Employment drives demand for office space. Since the recession of 2008-2009 ended, total employments has grown at a slow pace, both locally and nationally. Office demand traditionally lags the labor force by one to two years, suggesting that occupancy should be falling, causing vacancy rates to rise. However, total vacancy, (sublease space included), has declined since the fourth quarter of 2010. So why hasn’t vacancy acted intuitively given the current employment climate?
Chicago-area total employment for professional and business services, the labor category most closely aligned with office use, peaked during the fourth quarter of 2007 before falling 14.9 percent compared with the first quarter of 2010. Total office occupancy in Chicago’s CBD peaked during the third quarter of 2007, but only fell 1.3 percent before bottoming out the third quarter of 2010. Occupancy declined at a less severe rate than employment because firms cannot shed space instantaneously with job cuts. The graph below shows that occupancy is highly correlated with employment changes but lags one to two years. Professional and business services employment began a three year climb beginning in the first quarter of 2004 while occupancy did not sustain an increase until the fourth quarter of 2005. Thus, the recent uptick in occupancy can be attributed to the increase in jobs sustained from the very beginning of the recovery.
Large tenants grow their downtown presence
A select group of companies have bolstered the CBD market by establishing their headquarters in downtown Chicago. Since committing to move its global headquarters from Elk Grove Village during the heart of the recession, United Airlines has leased a total of 650,000 square feet at Willis Tower—roughly 0.5% of the CBD’s total office inventory. Groupon, which was established in November 2008, currently leases and subleases a combined 536,000 square feet throughout the CBD. While its 196,000 square foot lease at 303 East Wacker expires next year, the deal-of-the-day website has supported the River North and East Loop submarkets. Last year, BP began to occupy 225,000 square feet at the CME Center, relocating from the Western Suburbs, resulting in all new demand for the CBD. As many companies have cut their space requirements, the aforementioned have provided significant new demand to help occupancy.
Lack of new inventory
The addition of a new building can adversely affect vacancy rates by adding new competitive stock to the market. Fortunately for existing landlords, there have been no new deliveries since 2009 besides a 933,170 square foot vertical expansion at 300 East Randolph, which is currently 94 percent leased. No new developments are under construction in the CBD. Eight sites, all located in the West Loop submarket, have been actively marketed in the past 12 months. The proposed developments range from 350,000 to 1.1 million square feet and will need to be at least 60% preleased in order to break ground. Even if the smallest of these developments obtains financing, it is unlikely that any new inventory will be delivered until at least 2013.
Chicago-based firms show increased confidence
Total vacancy has declined this year due to companies reducing the amount of available sublease space. At the end of the third quarter, 381,000 square feet has been either subleased or removed from the market year-to-date. Available sublease space has declined by more than1 million square feet since peaking at the end of 2009. Since sublease space is often leased at reduced rental rates as tenants are content to recuperate even a portion of their costs, landlords benefit from a reduction in overhang.
Several large users, some of whom delayed real estate decision-making, have made commitments to stay in the CBD. Wells Fargo is consolidating multiple locations throughout downtown, but slightly increasing its total footprint with a long-term lease for 293,000 square feet at 10 and 30 South Wacker. Across the street, PricewaterhouseCoopers signed a 15-year renewal to remain in 279,000 square feet at 1 North Wacker. Fifth Third Bank extended its lease until 2024 and will expand by 38,000 square feet at 222 South Riverside to occupy a total of 218,000 square feet. While some firms have threatened to exit Chicago, the aforementioned have solidified their presence in the city and stabilized occupancy in their respective buildings.
Despite declining vacancy numbers year-to-date, many uncertainties exist on whether vacancy will continue to fall in the CBD. On one hand, several firms have committed to expanding their workforce. GE Capital, Ernst & Young, and Seaton Corp have announced plans to add 1,000, 500, and 400 jobs, respectively, to their downtown offices. Google, which currently leases 130,000 square feet, is currently searching the market for up to 350,000 square feet. However, sluggish job growth will continue to work against demand for office space. Shadow vacancy, which refers to underutilized space that companies lease but are likely to shed at lease expiration, is difficult to quantify, though is expected to have a significant impact on occupancy since several firms are expected to reduce their space upon lease expiration. Combined with a bleak economic outlook, MB Real Estate forecasts slight occupancy losses through 2012.