Q1 Report: Bottom Still To Come in CBD

Grubb & Ellis' recently issued Q1 CBD office market report confirms this, showing a significant decrease in occupancy, down to 85.6% overall at the end of the first quarter, as compared 86.7% at the same time last year. Average asking rents have also fallen to $37.83 per square foot for class A office and $30.05 for class B, down about $1 per square foot from 2008, Grubb's research shows. However, Tom Tunnicliff, SVP director with Grubb & Ellis, says the bottom is still ahead.

"Commercial real estate is a lagging indicator to the overall economic market in the United States, and in the situation here, the worst has yet to come," Tunnicliff tells GlobeSt.com. "In the first quarter, there was very low activity and velocity of deals, and those deals that were out in the market were being pursued with vigor from landlords. That trend is only going to grow, and we're going to see things get a lot worse than they are currently."

In the same quarter that Hines brought online its 300 N. LaSalle, a 1.3-million-square-foot Central Loop office tower, the company also delayed plans for its 444 W. Lake development, a planned 1.1-million-square-foot office building. Tunnicliff says such developments are not surprising, and that he expects new construction will remain nonexistent for at least another year.

"I don't think you're going to see any new cranes in the sky for a long time, unless this Hines project gets kicked off, and that's looking more and more unlikely every day," Tunnicliff says. "I would project you won't see any stabilization in the Chicago CBD market until most likely 2011, maybe 2010."

NAI Hiffman's research indicates that there will be a migration of tenants to newer and more functional buildings and that effective rents will fall through the remainder of the year. "As the credit crisis continues and the threat of deepened recession grows, the outlook for 2009 calls for increased sublease listings as tenants retrench," according to NAI Hiffman's market report released in late March. "However, the market has a way to go to reach levels seen after the dot-com collapse earlier this decade when sublease reached almost 4% of inventory, or 2.7 million square feet. As vacancy rises, look for landlord concession packages to increase as owners desperately try to hold on to or attract the tenants in the market."

Grubb's research concurs that effective net rents will continue on a steep decline, with no bottom in sight till late this year at best. "Effective net rents are really our stock market price and the effective net rents are going to continue to decline, and I think there could be a very sharp spike downward in those effective net rents in the next three to six months," Tunnicliff says. "Obviously the real estate market in Chicago is cyclical and we're in a downward part of the upside down bell curve. Since the effective net rents are still now as low as they were in 1996 or 1997, there's still room for a spike downward."

MB Real Estate's recent report suggests that as sublease space increases and effective net rents decrease, tenants will have a growing number of attractive options, which they would be wise to pursue. "Although the economy is in the early stages of the recession, tenants are beginning to take advantage of good existing sublease space, which will put downward pressure on prices for direct tenant space," the report said. "In a tight credit market, subleases offer tenants attractive opportunities to get an above standard build out, furniture and concessions that on a direct basis would be more expensive and capital intensive, and in many instances would require a letter of credit."

Tunnicliff too says this is a hugely opportune time for tenants, particularly smaller ones who have even more options than larger users, to negotiate or renegotiate a lease. "There's an inverse relationship between the size of the deal and the number of opportunities, but it's a great time to be a tenant today," he says. "If you have a lease that's up in the next three to four years, you need to be considering renegotiating with your landlord."