What the Glut of Chicago Office Space Means for Tenants

Willis Tower Office Glut

It might seem like all the space in the world. But appearances can be deceiving.

A recent article in the Chicago Tribune illustrated the HUGE amount of vacant space downtown with the vivid comparison to 5 empty Willis Towers! And the article states that more of that than ever is sublease space. 

What this means is different to different organizations that lease office space. What that means is also different to different real estate professionals, depending on whether you represent building owners or office tenants. MAP Real Estate is an office tenant-rep. So to us, the glut is the opposite of a headache. To brokers that represent building owners, it’s a headache. 

From the perspective of office tenants, it’s like a sale on caviar or Cadillac. A great buying opportunity if you are in the market for either one. But “in the market” means you have a need and you have the money to make the bargain purchase. If you just bought a lot of caviar or a Cadillac, the timing might be bad for you. And a bargain might still be out-of-reach-expensive. As it goes with caviar and cars, so it seems to go with office space for charities and businesses.

Is your timing right? Is their credit strong enough?

Subleasing

So the glut of space might be an opportunity that you can take advantage of. But it might not be. The adage “timing is everything” applies. For starters, I’m talking about the timing of when your current lease expires, if you have one. And, there are other timing considerations. 

With subleases, before, during and after the pandemic ends, there three issues to consider: 

  1. Length of lease. Their length is whatever remains of the “underlying lease” that the sublandlord entered into with the building. Typically, that makes them shorter than a direct lease. By direct lease, I mean a lease with the building owner, rather than with a sublandlord that stands between you and the building owner; 
  2. Sub-tenant credit. The right of a subtenant to enjoy the beneficial below-market rental rate exists only as long as the sublandlord does not default on the underlying lease. So you might agree that it’s important for the credit of the sublandlord to be stronger than the credit of the prospective subtenant. If the sublandlord defaults on its lease obligations, the subtenant should expect to pay the going market rate for the space or move out.
  3. As-is layout. The layout of the space is another. Typically, the layout of sublease space will not be changed at the expense of the sublandlord. Usually, subleases are offered in “as-is” condition. 

Direct Leasing

And, even with direct leases, the pandemic seems to have made this point more broadly applicable. Building owners now desire, more than usually, to sign leases that have a low “transaction cost”. That’s accomplished most effectively if a prospective tenant can use the existing layout that’s been left behind from a previous lease. Because the landlord’s transaction cost will be so much lower as the result of not having to build the layout needed by the prospective tenant, the rental rate the landlord will agree to is likely to be less than it would otherwise be. 

I want to point out it’s always been the case that, if a tenant can use space without a completely new build-out, the lease economics can be more favorable for both landlord and tenant. Lower transaction costs for the landlord should translate into lower rent cost for the tenant. 

On the question of whether your organization can take advantage of the huge amount of space now on the market, here is a little more detail to consider about the available “direct-lease” and “sublease” space.

Size does matter, in office leasing.

The size of your needed space compared to the size of a particular available space is almost always an important issue. Dividing a large space is sometimes just not desirable to the landlord. Or sometimes it’s simply not possible because of building-code mandates for ingress/egress. Or it’s prohibitively expensive. On this point, typically, direct leasing presents a greater opportunity to cut a space to the exact size that your organization might need. 

“What’s in your wallet?”

Are you in the market for caviar or lentils? In other words, will your organization benefit from discounted high end space? Or do you really need good utilitarian space that’s more economical? Just because space in A-class buildings is being discounted, doesn’t mean it’s a good buy for you. 

Now for the buzz question of the moment… just ….what is your “new normal”? As always, the amount of space you need is based on staffing levels. And, hopefully for not much longer, the amount of space you need will not also be conditioned by covid-physical-distancing. Maybe companies will be able to use alternate-day scheduling, so that the same or less space can work for your organization. How far into your crystal ball can you see?

Without question, the glut of available space suggests advantage for tenants. How long will that last. How long will it be before rental rates resume their upward climb. In other words, how long should your next lease be? The glut and our developing understanding of the desirability of remote-working make it rational to think that the most economical lease, whether for sublease or direct lease space, is going to be short-term and makes use of existing conditions. 

