Effects of Recession Hit Office Market in Q4

"2008 was really a tale of two cities, and we really had a very different fourth quarter than the first couple quarters of the year," says Tamara Kos, a Transwestern EVP that heads up company leasing in Chicago's Central Business District. "The first two-to-three quarters of the year were slower, and it didn't match up with the velocity and growth we saw in 2005, 2006 and 2007, but it was still a good year. There was still positive absorption and until early September when the equity markets fell apart and the stock markets plunged, we were having not a great year, but a good year."

Kos says the events of September took a serious toll on the market, namely through a decrease in consumer confidence. "What is happening right now is because this is such a different event with the economic trouble and recession hitting every industry on an international basis, everyone is frozen," Kos tells GlobeSt.com. "They don't know what they are going to do, so if they had expansion plans that's been put on hold or if they have a lease renewal they're putting new leases off, and if they have to make a decision now, they're doing short-term leases. It's just because the change was so dramatic and condensed in time frame, everyone in real estate is concerned about making long-term decisions in the dire financial markets."

Despite the economic downturn, World Business Chicago, the city's economic development office, deems the year a success, citing direct investment and numerous companies having opened new offices here. The group cites firms including MillerCoors, who took 130,000 square feet at 250 S. Wacker; and Veolia Environment, which now occupies 34,500 square feet in the Aon Center, located its corporate headquarters in the city. The nonprofit group also notes the opening of insurance company Aviva's national executive offices in the city and Barry Callebaut's locating its first US Chocolate Academy here as evidence of the market's continued strength.

"Chicago's ability to provide companies with a strong and vibrant talent pool, a central location with easy access to the world and an incomparable quality of life have helped contribute to a successful year," Rita Athas, WBC's executive director, said. "In addition, the city's highly diversified economy has helped us weather some of the economic uncertainty that other global cities are facing."

Still, Kos says this market contraction is different from others she's seen in her 25 years in the business, due to its speed and impact on all industries as opposed to certain sectors. "I've been through these cycles before and what I think was interesting was how quick and dramatic it was," Kos says. "I've never seen anything freezing every type of industry. This is pervasive and across-the-board with every city and every industry, and that's the difference."

Grubb & Ellis' recent market research says the CBD has a rough road ahead in 2009, due to the 3.6-million-square-foot of space planned to come online, with "no tenants entering the market to backfill the vacated space." The company says the distinction between well-capitalized and debt-heavy landlords will become increasingly obvious, as the former will be able to offer space improvement dollars and moving allowances to potential tenants, while the latter will only be able to offer rent abatements. "Regardless it will be difficult for landlords to start a game of musical chairs as companies wait out the market and sign short-term renewals until the future becomes clearer," the company said in a statement.

Kos says the impact of the new space coming onto the market will be lessened by the strong preleasing that has taken place at each development. "While we do have significant new development, it's well preleased," Kos says. "All of the developments are 70% to 100% preleased, so the majority of those new developments have been claimed or accounted for."

In addition to the 3.6 million square feet under construction at 300 N. LaSalle St., 353 N. Clark St., and 155 N. Wacker Dr., another 800,000 square feet is being developed at 300 E. Randolph. The space will not come onto the market for leasing however, as it is being added on top of the Blue Cross Blue Shield's existing building and will become immediately occupied by the company upon its completion. Looking forward past these four developments already under construction, Kos says she does not expect any more space to come onto the market until late 2011 or early 2012.

"With the equity and debt markets, it is very difficult for developers to finance a new building, even with significant preleasing," Kos says. "We won't have any 2010 deliveries. We may have a 2011 delivery if someone manages to get something financed, but right now, that's almost impossible, so that's going to slow things down."

Kos says she foresaw the slowing economy six months ago, and predicted the possibility of a slight recession, but never imagined anything like this. "I didn't see anything of this magnitude on the horizon, and a lot of people that are much smarter than me didn't see it coming either," Kos says. "This was very painful, but if you get beyond what has happened the last few months and start looking longer term, you see the government and companies pumping more money in. Hopefully, there will be more oversight in the future, which will give us more protection moving forward."

Kos also says that Chicago has sustained a far less severe hit than some other office markets. "Chicago is still very well-positioned within the overall markets in terms of having a more diversified business base and not having hit crazy rents," Kos says. "I don't think we'll look like New York City in terms of lay-offs and consolidations and business failures, and we're not going to see anything near what they do percentage-wise. We won't see as many hurdles looking forward that many of the other major and even secondary marketplaces will be facing from having been overdeveloped in the past."

Despite recent weakness, Kos remains optimistic about the future and relative improvement being seen quickly. "Things don't stay frozen forever and the government is trying to do many things to help," Kos says. "As we look into 2009, people will become more comfortable with what they think will happen with the economy and their business in the next couple of years. Even if they're anticipating their business will be down, they may be willing to make long-term business decisions and based on that, we'll see more movement."