• To See How the US Office Sector Is Changing, Check Out Chicago’s Rising Vacancy Levels

    To See How the US Office Sector Is Changing, Check Out Chicago’s Rising Vacancy Levels

    Savills’ Goodman Expects Flood of Space To Hit the Market as Tenants Rethink Needs and Fish for Better Deals

    ?Vacancy rates will go up more over the next 12 months,? Savills? John Goodman said of the downtown Chicago office market. (CoStar)
    “Vacancy rates will go up more over the next 12 months,” Savills’ John Goodman said of the downtown Chicago office market. (CoStar)

    Companies in cities across the United States are prepping employees for a return to the office even as corporate workspace is shrinking. Chicago, one of the largest markets, is no exception as businesses put offices on the market in a pandemic move that could push down lease rates for the foreseeable future.

    Availability rates, which include vacant office space plus square footage marketed as sublease or new construction, are approaching a gut-wrenching 22%, much to the concern of landlords. John Goodman, a vice chairman at real estate firm Savills, reckons availability in Chicago could top the record-high 23%-to-25% range of the savings and loan fallout in the early 1990s.

    “I think we’ll be there,” said Goodman, whose firm represents tenants in lease negotiations. “Vacancy rates will go up more over the next 12 months. There’s still a lot under construction, and there hasn’t been much of anyone new coming in town over the last year.”

    John Goodman is a Savills vice chairman based in Chicago. (Savills)

    The American office sector is coming out of a major jolt, going from booming demand for new space at the end of 2019 to the current state in which companies are evaluating their office needs. A look at the third-biggest U.S. city provides a snapshot of what's going on in the urban office market as corporate America starts returning to the workplace.

    Even if every company were to insist every employee come back to the office, downtown Chicago’s office vacancy would still be lofty given the abundance of space under construction, executives say. The 50-story, 1.46 million-square-foot BMO Tower under construction is expected to be completed by January, and the 1.2 million-square-foot Salesforce Tower Chicago, reaching 59 stories, is slated for a March 2023 end date.

    There’s also a handful of office buildings under construction in the bustling, trendy Fulton Market neighborhood just west of downtown, including Fulton Labs at roughly 423,500 square feet spread across 16 stories and the 13-story 320 Sangamon St. project that calls for nearly 302,000 square feet. What’s more, there are various new projects beginning to make their way through the city approval process or attempting to garner financing to begin activity.

    Larger companies such as Uber and Google have already made big decisions on less office space and hybrid in-office staffing that includes a work-from-home component, but others are still weighing alternatives. And still more continue to quietly list big chunks of office space on the sublease market. For example, accounting and consulting firm PwC recently added more than 71,000 square feet to the downtown Chicago sublease market, according to CoStar data.

    “I can’t overemphasize the degree to which companies are just coming back to kick the tires and consider their options” before signing leases, Goodman said.

    Of course, leasing activity has picked up since the virtual standstill last spring, summer and fall. Even so, it's nowhere near the hectic pace of 2019 when companies were making big bets on future expansions and flooding the market.

    Shrinking Footprints

    And while Chicago is a good example, office space is coming onto the market all across the United States. Goodman said Savills has one national client “at one end of the extreme” chopping its office footprint from as much as 230,000 square feet in seven cities to a mere 70,000 square feet total by closing offices and doing away with assigned seating.

    Another company has a lease coming up for 270,000 square feet that it is downsizing to 80,000 square feet with very limited assigned seating to allow those who want to work 100% from home to do so.

    “It’s very company-specific and very industry-specific,” he said. “We’re going to see minimal impact among some sectors like the law industry and financial services and wealth management — industries where people work in teams and they want that energy and people feeding off one another."

    “It’s highly nuanced,” he added.

    The situation has created a battle for tenants, with landlords brandishing their well-honed weapon of attractive lease rents and terms. The general consensus, according to Goodman’s own surveys of tenant and office representatives over the past year, is that office space users able to make changes to their leases will require 15% to 20% less square footage going forward.

    “But you can’t switch a switch and make that happen overnight,” he said, noting many office leases are still running for another 10 years.

    Already net effective rents in Chicago — gross rents minus discounted months and tenant improvement costs — are down 27% to 40%, dependent on the building type and age and the submarket it’s in, according to Goodman.

    “It’s huge,” he said. For example, the city’s steel-and-glass skyscrapers of the 1970s, '80s and '90s might have had average net rents of $26 a square foot a year ago and concessions such as rent abatements and tenant improvement allowances valued at roughly $10 per foot per lease year.

    Today, those net rents are down by an average of $4 per foot per year, and the concession packages are up by an average of $3 to $4 per foot per year. The result is a 35% to 40% drop in effective rental rates over the course of 12 months.

    That’s not true for trophy buildings that have become more expensive in recent years. “Maybe rents have not gone down that much, but there’s also very, very little deal activity,” Goodman said.

    Landlords are learning they have to be “cost leaders” if they want to do business, he said.

    Sublease Strategies

    Consider Chicago’s sublease space: Today, there’s nearly 6 million square feet on the market, some 40% above the 2.5 million square feet before the pandemic. Much of it was built out by technology companies looking ahead to their needs in, say, 2023 and 2024.

    As business gets back to some fresh form of normal, companies are still hashing out how their workspace might be evolving and are looking for better lease deals than they might have had before the pandemic.

    Here’s what some opportunistic companies are doing, according to Goodman: A tenant might have a lease for 100,000 square feet and knows it won’t need about 40,000 square feet. But it’s putting the entire space on the sublease market, thinking if another firm comes along and takes all 100,000 square feet, it’ll go figure out where to find 60,000 square feet at a lower cost. If the tenant finds only firms that want a sublease at a bargain price, it’ll take the 100,000 square feet off the market, Goodman said.

    “There are companies dropping the line in the water to see if someone bites,” he said, adding brokers are encouraging tenants to give it a shot in this environment.

    “There’s more quality space options with existing conditions for tenants today than I’ve seen in my 36 years of doing this,” he said. “It’s very appealing to tenants who want to do something different.”

    As a result, Goodman expects more subleases coming to the market in Chicago, heating up the competition among landlords to a point where space may be leased for 50 to 60 cents on the dollar.

    “Landlords are being forced by tenants’ desires to have their cake and eat it too,” he said. “Landlords who want to make deals in today’s market have to come to the table with a new reality about privilege and a willingness to provide the tenants with flexibility.”