Research & Forecast Report DOWNTOWN CHICAGO | OFFICE Third Quarter 2017 Supply Outpacing Demand Robert Patterson Research Analyst | Downtown Chicago Chicago’s downtown office market Market Indicators Q3 2016 Q2 2017 CURRENT posted another stable quarter of VACANCY 11.2% 12.7% 12.7% demand during the third quarter of QTR ABSORPTION 841,235 -386,469 245,552 the year. With 245,552 square feet YTD ABSORPTION 920,856 30,262 275,814 of positive net absorption, the CBD’s RENTAL RATE $37.33 $38.95 $39.22 vacancy rate remained unchanged at 12.7 percent, as the positive demand was offset by the delivery of vacancy rate should reside closer to its historical equilibrium of approximately 287,000 square feet 13.2 percent, as tenants’ options for space continue to increase with supply. Considering the Fulton Market submarket will deliver of new supply delivered to the Fulton two additional speculative developments in the second half of Market submarket. At 12.7 percent, 2018 that will add approximately 266,000 square feet to the submarket with minimal preleasing at the moment, and the Old the CBD’s vacancy rate remains at its Main Post Office is slated to deliver a whopping 2.5 million square highest point in more than two years. feet to the market in 2019, the CBD’s market will likely continue to The delivery of approximately 2.6 shift in favor of tenants over the next 24 months. million square feet to the market over Trends the past 10 months has pushed the While leasing activity remains strong throughout the CBD, the vacancy rate up 145 basis points. amount of large leasing activity, or leases signed in excess of 40,000 square feet, diminished during the third quarter. The While the CBD remains a landlord’s market, tenant demand has continued trends of traditional users downsizing into more not met the recent influx of supply and will be hard-pressed to efficient spaces while younger technology companies continue to keep up with an additional 1.25 million square feet that will hit expand remained prevalent, as Northern Trust signed a lease to the market by June 2018 when The John Buck Company’s new relocate from multiple locations into 468,000 square feet at 333 807,000-square-foot tower at 151 N. Franklin and White Oak S. Wabash in what the company described as “part of its ongoing Realty’s 435,000-square-foot development at 625 W. Adams focus to drive efficiency.” GATX announced it will decrease its deliver to the market. The buildings are currently a combined footprint by approximately 30,000 square feet in a move to occupy 35 percent preleased with tenants shrinking their footprints in 90,000 square feet at the Willis Tower, while software producer relocations to the new developments. By mid-2018, the CBD’s Relativity (formerly kCura) signed a lease to expand its space at 231 S. LaSalle by 46,219 square feet. Trends (continued) Investment sales activity within the CBD is gaining momentum after a sluggish first half of the year. While only three properties traded during the third quarter, five additional properties are expected to close during the fourth quarter, including the sale of 401 N. Michigan Avenue – with the new Apple Store on its property – to Walton Street Capital for approximately $366 million ($484.77/SF). Prudential Plaza is expected to sell in the fourth quarter to local developer Sterling Bay for approximately $680 million ($308.78/SF). Despite the increased investment sales activity expected as the year ends, the CBD is unlikely to match the rapid investment sales activity it has enjoyed throughout 2015 and 2016, 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. Despite the limited number of investment sales transactions, Blackstone’s recently announced $500 million-dollar investment to revamp the Willis Tower, 601W Companies ongoing $500 million-dollar rehabilitation of the Old Post Office, and Sterling Bay’s massive land acquisitions in the Clybourn Corridor illustrate investors optimism in Chicago’s long-term health. Leasing & Sale Highlights Large leasing activity decreased during the third quarter, as the CBD posted six lease transactions larger than 40,000 square feet, making it the weakest quarter on a transactional volume basis since the third quarter of 2016. Despite the muted large leasing activity, Northern Trust signed a lease to occupy approximately 462,000 square feet of the space CNA Financial will vacate at 333 S. Wabash. This deal will prove unusually important for Chicago’s market in the coming years, as it will help the market cope with the massive negative absorption set to occur when CNA Financial vacates its current space of 750,000 square feet in June 2018 and moves into approximately 300,000 square feet at its new tower located at 151 N. Franklin. As CNA is set to vacate a much larger space than the one it will occupy, the