Downtown Chicago beating: Office vacancy rises By Eddie Baeb, Crain's Business Sep. 28, 2009

Downtown Chicago beating: Office vacancy rises
By Eddie Baeb
Crain's Chicago Business
September 28, 2009

A blistering year for downtown office building landlords went from bad to abysmal in the third quarter, as the vacancy rate jumped to almost 15%, the highest in three years.

The overall vacancy rate surged to 14.8% in the third quarter from 13.7% in the second quarter, according to a preliminary report from Chicago-based Jones Lang LaSalle Inc. The current rate is almost three percentage points higher than a year ago, when it stood at just 11.9%. The last time the vacancy rate was higher was the third quarter of 2006, when it was 15.3%.

Office vacancies have been rising since the second quarter of last year as the recession has prompted companies to cut employees, downsize their offices and flood the market with space available for sublease — which generally goes for far lower prices than so-called direct leases with landlords.

Net absorption, a demand gauge that measures the change in the amount of leased and occupied space from the previous quarter, was a whopping negative 627,419 square feet in the quarter. For the year, net absorption is approaching negative 2 million square feet, says Elaine Melonides, a managing director with Jones Lang who represents office tenants.

Ms. Melonides notes, however, that almost half of the year’s negative absorption can be attributed to Bank of America Corp. shedding former LaSalle Bank space. In the third quarter alone, the Charlotte, N.C.-based bank accounted for the majority of the negative absorption by giving up more than 500,000 square feet at two buildings: 350 N. Orleans St. and 135 S. LaSalle St.

“This is probably one of our worst years over the last 10 years,” Ms. Melonides says. “Rarely does Chicago have negative absorption.”

Still, the market’s momentum has brought gross asking rents down about 5% for the year to $30.66 per square foot, according to Jones Lang data. The bigger movement has come in landlord concessions, which Ms. Melonides says have doubled over the past year to about one month of free rent for every year of lease term. So a 10-year lease, for instance, would now have 10 months of free rent while a year ago the same transaction would have included about five months of free rent.

“The market is the market,” laments one landlord, who declined to be identified.

There was one sliver of hope for landlords in the quarter, as Jones Lang reports that the pace at which new sublease space hit the market slowed.

Overall, there’s now more than 4 million square feet of sublease space available, just less than 3% of the market’s total inventory. But Jones Lang data shows in a monthly report that there were 24 new sublease listings in August totaling 304,887 square feet, compared with 47 new subleases available in April that totaled 527,283 square feet. April was the first month Jones Lang began the report.

The sublease vacancy rate held steady from the second quarter at 2.2%. The direct vacancy rate jumped to 12.6% in the third quarter from 11.5% in the second quarter.

The bigger bright spot for landlords these days is that the credit crunch has already thwarted one new development, a 1.1-million-square-foot tower planned at 444 W. Lake St., and will probably prevent any big office projects from coming out of the ground for a couple years.

“Chicago’s never had much of a barrier to entry (for new construction), and now you have it with the capital markets,” says Michael Watts, a senior vice-president with J. F. McKinney & Associates Ltd., a Chicago-based firm that represents office building owners.

Mr. Watts says he thinks things will start improving for landlords in the second half of next year because of the lack of new supply and widespread sentiment that the economy is slowly improving. While the vacancy rate may rise a little further, Mr. Watts doesn’t believe Chicago is in for a repeat of 2003-2005, when the vacancy rate hovered between 16% and 18%.

“In the early 2000s there was a supply and demand problem,” Mr. Watts says. “Now it’s really a demand-driven slowdown.”

Mr. Watts and Jones Lang’s Ms. Melonides both believe there will be more leasing activity in the coming year, thanks to greater certainty about the economy and the sense that the market is bottoming out.

“You’re going to see deal velocity pick up in 2010,” Ms. Melonides says. “I do think that tenants are going to be focusing on the future and looking to take advantage of low (rental) rates.”

Notable leases in the third quarter included:

• Radio giant Clear Channel Communications Inc. expanded to 107,000 square feet at 233 N. Michigan Ave., adding about 33,000 square feet there. The company will move a subsidiary out of 40,000 square feet at NBC Tower, 455 N. Cityfront Plaza Drive, into the Illinois Center building.
• Law firm Meckler Bulger Tilson Marick & Pearson renewed for 68,000 square feet at 123 N. Wacker Drive in a deal that reduces the firm’s space by about 14%.
• Law firm Polsinelli Shughart leased 29,000 square feet at 161 N. Clark St., where the firm will move and roughly double its existing space at Two Prudential Plaza, 180 N. Stetson Ave.