Chicago’s Office Market … It’s Complicated

If you’ve been paying attention, you know that Chicago — Frank Sinata’s “toddling town,” America’s “Second City,” and the unspoken capital of the Midwest — has experienced a bit of a cultural renaissance. 

The Illinois city hosted the Democratic National Convention this summer, Grant Park’s annual Lollapalooza music festival drew more than 100,000 daily attendees, and the Emmy-winning culinary drama “The Bear” has generated national buzz around the city’s famous Italian beef sandwich. Moreover, the Chicago Bears were featured on HBO’s “Hard Knocks.” 

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However, one element of the Windy City that has failed to engender much excitement is the city’s beleaguered office landscape. Vacancy for the downtown office sector — which encompasses neighborhood’s as diverse as River North, the Loop, the West Loop and Fulton Market — sits at a dismal 23.6 percent, according to a second-quarter analysis by CBRE (CBRE). 

And some analysts believe true office vacancy reaches closer to 30 percent. 

“Before the pandemic, office vacancy was 13 percent. Now it’s about 29 percent, if you include subleasing — without subleasing, it’s at 24 percent,” said Tomasz Piskorski, professor of real estate finance at Columbia Business School. “One-third of space is essentially vacant or being subleased, there is not yet a full return to office, and the city has fiscal issues and other quality-of-life problems.”

Year-to-date, central business district vacancy in Chicago has increased 140 basis points, while absorption sits at about negative 1.5 million square feet for the same period, according to Newmark’s most recent quarterly report. The brokerage noted that, not counting 2021, this year has seen the slowest first half of downtown office leasing activity since 2009. 

“The numbers don’t lie: the vacancy is the highest it’s ever been, sublease availability is some of the highest it’s ever been, so there’s no avoiding that,” said Jeff Lindenmeyer, a Chicago-based principal of tenant representation at Avison Young.  

And then there are the trades. In February, R2 Companies acquired 150 North Michigan Avenue, a 41-story office tower, for $60 million, roughly 50 percent its 2017 sales price. One month earlier, 300 West Adams, a 12-story office building that opened in 1927, sold for a piddling $4 million, a far cry from its $51 million price tag in 2012. 

Even icons like Willis Tower — formerly known as Sears Tower, and once the world’s tallest building — are being hampered by increasing operating expenses and falling cash flow. The 2018 single-asset, single-borrower CMBS loan secured by Willis Tower was underwritten for operating expenses of $97.7 million in 2018, but those same expenses rose to $126.4 million in 2023, according to credit rating agency KBRA.   

“It’s a common problem for CRE operators over the last several years. With inflation there’s a rise in different operating costs,” said Mike Brotschol, managing director at KBRA Credit Profile, who added that Willis Tower saw its property taxes jump from $39.1 million in 2021 to $56.5 million in 2023. “That’s a pretty significant contributor to the rise in operating expenses for that property.”  

KBRA data highlighted another distressing metric: Of U.S. cities carrying more than $5 billion of outstanding CMBS office debt, Chicago took the cake with a distress rate of 75 percent — meaning 75 percent of the city’s CMBS balance collateralized by office debt is distressed.

Yet, there’s something funny about Chicago. The same city that recovered from the devastating Great Chicago Fire in 1871 appears to be primed to recover from the COVID-19 office apocalypse, largely on the back of surging Class A office leasing, rising rents, top-tier corporate investment, and a dedicated workforce of young professionals who arrive each year from dozens of top universities across the Midwest. 

Not unlike Charles Dickens’s Paris and London, Chicago appears to be a tale of two cities, with its highest-quality office assets emerging as its best-performing assets, even as its Class B and Class C properties have been left to rot. 

“While we have lower overall leasing volumes, there’s still super strong demand at the high end of the market,” said Neil Bouhan, senior managing director of research and communications at Bradford Allen, a local brokerage. “There’s real demand for highly amenitized buildings and high-class properties, there’s real demand for built-out space … and that’s been consistently up quarter over quarter for the past six quarters.” 

