Second City Battles Office Space Glut

A combination of corporate layoffs and new supply is causing the metro area's vacancy rate to spike.

In the heart of Chicago, along the downtown streets fanning from the river, the recession and market crisis that has wreaked havoc on the New York office market is now dealing a blow to the Second City. Skyscrapers along LaSalle, North Wacker and other thoroughfares are feeling the effects as employers downsize.

Real estate services firm Marcus & Millichap estimates in its 2009 National Office Research Report that 68,000 jobs, or 1.5% of the area workforce, will be cut this year on top of 59,000 in 2008.

Corporate downsizing has hit financial companies hard. Up to 26,000 finance-related jobs locally are targeted for elimination in 2009, the report notes. The employment trends are playing havoc with the office market.

“We're seeing a prolific increase in sublease space,” says Lisa Konieczka, executive vice president of brokerage CB Richard Ellis (CBRE) in Chicago. In the first quarter, downtown sublease space rose 30% to 3.7 million sq. ft.

Marcus & Millichap notes that new supply will drive up the metro vacancy rate by year's end to nearly 20%, including sublease space, the highest since the early 1990s. An estimated 4.7 million sq. ft. of office space will hit the Chicago market this year, up from 3.1 million sq. ft. in 2008, the report says.

“This is the largest annual delivery in more than a decade,” notes John Abuja, vice president of investments at Marcus & Millichap in Chicago.

Even downtown, where the office market is much tighter, vacancy is on the rise. In the first quarter, the vacancy rate was 12.1%, reports Torto Wheaton Research, up from 11.6% in the prior quarter. By 2011, the rate is expected to reach 17.5%.

The average effective rent across the metro area will fall 6.6% to $20.97 per sq. ft. this year, Marcus & Millichap estimates. A fresh supply of Class-A space and downward pressure on rents have led to a high-level game of musical chairs.

“We're seeing Class-C tenants move into Class-B buildings for the same rent they were paying. A lot of Class-B tenants are moving into Class-A buildings for similar rents,” says Abuja. Several firms are trading the suburbs for hip downtown sites to attract young professionals.

While some tenants are absorbing space, others are unloading it. Bank of America is vacating 231 LaSalle Street and freeing up 300,000 sq. ft. But down the street at the new 1.3 million sq. ft. high-rise developed by Houston-based Hines at 300 North LaSalle, the law firm Kirkland & Ellis is moving into 650,000 sq. ft. The building is 92% occupied.

Another Hines development, at 444 West Lake St., hasn't fared so well. “They're still working to secure financing for that project,” Konieczka says. One of two anchor tenants has pulled out and Hines has until the end of the year to get financing so the project can proceed, adds Konieczka.

A Hines spokesperson confirmed that the project has been delayed. Hines is not alone. A lack of available credit has thwarted many projects, says Abuja.

But some deals are getting done. Abuja closed a $15.4 million office sale in December at a capitalization rate of 8.1%. “The buyer was able to get an 80% loan-to-value, 10-year fixed-rate loan at 5.9% — but he was a strong buyer.”

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