market’s vacancy rate would have been driven much higher without Northern Trust stepping in to backfill CNA’s space. Provided that Northern Trust is relocating from a location outside of the CBD’s inventory, no other submarket will suffer due to Northern Trust’s relocation. The market’s other major lease transaction of the quarter was WPP’s announcement that it will occupy 253,000 square feet of a proposed office development that developer Sterling Bay will build at 331 N. Halsted in the Fulton Market. The deal indicates that another development of at least 500,000 square feet will break ground in the Fulton Market submarket, and that the development will have large blocks of space available to other users, unlike McDonald’s build-to-suit in the submarket. Investment sales activity within Chicago remained steady during the third quarter, with three properties trading during the quarter and five others nearing sales. Boston-based Beacon Capital Partners continued its spending spree in Chicago, purchasing 231 S. LaSalle from Michael Silberberg for $165 million ($176.13/SF), while investors continued to demonstrate strong demand for loft-office space as 213 W. Institute Place was purchased by KBS Realty Advisors for $43.5 million ($254.39/SF). After many of Chicago’s strongest Class A assets traded throughout 2015 and 2016, investors are beginning to target more Class B and C options throughout the CBD, as six of the eight properties that either sold or are likely to sell in the near future are Class B assets with strong locational attributes. The fourth quarter should increase the number of Class A sales on the year, as the sales of 401 N. Michigan Avenue and Prudential Plaza are expected to close, but 2017 will not come close to matching the overall investment sales activity the city experienced over the past two years. While investors will continue to remain attracted to the significant discount in pricing Chicago’s assets offer relative to their counterparts on the coasts, the rising interest rate environment, record-pricing of CBD assets and softening local market will likely ensure that the most active period of investment sales activity of this cycle is in Chicago’s past. Outlook Looking ahead, fundamentals suggest that both tenants and landlords feel confident in the future despite the risks sizeable local and state budget deficits, further interest rate increases, and local crime rates pose to Chicago’s market. Continued corporate migration into the CBD will be a key factor moving forward as approximately 2 million square feet of Class A product is set to hit the market by the end of 2018 and many traditional tenants are actively working to downsize their spaces to reduce costs. As the additional space hits the market, followed by the delivery of an additional 2.5 million square feet in 2019 when the Old Main Post Office’s rehabilitation is completed, it is hard to imagine a scenario where tenant demand can keep up with supply barring major relocations into the CBD from out of the market. Despite momentum moving in tenants’ favor, Chicago’s downtown office market appears to have a bright future as companies remain attracted to Chicago’s diverse local economy, talented labor pool, and world-class infrastructure. 2 Research & Forecast Report | Third Quarter 2017 | Downtown Chicago / Office | Colliers International Statistical Highlights Net Absorption & Vacancy | Chicago CBD Office Market The CBD posted 245,552 square feet of positive net absorption during the third quarter, bringing the total amount of net 1,600,000 14.5% 1,463,456 14.2% absorption since the beginning of the year to 275,814 square 1,400,000 1,319,108 14.0% feet of positive demand. Tenant flight to quality remains strong, 1,200,000 13.8% 1,600,000 14.5% 1,463,456 13.5% as the CBD’s Class A Inventory has posted 464,036 square Vacancy 1,000,000 14.2% 13.4% 932,682 1,400,000 feet of positive net absorption throughout 2017, while its Class 1,319,108 790,152 794,246 14.0% 800,000 13.0% 1,200,000 13.8% 12.8% B and C assets have reported 9,318 square feet of positive 578,831 Square Footage 12.7% 600,000 13.5% 12.5% Vacancy demand and 197,540 square feet of negative demand over 1,000,000 13.4% 932,682 400,000 790,152 794,246 275,814 the same period. Additionally, tenants continue to flock to the 800,000 12.0% 13.0% 11.9% 200,000 12.8% 11.9% West Loop from the older inventory base of the Central Loop, 578,831 Square Footage 600,000 12.7% 0 11.5% 12.5% as the West Loop submarket has posted 833,206 square feet of 2011 2012 2013 2014 2015 2016 2017 400,000 35 positive absorption over the last nine months, while the Central Absorption Vacancy 275,814 12.0% Loop has reported 739,470 square feet of negative demand 200,000 31 11.9% 11.9% Source: CoStar,30 Colliers International Research 27 over the same period.