Office N Illinois

Chicago's office market had a strong first half and looks good going forward

Chicago's office market had a strong first half and looks good going forward,ph1
Vintage office buildings like 1525 W. Homer Street in Chicago are attracting buyers who seek loft/creative spaces used for collaborative work environments.

Vacancy plummeted in downtown Chicago during the second quarter as companies continue to expand their presence. With a vibrant urban core that boasts a lifestyle attractive to many young professionals, many corporations are motivated to expand their workforces in Chicago, boding well for the city’s office property performance.

In particular, tech firms like Google and Facebook—which just signed a lease for 263,000 square feet in John Buck Company’s recently completed 151 N. Franklin building—are looking to increase their presence in downtown Chicago, potentially bringing many higher-paying jobs to the area. This steady corporate growth, combined with few completions within the core, has slashed CBD vacancy notably in the past 12 months. In the first quarter, this area’s vacancy rate remains roughly 200 basis points below the metro average.

Outside the CBD, according to Marcus & Millichap’s second quarter 2018 market report, Lincoln Park is performing very well. The 3.7 percent vacancy rate is unchanged from this time last year, but asking rents of $31.42 per square foot are up 12.6 percent year-over-year. This makes it competitive with other neighborhoods like River North and Gold Coast/Old Town which can command rents of $35.64 and $32.25 per square foot, respectively. The overall metro average is $24.73 per square foot.

While downtown transaction velocity held relatively steady during the past 12 months, the number of sales fell roughly 8 percent in the suburbs. However, heightened demand for Class A and B assets did lift average prices 15 percent to $145 per square foot, compared to the CBD where properties changed hands with an average price of $220 per square foot.

Looking forward, many buyers continue to seek loft/creative spaces used for collaborative work environments. These properties trade with returns in the high-5 percent band. Earlier this year, Marcus & Millichap facilitated the $4.5 million sale of a loft office space at 1525 W. Homer Street, on the border between Bucktown and Lincoln Park.

“This modernized loft building is in an area that’s poised for tremendous growth and development over the long term,” said Stephen Lieberman, a first vice president of investments in Marcus & Millichap’s Chicago downtown office. “With the expected transformation from industrial to mixed-use, North Branch could prove to be one of strongest pockets in Chicago, causing rents and property values in the area to soar.”

The suburbs led vacancy improvement metrowide as many companies seek cheaper rents than in the urban core while maintaining proximity to a large workforce. Many inner-ring suburbs registered healthy levels of net absorption during this quarter, with office spaces directly north of the core generating significant vacancy declines and considerable rent growth. The suburbs’ office vacancy rate plummeted 190 basis points during the past 12 months to 18.0 percent. Kenosha County posted a 330-basis-point decrease.

One downside for the region is that job creation in Chicago still lags the rest of the country. Unemployment rests at 4.7 percent, 60 basis points higher than the national rate. In the first quarter, 13,500 positions were created, contributing to the prior 12-month total of 21,000 jobs. Hiring was led by the government sector, with the addition of 8,600 workers to staffs. The construction sector followed, with more than 6,800 positions. The report forecasts overall employment growth in the metro at 0.7 percent (compared to 1.2 percent on average across the U.S.). Office-using job growth is projected at only 0.1 percent, versus the 2.2 percent predicted nationwide.

For investments, low vacancy and steady rent growth are sustaining both local and out-of-state buyer interest in Chicago’s office properties. Investors from California and New York are particularly active, seeking higher initial yields than are available in their home markets. Cap rates across the metro average in the high-6 percent area. In particular, investors’ appetite for medical office buildings picked up considerably during the past 12 months, with transaction velocity jumping nearly 30 percent. These investment opportunities offer returns up to 150 basis points higher than the metro average for office properties overall, according to Marcus & Millichap.

While investor demand remains healthy in the CBD, the dearth of available listings is compelling many buyers to consider assets in the suburbs. Properties west of the urban core, near Interstates 88 and 355, remain popular. Cap rates in this area can average between the low-8 and low-9 percent band.