CHICAGO 2005 Chicago Downtown Office Market Overview Office Market Downtown Chicago Downtown Office Overview and subsequently, increased demand for In 2003, positive news in the stock market office space. As we leave 2004 behind, the and the overall economy were cause for same concerns are present with the added optimism despite a weakening dollar and strain of unprecedented energy costs. the war on terrorism. It remained to be seen if there was enough strength in these The downtown Chicago office market has economic factors to translate to job growth, not seen increased activity despite a 2004 monthly average job growth of 185,000 and an unemployment rate that edged down below 5.4% by year-end. Most hiring was concentrated in part-time work and at low- er pay scales. Businesses moving offshore continued to impact the local market, as there has been a continued transfer of jobs to Mexico or overseas to a well-educated work force that is paid a small fraction of American wages. Further impacting the demand for office space are continu- ing trends in office hoteling and remote workforces. Corporations are requiring less space to perform effectively and our work environment is now defined more through its connectivity – a network of places both geographical and virtual. Vacancy/Absorption The good news in the downtown market is that while absorption for the year was a negative 822,133 square feet, there was actually positive absorption in the fourth quarter of 25,321 square feet. This is a significant improvement over 2002 and 2003 where negative absorption registered more than two million square feet in each of those years. Downtown Chicago Quarterly Absorption Square Feet 100,000 25,321 0 -100,000 -140,730 -200,000 -300,000 -283,369 -400,000 -500,000 -600,000 -656,355 -700,000 -800,000 Construction was recently completed on 71 South Wacker, a 1.7-million-square- 1st 2nd 3rd 4th foot, 49-story building in Chicago’s West Loop. 2005 Chicago Metro Market Report The West Loop, which in 2004 accounted Downtown Chicago Sublease Availabilities for nearly 45 percent of the total downtown Square Feet 8,000,000 leasing activity, experienced a decrease in 7,000,000 6,250,000 vacancy from 16.5 percent in 2003 to 16.1 6,000,000 percent by the end of 2004. Tenants have 5,000,000 4,400,000 continued to move to the West Loop as a 4,000,000 3,800,000 result of the new construction and conve- 3,000,000 2,170,000 nience of public transportation. The River 2,000,000 1,500,000 North market also demonstrated continued 1,000,000 0 improvement throughout the year, with 2000 2001 2002 2003 2004 most of the activity occurring with smaller tenants in the 2,000- to 5,000-square-foot Notable Transactions range. The vacancy rate in River North Another positive sign in the downtown dropped from 17.9 percent in 2003 to 16.7 market is the diversification of large ten- percent by year-end 2004. The Central ants. Over the last few years most of these Loop has experienced a vacancy rate that transactions were focused in the legal sec- has risen from 14.3 percent in 2003 to 15.4 tor as law firms represent 27 percent of the percent at year-end 2004, largely a result downtown market. The 2004 list of trans- of the “flight to quality” trend discussed actions covered a wide range of industries. throughout this report. The best news in 2004 in the downtown Vacancy Rate by Submarket real estate market continued to be the sales 20 activity. 2004 was a record year not only 16.1% 16.7% 15.4% 15.5% in the volume of transactions but in the 15 price per square foot generated for those 11.8% buildings as well. Specific examples include 10 9.3% 191 North Wacker, a 732,000-square-foot, 37-story building completed in 2003 which 5 sold for $305 per square foot and One North Wacker which sold for $310 per 0 Central South East West N. Michigan River Loop Loop Loop Loop Avenue North square foot. In 2004, the overall vacancy rate continued The hot investment market continues to to increase and ended the year at 15.5%. drive potential for new construction, de- However, the amount of sublease space spite sluggish leasing activity. Developers has declined dramatically. This is the re- are enticed by high sale prices and large sult of large companies with growth needs existing tenants seeking upgraded space continuing to backfill sublease space such and negotiating leverage with their current as the new chemical division of BP Amoco landlord. More specifically, several tenants filling the excess space BP Amoco was try- with leases expiring between 2009 and 2011 ing to sublease at 200 East Randolph. In have threatened to vacate their existing 2004 the amount of sublease space fell to space for new buildings. With a 30-month about 2,170,000 square feet from 3,800,000 construction cycle and a 12-month zoning square feet in 2003 and 6,250,000 square and entitlement process, tenants expiring in feet in 2002. 