JLL (JLL) reported that only 1.5 million square feet of leases have been signed in Chicago since the start of the year, a 75 percent decline year-over-year. But, of those leases, 63 percent were signed at trophy properties like the Salesforce Tower in River North and other Class A offices around the Loop. 

“The bifurcation between flight-to-quality buildings that offer newer amenities, views, light, and are close to [the transportation] infrastructure, they’re attracting an outsized share of users in the market today,” explained Brian Atkinson, managing director at owner Hines in Chicago. “The buildings further removed from transit that are maybe not as improved and have other dynamics working against them, they’re seeing a much smaller amount of traffic, if any at all.” 

A research paper from CBRE found that since April 2020, 78 percent of tenants who have relocated downtown have upgraded their space, with data showing that buildings that have made significant capital investments in recent years to elevate the tenant experience attracting tenants who are willing to pay for it. 

CBRE Vice Chairman Brad Serot noted that even though companies were down-sizing leasing across the city and demand has fallen, central business district rental rates have increased.  

“It goes to this flight to quality, and all ships have risen because you have these brand-new glass and steel buildings in the West Loop and in Fulton Market,” explained Serot. “And, because of construction pricing, the cost of construction, they demanded the highest rents we’ve ever seen, and as a result the other Class A buildings also increased their rents.”

So, similar to a slice of deep dish pizza, maybe there’s more to Chicago’s office scene than the first layer. 

Wider Loop renaissance

To understand the city, you must see the city. 

Take a walk along the Chicago River and notice how the bend of West Wacker Drive curves into a row of offices boasting innovative architecture, like the reflecting glass of 333 West Wacker or the post-modern Greek pediments of 77 West Wacker. Down along the famous Magnificent Mile, world-class hotels and retail outlets alternate with residential high-rises like 875 North Michigan Avenue and 900 North Michigan Avenue, each exceeding 66 stories. Then look at LaSalle Street and see why the neo-classical Continental Illinois Building, romanesque Rookery Building and Art Deco Chicago Board of Trade provide an understated Midwestern response to Wall Street’s reputation as America’s oldest money center. 

All of these addresses reside inside The Loop — Chicago’s square-shaped central business district bordered by the Chicago River that turns like an L around its western and northern limits, and closed off by Millenium Park and Lake Michigan to the east and Roosevelt Road to the south. 

Each of these neighborhoods, and the dozens of streets within them, have seen their office leasing altered in recent months. 

“There’s more nuance to the market than before because geography and location has become more important than ever on the leasing side and on the investment side,” said Michael Lirtzman, head of office agency leasing at Colliers. “And tenants are showing a certain location preference that might be slightly different from market cycles in the past.”

Over the past three decades, Chicago office tenants have shifted their collective center of gravity from neighborhood to neighborhood within the Loop, almost like an amoeba following the flow of capital. CBRE’s Serot recalled watching how improved transit lines, sudden investment patterns and new development influenced building and leasing over the past 23 years. 

“When I first started, North Michigan Avenue was hot. That’s where the marketing and health care systems were, and LaSalle Street was the financial street, and Wacker Drive was new office. And then the center of gravity moved from North Michigan over to the West Loop, strictly because of transit,” he said. “Then River North became hot for a minute, and Fulton Market appeared, but then COVID hit and the center of gravity moved back to West Loop due to nearby transit and high-quality buildings.”  

The constantly evolving nature of Chicago’s business district is partly due to the city’s hyper-diverse economy. Unlike Houston, which is beholden to oil, and New York, which is defined by finance, or San Francisco, which is all about tech, Chicago has a little bit of everything: commodities, tech, banking, health care, big legal — all power the city, but none dominates it. 

“The Chicago office market is very diverse, we have no single concentration of user groups, and for the most part it’s a very dynamic office market that’s not over-weighted by any particular business sector,” said Atkinson, who called Chicago “the hub” for Midwest employment.

“There’s a reason why some of the largest companies in the world have a very significant office presence here in Chicago,” he continued. “The Chicago market, by and large, is strong in the aspect that it attracts employers that are seeking to engage employees at a basis that is different from the coasts.”

