Shifting tenant demands, new supply will challenge office market: report

Chicago’s Downtown office market absorbed 1.4 million square feet of space in 2018 as corporate relocations and a growing technology sector continued to fuel demand.

But with absorption dipping at the end of the year — and with a number of new deliveries on the horizon — the market could be in for a shift, according to a new report from Colliers International.

The local office market has been humming along, with 2018 posting the second-strongest growth year in a decade. Six office buildings totaling 2.1 million square feet were delivered in Downtown in 2018, with 86 percent of that space leased or occupied by the end of the year, according to Colliers’ fourth-quarter Downtown office market report.

That growth appears to be slowing, however. Chicago’s office market reported 3,500 square feet of negative absorption in the fourth quarter, according to Colliers, and a wave of new construction deliveries could make a rebound difficult.

In 2019, Chicago will add 3.6 million square feet of office supply, of which only 9.5 percent is pre-leased, the report said. The majority of the new supply — about 2.5 million square feet — will come from the redeveloped Old Main Post Office. About 320,000 square feet of space has been pre-leased in the 601W Companies’ development, led by Walgreens.

The wave of new supply has already caused office vacancy to rise. The fourth quarter posted a vacancy rate of 12.9 percent, an increase of 40 basis points year over year. That number will likely continue to trend upward, according to Colliers, but not every part of Downtown will be affected equally.

The increasing popularity of the West Loop and Fulton Market, plus tenants’ preferences for the amenities available in new construction properties, will continue to put stress on the Central Loop office market, according to Colliers.

“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,” Colliers research analyst Will Goldstick said. “This rift between quality assets and older assets had widened throughout 2018 and is expected to widen further.”

Last year was a “defining” one for the Central Loop, which ended 2018 with more than 145,000 square feet of negative net absorption, according to Colliers. The submarket posted a fourth quarter vacancy of 14.3 percent, up from 13.4 percent in the fourth quarter of 2017.

Even worse, there was no significant leasing activity in the Central Loop during the fourth quarter of 2018. With a number of financial institutions planning to vacate 1.8 million square feet in the Financial District by 2022, landlords in the area will have to adapt to attract tenants.

“Overall, the expectation is that the Central Loop submarket will continue to soften over the next 12 months,” the report said. “Landlords will have to make the decision of how to retain tenants, such as renovating and deploying amenities, friendly tenant-improvement packages or a combination of the two.”

Chicago’s office market will be buoyed by the continued success of Fulton Market. More than 1.4 million square feet of office space has been absorbed in the submarket over two years, according to Colliers. Though there is another 1.2 million square feet of Class A office space coming down the pipeline, demand for the space will remain.

At the end of the fourth quarter, Class A office space in Fulton Market had an asking rent of $48.13 per square foot, the highest asking rent of any submarket in the city, according to Colliers.

“Overall, the submarket is unlikely to be flooded with space at any one point, allowing landlords to control rental rates in their favor,” the report said.