The tenant’s market in Chicago continues. There is good news and bad news for tenants in how the market is evolving. The good news is that some landlords are finally willing, in some cases, to accept lower rental rates. (Up until now, most landlords have held firm to their pre-pandemic rental rates, preferring to sweeten the deal with higher tenant improvement allowances and additional rent abatement). The bad news is that many landlords don’t have the capital to fund tenant improvements. They’re asking the tenant to fund its own improvements. This represents a major shift in the market.
Long Term Reset of the Market
The effects of the changing market will take years to be felt fully. This is for two reasons: 1) many long-term office leases haven’t yet expired, and 2) many office building mortgages haven’t yet come due.
When leases expire over the next 2-3 years, it’s unlikely they’ll be renewed at the same size if they get renewed at all. As for mortgages, when they come due over the next few years, often the reduced value of the property won’t support the outstanding principal balance. The borrower then has two choices: 1) contribute significantly more equity to “buy down” the principal balance to market levels, or 2) hand the keys back to the lender in a “deed in lieu of foreclosure”.
Building Supply Declining
Some lower-end office product is beyond help and will never recover. In many recent cases, buildings like this are either being renovated to serve another purpose (e.g. residential) or more likely, torn down to make way for an alternate use. We’ve seen examples of offices buildings being torn down and replaced with apartment buildings, retail centers and warehouses.
Tenants Adapting to the Work from Home Phenomenon
Quite a few companies are mandating that their employees return to the office for at least a few days a week. Still, it seems unlikely attendance in the office will ever reach pre-pandemic levels. This has allowed many tenants to reduce the size of their space, and allocate more area to “we” space (conference rooms, break rooms, collaboration areas) and less to “me” space (private offices, large workstations, etc.)
Flight to Quality
As tenants downsize, many are opting to trade up to a higher quality building, partly to attract employees back to the office. Often, they can make this move without increasing their total rent cost. They end up with a nicer environment at roughly the same occupancy cost.