To wit, earlier this year, J.P. Morgan Chase announced plans to refurbish, rather than leave, its offices at 10 South Dearborn, signaling its commitment to the Loop. And in May, Google announced a $280 million renovation to the James R. Thompson Center, turning the 39-year old former state government building into a modern tech headquarters. 

Other recent deals include Salesforce opening its eponymous 60-floor office tower at 333 West Wolf Point Plaza, and snagging law firm Kirkland & Ellis into leasing 26 floors. Then there’s the 148,000-square-foot lease law firm Winston & Strawn inked at 300 North LaSalle Street in July. 

The common denominator in all these deals: proximity to Ogilvie Transportation Center, which connects the downtown streetscape to the nexus of suburbs sprawled across the Chicagoland area via the Metra, an expansive commuter train network. 

“In Chicago we have a suburban commuter line, the Chicago Transit Authority downtown, and people who can live in proximity  to their offices,” said Mason Taylor, executive managing director at Cushman & Wakefield (CWK). “It checks big boxes when companies are trying to recruit nationally.”  

Proximity to transportation is why the West Loop has been the most desired neighborhood to lease in the last 20 years, explained Colliers’ Lirtzman, who added that new commuter train stations and better access to expressways have only intensified that importance. 

“It’s generally where the newer building stock is, and newer buildings tend to have better capitalized owners,” he said. “You look at those factors, and that’s why that submarket has seen such major activity in recent days.”

Plan of action

But all’s not well in the Loop. 

As noted earlier, the Second City has two faces, and once-mighty business corridors like LaSalle Street have experienced high vacancy as early 20th century office buildings turned into derelict, if not disused, shells of their former selves. Elsewhere across the city, local sponsors have made headlines for all the wrong reasons. 

Ownership at 1 North State Street defaulted on a $60 million loan on the building’s retail portion in August, while sponsors at 70 West Madison Street defaulted on a $305 million loan in April. 

In 2022, Citadel’s Ken Griffin, an Illinois resident and one of the richest men on the planet, announced his hedge fund will leave Chicago for South Florida, taking thousands of employees and billions of property tax dollars with it. 

“If you want to skate to where no one is going, that’s a good place to go,” said a real estate investor who did not want to be named. “Chicago, from an office environment standpoint, has been a trading sardine: People make money, lose money, but, overall, long-term values haven’t grown over my 20-year career. … I wouldn’t skate toward that puck.” 

To change the perception around its uneven office landscape, Mayor Brandon Johnson has announced a pair of government initiatives to pump billions of dollars into CRE development. 

In April, Johnson secured City Council approval to borrow $1.25 billion over five years to fund new affordable housing development and support small businesses and nonprofits downtown. He also announced a revitalization plan for the LaSalle Street corridor, which will invest $525 million to repurpose 1.3 million square feet of office space into 1,000 mixed-income rental units, of which 300 would be reserved for affordable housing. The plan is funded by tax increment financing, public subsidies to private development that are paid back in the form of higher property taxes down the line. 

“LaSalle Street is an older stock of buildings that has faced challenges,” said Bruce Miller, senior managing director and office group leader at JLL. “It’s a new development that will have a number of positive effects on the corridor — reduced supply of space will tighten [vacancy], bring more residents into the business district, and it will bring more vibrancy into the area.” 

Many questions remain. 

“You can put rental units in the Central Loop, but do people really want to live here?” asked Bradford Allen’s Bouhan. “Where do the kids of these residents go to school? Where do they get groceries? The size of these initiatives, it’s filled with questions going forward on whether it can be successful at scale.”

Others aren’t so credulous that a Chicago mayor — or a state where a parade of recent governors and Illinois House speakers have either been convicted of crimes or indicted on corruption charges — will be able to effectively manage billions of dollars of public-private partnerships. 

“The state doesn’t have great fundamentals,” said Piskorski. “There’s concerns about insolvency, the high deficit of the State of Illinois, and Chicago has experienced an outflow of people, so it’s not like the economy of Illinois is doing amazingly great.” 

Over the last nine years, Chicago has lost more than 128,000 residents, and its most recent population estimate of 2.7 million people is the city’s lowest total since 1920, according to Census data. 