Will the world, and work, return to mostly the old normal? I think it will. If it does, how quickly will that happen?  Why this matters for our discussion is because the amount of available space will, in time, return to a more normal balance. Pandemic-induced downward pressure on rental rates will lessen. Rental rates will increase. At least that’s what the experts are forecasting.

office vacancy

Where is this glut located?

Then there is the issue of where all of this available space is located – at what addresses? All office buildings are not equally affected by the pandemic. 

As is always the case, negotiating dynamics are conditioned by the overall market conditions (lots of direct & sublease space now being offered) and also by the specifics at each building with regard to it’s leased-up percentage. Just because organizations have not been using their office space does not mean that they are not paying the rent.

Some buildings are much more fully leased, and with strong-credit tenants, than are others. So, while there may be the equivalent of 5 Willis Towers worth of available space, that news still needs to be understood with a grain of salt.

The statistics, below, are taken from CoStar, the industry gold-standard for information on commercial properties. They provide further insight into which organizations might go bargain hunting and where bargains might be found, showing the available space by caliber – Class A, Class B, and Class C, and pricing. 

Available Space For All Greater Downtown SubMarkets 

Class A  Class B Class C 
Vacant sf 16.5M+  9.9M+  1.6M+
Sublet sf    4M+ 2.1M+ 161K-
Availability Rate  22.8%+ 19.3%+12.5%+
Available Asking Rent/sf$45.32-$37.30+$26.07+
Occupancy Rate         84.7- 85.1-90.1-
Percent Leased Rate87.7-87.5- 90.9-

M=1,000,000 

K=1,000 

+ or –  indicates if the number is trending up or down.

Notes about the Table: For the purposes of this discussion, it doesn’t matter that the numbers don’t balance in each column. The reason they don’t is because you can have a direct available space for lease that is not vacant. The tenant can still be occupying the space and the Landlord has already started marketing it. Thus it is available but NOT vacant. You can also have the situation where a space has been leased and the move in date is in the future. In that case it is Vacant but NOT Available.

Costar projects that rental rates for the three caliber-categories will return to their 2020Q1 levels by 2023Q2 for Class A, by 2024Q1 for Class B, and by 2023Q3 for Class C.

While these projected “return” dates are not guaranteed, if you are going to be in business after 2023 and if in the next few quarters you can be in the market for a new lease, it might be more conservative to negotiate a longer lease, than just a year or two. When the next pandemic happens, we all hope our country will do a much better job of controlling it than we did this time. I think it’s probable that we will do a much better job, regardless of the political party in power.

I would like to end this post by sharing a real-time example, which may give you food for thought. This example is an assignment that we just completed for an established 501(c)3 that had signed a 12 year lease for 5,345 square feet in 2012.  This example is a version of a “blend & extend” negotiation. But one that’s on steroids and with a twist.

Our client, probably like you, had not been using its space for this past COVID-year. And probably also like you, its leaders had learned more about remote working than they had ever hoped to. Their space had become too large and it would remain too large because of the work-from-home lesson. The problem was that they still had 3.75 years remaining on that lease. And while this is a great time to be shopping for sublease space, it is not a good time to be selling sublease space. 

The solution, which will save our client just over $5,000/month starting late this spring, was a new 15 year lease for 3,573 square feet. Blend & extend is the expression, more common since the pandemic, for renegotiating an existing lease to obtain a value for both landlord and tenant, which neither enjoyed under the old lease. Typically the tenant receives short and near-term cash-flow relief, in return for the landlord receiving a greater value because of a significant extension of the original expiration date. The remarkable thing about this example is its relatively small size, coupled with its relatively long lease term.

Our client had concluded that its “new normal” includes staff working remotely, not as many as over the past year, but enough to permanently warrant reducing its office space by 1/3. And our client concluded that the world will return to “normal” once the pandemic has ended. In other words, it concluded that rental rates will most likely resume their upward climb. So there was no time like the present, because pandemonium-induced anxiety is also felt by building owners, to lock in very favorable lease economics for a very long time, something that short-term sub- and direct-leases definitely do not do. 

To top off the good, because of MAP’s commitment to the community, this pretty small office lease will result in a $6K+ unrestricted contribution, via Investing In Communities®. This will bring to over $575,000 the funds that MAP has given to our nonprofit clients and to charities that our for-profit clients support.