2009 and later will begin the site selection process in 2005. In the last year alone both USG Corpora- Lease Rates tion and Sidley Austin Brown & Wood In 2003 landlords endeavored to stabilize took this course of action, choosing to an- their net rents by offering generous con- chor new buildings rather than relocate to cession packages so they could race to the existing space. USG became the lead ten- investment community and sell their build- ant of a 470,000-square-foot building at 550 ings before demand slowed. With the glut West Adams by signing a 15-year, 248,685- of space coming back to market in 2005, square-foot lease, and Sidley Austin Brown these face rents began to fall in 2004 despite & Wood anchored an 820,000-square-foot the fact that there was no new construction building at One South Dearborn by signing completed throughout the year. As a result, a 15-year, 549,000-square-foot lease. The concessions packages and lease flexibility reward has been much greater than the risk continue in the tenants favor. to developers. Over the past five years, a new generation of buildings with enhanced 2005 Forecast efficiencies, technology, and security has continued to entice tenants, and in turn, The economy in 2004 sent many of the generate extremely attractive returns. right messages, yet corporate America remains skittish about capital spending. The trouble with this philosophy is it has As such, demand for new or existing of- decimated the balance of the market. Par- fice space in downtown Chicago remains ticularly vulnerable are the last generation anemic. This will continue to be the trend of buildings where tenants were paying in 2005 and 2006 for several reasons. First, $18.00 to $22.00 per square foot net and the dominant American industries that now find themselves able to move to the are showing strong corporate earnings new trophy-quality buildings at comparable – telecommunications, financial services, prices. The result of this “flight to quality” pharmaceuticals – created these profits by is a long list of buildings suffering very low merging and then consolidating to identify occupancy rates. ABN AMRO has vacated efficiencies rather than through job growth. 200 West Monroe for its new headquarters Secondly, the demand that was created in at 540 West Madison, leaving the build- the market was primarily a result of small ing only 33 percent occupied. In addition, businesses taking advantage of the tenant’s as J.P. Morgan Chase & Co. continues to market. To date, large companies have not consolidate its various downtown locations followed suit. They have instead backfilled the story gets even more troubling. existing subleases or hired consultants. While this has taken away a large portion of the competing sublease space, it has not had Looking ahead in 2005, tenants relocating a significant positive effect on absorption. to new buildings at 111 South Wacker, 71 South Wacker, and One South Dearborn will leave their existing space with the fol- In existing Class A and B buildings, deeper lowing occupancy levels: rental rate cuts are expected in 2005. Once the owners of the last generation of buildings finally have their tenants vacate and these Occupancy Building Tenant Vacating After Landlords stop receiving rent payments 190 South LaSalle Mayer Brown Rowe & Maw 34 percent they will feel the pressure to reduce rental Bank One Plaza Sidley Austin Brown & Wood 76 percent rates even further. This will be especially 200 West Madison Hyatt Corporation 58 percent IBM Plaza IBM 72 percent true of Class A – and B+ properties that are Two Prudential Plaza Deloitte Touche 45 percent seeing the greatest vacancies. This will put 77 West Wacker R.R. Donnelley 65 percent pressure on all the other property classes to 115 South LaSalle Lord Bissell & Brook 49 percent reduce prices accordingly or risk exacerba- tion of the “flight to quality” trend. 2005 Chicago Metro Market Report Major Downtown Office Transactions Tenant Buildings Square Feet Sidley Austin Brown & Wood One South Dearborn 549,000 Mercantile Exchange Mercantile Exchange 445,000 Deloitte Touche 111 S. Wacker 428,000 Hyatt Corporation Hyatt Center 300,000 GE Capital 500 W. Monroe 282,000 Citadel 131 S. Dearborn 274,419 USG Corportion 550 W. Adams 248,685 Goldman Sachs Hyatt Center 211,000 Schiff Hardin LLP Sears Tower 197,000 UNICARE/ WellPoint Sears Tower 146,751 Jones Day, et al 77 W.