Downtown office vacancy highest in 4 years By: Thomas A. Corfman Crain's 03-29-2010

Downtown office vacancy highest in 4 years
By: Thomas A. Corfman
Crain's Chicago Business
March 29, 2010

The downtown vacancy rate has made its biggest leap in seven years, as a sharp drop in demand was compounded by the completion of yet another office project.

The vacancy rate spiked to 14.9% during the first quarter, compared to 13.8% during the fourth quarter and 11.5% during the first quarter of 2009, according to a report by the Chicago office of real estate firm CB Richard Ellis Inc.

The jump of 1.1 percentage points is the largest single-quarter increase since the fourth quarter of 2002, when the vacancy rate climbed 2.1 percentage points, to 12.9%, in the wake of another recession.

The vacancy rate has climbed for six consecutive quarters and now stands at the highest level since first-quarter 2006, when the vacancy was 15.1%. During the last decade, the vacancy rate peaked at 16.0% at the end of 2005.

Yet in a hopeful sign, the amount of sublease space fell during the first quarter, the first decline in two years, prompting some landlord representatives to think the worst may be over.

“I think we have nudged off the bottom,” says landlord rep Robert Gillespie, a senior vice-president with CB Richard Ellis. “I am not suggesting that we are on a sharp V-type of recovery, but we are on an upward trajectory.”

Including sublease space, the overall vacancy rate shot up to 17.1% during the first quarter, compared to 16.2% during the fourth quarter and 13.3% during the first quarter of 2009, CB Richard Ellis says.

The increase in overall vacancy is the largest single-quarter jump in five years.

Demand for downtown office space plunged by more than 700,000 square feet during the first quarter, the fourth time during the past six quarters that demand has fallen. The drop in demand is the biggest single-quarter decline since the fourth quarter of 2002.

Demand is measured by net absorption, the change in the amount of leased and occupied space, compared to the previous quarter.

Mr. Gillespie says that first-quarter demand reduction is the result of corporate decisions made six to nine months ago.

But tenant representative Daniel Arends says he expects the vacancy rate to rise another full percentage point this year, adding, “There just doesn’t seem to be a lot of demand.”

More than half of tenants with leases coming due are renewing, compared with just 30% to 35% in 2008, says Mr. Arends, a principal in Rosemont-based Colliers Bennett & Kahnweiler Inc.

“Most of those guys, when they are renewing, are slightly downsizing,” he says.

New development is also a culprit in the growing amount of vacant space. During the first quarter, the parent company of Blue Cross & Blue Shield completed the 860,000-square-foot vertical expansion of its headquarters, 300 E. Randolph St. The space is currently vacant, but most of it will be taken up by the health insurance company and law firm Baker & McKenzie LLP. When they move, those two firms will leave vacant spaces totaling about 487,700 square feet in two nearby buildings.

Since the recession began in late 2007, the downtown office market has grown 5%, to 127.1 million square feet, because of development deals put in place before the downturn began.

But the current freeze on development — how long is a matter of debate — is giving the owners of existing buildings hope.

“If the recent uptick in economic activity can produce even moderate job growth, you will see a fast turnaround in the market,” predicts Brian Whiting, senior vice-president with Chicago-based J. F. McKinney & Associates Ltd., which represents landlords.

The noteworthy office spaces that came on the market include:

• 161,000 square feet at 540 W. Madison St., according to a spokeswoman for Bank of America Corp., which owns the building. In late ’08, North Carolina-based BofA leased 125,000 square feet to DRW Trading LLC, the first outside tenant in the building.

• 80,000 square feet at 200 S. Wacker Drive formerly occupied by Boston Consulting Group, which moved to 300 N. LaSalle St., developed last year by Hines Interests L.P.

• 75,000 square feet at 350 N. Clark St., a terra cotta classic where Mesirow Financial was based until it moved to 353 N. Clark St., which the Chicago-based investment firm co-developed last year.
As the building boom winds down, the vacancy rate for Class A space in newer, top-quality office building rose to 14.4% during the first quarter, compared to 12.5% during the fourth quarter and 9.5% during the first quarter of 2009.

Thanks in part to the expansion of 300 E. Randolph, the vacancy rate in the East Loop is the highest in the city, at 17.8%, compared to 14.7% during the fourth quarter and 11.9% during the first quarter of 2009.

The vacancy rate in the West Loop shot up to 15.8% during the first quarter, compared to 14.9% during the fourth quarter and 12.1% during first-quarter 2009.

Vacancies are lowest in River North, where the rate rose to 11.4%, compared to 10.3% during the fourth quarter and 11.3% during the first quarter of 2009.

The downtown office market may be slightly tighter than it appears, CB Richard Ellis says.

Amid rising concerns about the financial condition of some landlords, the real estate firm has begun separately tracking buildings that are either unable to pay or have a difficulty making payments for concessions to woo new tenants.

Such properties, sometimes called zombie buildings by real estate insiders, can’t compete for most tenants, who want landlords to offset the upfront costs of moving, such as interior construction.

CB Richard Ellis declines to identify the 14 buildings it says fall into this category, which total nearly 11.3 million square feet. Excluding these cash-constrained properties, the downtown office vacancy rate was 16.6% during the first quarter, compared to 17.2% for the entire downtown market.