“You’re only as good as your tenants,” said Piskorski. “The fiscal deficit might force the city and state to raise taxes, specifically property taxes, and there’s a sense that Chicago isn’t Palo Alto or Manhattan, that it doesn’t have as robust an economy as these other cities.” 

A new way forward

Even if Chicago lacks the dynamism of Silicon Valley, or the sheer scale of the five boroughs, the City of Broad Shoulders carries two enduring characteristics: pride and imagination. 

“Not enough people are talking about what makes Chicago go. It’s still the capital of the Midwest,” said Colliers’ Lirtzman. “There are still cranes in the air with new high-quality, multifamily housing being delivered, and you ask yourself why? Because jobs are being created in Chicago.”

No neighborhood better exemplifies Chicago’s appeal to young workers, its attraction to investors, and its sheer creativity to reinvent itself better than the Fulton Market District, a neighborhood on Near West Side, across from the Kennedy Expressway, that once served as the site of meatpacking warehouses featured in Upton Sinclair’s expose on that industry, “The Jungle.” 

Today, that same neighborhood of aging once-factories is home to the red-brick corporate campuses of McDonald’s and Google, to say nothing of the dozens of luxury apartment buildings and Michelin star restaurants that now define the area. 

Fifteen years ago, the idea of Fulton Market becoming the centerpiece of the city’s commercial real estate scene was as unlikely as a Cubs World Series win. And, yet, the Cubs won it all in 2016, and Fulton Market is now the highest-performing office submarket in the entire country as measured by rental growth, according to JLL’s Miller. 

“It started transforming in the 2012-to-2014 time period, but then things really accelerated, and it began with the development of Soho House that was followed relatively quickly by Google coming into the area,” explained Miller. “We started seeing great restaurants, great bars, and it fed upon itself and created one of the most successful mixed-use environments in the entire country.” 

The flight to quality of residential and retail tenants into Fulton Market has piqued the interest of office developers, who are always looking to follow the footsteps of workers, who in turn value easy commutes and good shopping as much as they might value a company’s corporate culture. 

Developer Sterling Bay is opening a 25-story office tower at 360 North Green Street this fall that is already 90 percent leased. Thor Equities’ 19-story mixed-use development at 800 West Fulton Market will span an entire city block and feature 470,000 square feet of office space and another 35,000 square feet of restaurant and retail. And Fulton Street Companies and JDL Development secured $233 million in construction financing last fall to build 919 on Fulton, a 373,000-square-foot office complex with 23,000 square feet of street-level retail. 

“It’s been extraordinarily dynamic over the last decade, and like any new marketplace it’s going through growing pains as any would,” said Atkinson. “It took many years for River North to grow and evolve, and it will take Fulton Market time to grow and evolve, too. It’s in its infancy.” 

This nascent mixed-use mecca has benefited from health care workers — Chicago is home to Northwestern Memorial Hospital and Rush University Medical Center — and recent college graduates. The city is a feeder market for Big Ten schools like the University of Michigan, the University of Wisconsin and the University of Illinois, but also private institutions like Northwestern University and Notre Dame, which produce an ambitious workforce that has enlivened the area’s restaurants and signed leases at former factories redeveloped into luxury residencies.  

“All those kids are coming to Chicago, and why are they coming here? Quality of living, and this is where the jobs are,” explained Lirtzman. “This is what gives me long-term hope for the office market’s continued recovery. It’s young people driving it, and that’s a good thing for the city.”

Besides perception, there’s also metrics. Kastle Systems, which tracks national office occupancy in the nation’s largest markets, found that Chicago’s 63 percent office occupancy is fourth highest in terms of recovery as a percentage of its pre-
pandemic baseline, trailing only Austin, Houston and Dallas, but exceeding the national average of 56 percent, according to David Hoebbel, Cushman & Wakefield’s director of research.

“Chicago is only going to continue to flourish,” said CBRE’s Serot. “We’re lagging behind New York, but we’re way ahead of San Francisco [in terms of perception], and as companies mandate return to office and as the employment market shifts, I absolutely believe Chicago is here to stay, and office buildings will thrive in this market.”  

Brian Pascus can be reached at bpascus@commercialobserver.com.