are experiencing substantial vacancy and delivery in 2019. Established coastal technology firms, such as implementing aggressive tenant concession packages and rental Google, Facebook, and Salesforce, also plan to expand footholds rates in an effort to lure tenants. Therefore, tenants in the market for high-quality, Class A space will continue to experience a tight market through 2019, while more cost-conscious users willing to occupy space in older assets are facing an increasingly favorable market in the near term. In 2019, Chicago will add 3,570,116 square feet of office supply, of which only 9.5 percent (340,000 SF) is preleased. The largest contributor of the upcoming office supply is The Old Main Post Office, which will deliver 2.5 million square feet of office supply by mid-2019. So far, 322,000 square feet have been preleased by four companies (Walgreens, Ferrara Candy, Chicago Agency for Planning.) While the CBD’s vacancy rate will climb, the Post Office’s ultimate impact on the market will depend upon which tenants elect to relocate to the property and the quality of space they are leaving behind, as the Post Office’s peripheral location doesn’t appeal to all tenants and tenants vacating older assets that don’t appeal to many users will not have a substantial impact on the current market dynamics. Leasing & Sale Highlights Large leasing activity was quite active in the fourth quarter, with seven leases signed, or 1,228,123 square feet of office space. Salesforce announced it would anchor a Hines development at Wolf Point South, or Salesforce Tower for 500,000 square feet, helping accommodate an additional 1,000 employees over the next few years. CDW announced it would occupy 625 W. Adams for 300,000 square feet, expanding by about 75,000 square feet. UBS agreed to give back more than 100,000 square feet at 1 N. Wacker over the next few years, for a total footprint of about 175,000 square feet. Google, having outgrown its 1000 W. Fulton office, signed a 132,000 square foot lease at 210 N. Carpenter in Fulton Market, bringing the tech company’s footprint to over 570,000 square feet in Chicago. Lastly, two co-working providers signed leases: New York based Bond Collective will be entering the Chicago arena with 68,123 square feet at 20 N. Wacker and WeWork signed a lease for its ninth Chicago location at 222 S. Riverside for 60,000 square feet. Over the past year, co-working throughout the Chicago area has grown immensely, growing by 538,237 square feet. Chicago ended the year with thirty-two leases over 50,000 square feet signed, or 4,966,593 square feet. Investment sales activity within the CBD during the fourth quarter consisted of four transactions: Manulife’s sale of 1 S. Wacker for $310,000,000 ($259.38/SF) to 601W Companies, Blue Star Properties sale of 125 S. Clark (The National) for $194,600,000 ($337.26/SF) to Commerz Real, GLL Real Estate’s sale of 444 N. Michigan for $138,000,000 ($274.35/SF) to CIM Group, and Sterling Bay’s sale of 121 W. Wacker for $118,500,000 ($241.71/SF) to Ameritus Real Estate. At the time of purchase, the 444 N. Michigan was 86 percent leased. 18 office sales closed in 2018, amounting to a total of $3,527,050,000. In 2018, the sales transaction volume increased by six buildings or $2,197,450,000 compared to 2017. The increase in sales volume was primarily driven by local developer Sterling Bay’s acquisitions, the two largest office purchases in 2018. Sterling Bay purchased Prudential Plaza for $680,000,000 ($308.78/SF) from 601W Companies and alongside JP Morgan Asset Management, acquired technology hub 600 W. Chicago from Equity Commonwealth for $510,000,000 ($324.55/ SF.) Despite the surge in investment sales activity, the CBD is unlikely to match the rapid investment sales activity it enjoyed in 2015, as the increasing interest rate environment, transitioning office market, and high-pricing achieved in recent sales offer potential buyers few opportunities to attain strong yields in the short term. While Chicago’s investment sales activity likely reached this cycle’s peak in 2015, Blackstone’s ongoing $667.8 million-dollar rehabilitation of the Willis Tower, 601W Companies current $500 million-dollar rehabilitation of the Old Post Office, and Sterling Bay’s land acquisitions in the Clybourn Corridor illustrate investors’ optimism in Chicago’s long-term health. Outlook Among the uncertainties of a global economic slowdown, the state budget deficit, the frequency of increasing interest rates, a new assessor, and local crime rates in Chicago, tenants, landlords and investors have so far veiled such uncertainties with optimism as continued corporate migration from the suburbs in conjunction with an increasing number of technology firms on the coasts consider Chicago for additional offices. In 2019, about 3,570,116 square feet of new Class A office space is expected to hit the market, of which about 9.5 percent has been preleased. With so much new supply coming to market, landlords of older assets will have a hard time contending with newer product with first in-class amenities. This rift between quality assets and older assets had widened throughout 2018 and is expected to widen further. Despite the number of options available to tenants increasing alongside the CBD’s vacancy rate over the next twelve months, Chicago’s Class A assets, appear to have a bright future as companies remain attracted to Chicago’s diverse local economy, talented labor pool, and world class infrastructure. As newer supply comes online and attracts tenants from older Class A assets, a vacuum of older high-quality space is expected to become available. Class B tenants looking for more value in their leases could have an opportunity to absorb the aforementioned space, resulting in the bulk of shadow space occurring in Class B assets. Overall, the market will gradually shift in favor of tenants as over 5 million square feet of office space delivers over the next twenty-four months. 2 Research & Forecast Report | Fourth Quarter 2018 | Downtown Chicago / Office | Colliers International Chicago Central Business District | Local Standards - 4th Quarter 2018 Office Market Statistics | Charts Up-Down Indicators (Input the Quarters You Wish to Compare in the Black Boxes) Submarket Vacancy Rates Net Absorption & Vacancy Asking Gross Rental Rates