Chicago Commercial Real Estate: 10 Things We Watched in 2021
Chicago, IL | December 29, 2021
As the world transforms away from being in a pandemic and starts to navigate a potential endemic, commercial real estate perseveres. Coronavirus, the Delta variant, and now Omicron—it’s difficult to see how the world has changed in the past year. Nevertheless, the commercial real estate industry has definitely done more than tread water the past 12 months.
In our report below, we’ll detail the current outlook of the retail and restaurant industries in the Chicago central business district, what companies are doing to draw employees back to the office, and discuss other looming issues, like sublease space, the industry is currently facing.
HOW MUCH LONGER WILL COVID-19 KEEP PEOPLE HOME, AWAY FROM THE OFFICE??
IN JANUARY, WE SAID: The road to recovery remains elusive, with many factors up in the air. America is currently dispersing multiple coronavirus vaccines, but timelines remain muddled, and other uncertainties (how many people will refuse the vaccine, for example) remain. There is also the Covid-19 variant, prominent in the UK and beginning to make its way through the US, which may further affect fully reopening the nation.
Every new development appears to be met by new roadblocks. Still, the CRE community, building owners in particular, have proven resilient in the ways they have pre-emptively prepared office spaces for their eventual reopening.
TODAY: Sadly, more time is needed to understand how long the coronavirus pandemic will keep employees away from returning to the office. Delays have been numerous, from vaccine hesitancy to Delta variant setbacks. Now, the looming Omicron coronavirus variant has many industries worried—companies don’t have enough information about the latest variant to make an informed decision. As of December 2021, companies are cautiously moving back return-to-office dates. Like the rest of the world, the CRE industry will remain on shaky ground until science and world leaders have inspired confidence in the workforce.
WHAT WILL THE CRE WORLD LOOK LIKE AFTER COVID-19 IS DEFEATED?
IN JANUARY, WE SAID: Experts seem to agree that all work-from-home strategies will not go by the wayside once the virus is gone. In the immediate years following coronavirus, this could take several forms: continued meetings via apps like Zoom, larger parts of the workforce become permanently work-from-home, some employees switch off between working from home and going into the office, among other changes.
Individual employers will likely mix and match the methods that work best for their specific needs, creating a much less homogenous office space world. And many employers are likely to give employees the power to decide how much time they want to spend in the office in the future, putting pressure on building owners to appeal directly to employees. Suppose office workers decide to adhere to even a modest balance between being in the office and working from home. In that case, that could translate into significant changes in the square-footage needs of the average business. However, those changes could be minimized by the decreased density and increased collaboration space the new office environment will require.
TODAY: Complete defeat may not exist in the near term, but the CRE world will learn how to effectively manage coronavirus as we move into an endemic. Once the World Health Organization (WHO) and the rest of the medical community agree, yearly Covid-19 shots may prove an effective coronavirus solution, making the virus analogous to cold and flu season.
As we said at the beginning of the year, signs still indicate that work-from-home and hybrid strategies will not go by the wayside once the workforce makes a healthy return. For one, employees have indicated that they enjoy the flexibility of hybrid models, and companies who want to retain their workforce take this into account. Also, recent lease deals suggest that the office is still very relevant. For example, Kirkland and Ellis have re-committed to River North by leasing 662,400 sf at Salesforce Tower, and Kraft Heinz renewed 161,717 sf of space at Aon Center—both deals made it onto MBRE Research’s “Best of 2021” biggest deals list. Additionally, River West, which contains the ever-popular Fulton Market, continues to see new lease deals. Two notable River West leases include HAVI Logistics’ 96,072-square-foot lease at 345 N. Morgan and MoLo Solutions’ 93,710-square foot lease at 167 N. Green.
WHAT WILL HAPPEN TO THE SUBLEASE SPACE CREATED BY THE PANDEMIC?
IN JANUARY, WE SAID: 2021 is starting the year with more available sublease space than the CBD has ever seen before. If the vaccine and other efforts do nullify coronavirus, will companies continue to add sublease space to the market? And how many companies will be interested in the abundance of sublease space? And, finally, how much of this sublease space will disappear as the world becomes safer and companies take it off the market and return to the office?
Despite the uncertainty, the sublease space has some immediate effects on the market. For one, landlords competing with a large amount of sublease space will have to be more flexible than ever when it comes to short lease terms and other stipulations, leading us to…
TODAY: Sublease space in the Chicago Central Business District continued to grow in the first and second quarters of 2021, which was expected. After a small contraction in the third quarter, sublease space rose slightly in the fourth quarter, with a historic high of 5,815,622 sf. It’s relatively safe to say that sublease space growth in the Chicago CBD has slowed.
Tech companies have proven less afraid of the plentiful sublease space available, seemingly more able to use the tools available to them to create seamless hybrid work models for employees. Rent prices remain relatively the same, though some landlords have offered lucrative incentives to tenants. A more significant push to fill the sublease space on the market seems unlikely, and it’s difficult to say when the continued slow growth of sublease space will plateau or start to consistently fall.
WHEN WILL RENT PRICES FALL?
IN JANUARY, WE SAID: Rents are widely expected to go down, but many landlords are trying to wait out the pandemic before they get too generous with their deals. The office market is slow-moving and always has a delayed reaction to an economic downturn; it will subsequently take a while for rising vacancy rates and negative absorption to prove the pandemic's real toll. For tenants who can wait on the sidelines, deals will eventually hit the market. Ultimately, with little leasing activity in the immediate, it is difficult to determine the current office space's accurate market rates.
TODAY: At a glance, rent prices have not fallen significantly, as landlords find other means to incentivize new leases. For example, landlords are more likely to give out larger sums for new or returning tenants to devote to tenant improvements. Similarly, tenants have been afforded more free rent—also known as rent abatement—when they sign long-term leases. And with tenants uncertain of how much post-pandemic space they will need, landlords are also offering more flexibility in leases than previously seen—average terms for new deals in 2021 were 7.25 years, down from an average of 8.6 years the year before. An early move-in date is another perk that has become more common in recent years.
So no, asking rents have not significantly dropped, but tenants are getting more for their money. According to the latest MBRE Research reports, the average initial net rent for new deals in the past year was $26.92 per square foot across all classes, down from $27.02 the prior year. In addition to economic concessions, landlords are offering greater flexibility with shorter lease terms, as well as termination and contraction rights.
WILL THE CRE INDUSTRY HAVE A ROBUST OR SLOW AND STEADY REBOUND?
IN JANUARY, WE SAID: Once the worst of Covid-19 is over, leasing activity will begin again—but on what scale? The sudden drop-in leasing activity this year is unprecedented. On a practical level, it has been challenging to get out into the market and see space. With everyone working from home and uncertainty about the future necessity of offices, there is a lack of urgency for decision making. Once we all crawl out of our hidey-holes and emerge into a post-coronavirus world, will there be pent-up demand that leads to a leasing bonanza? … Or will we see a protracted rebound as everybody waits to see what their needs will be in the new reality? If market uncertainty is slow to dissolve, the office market will still rebound, it will just be a slow and steady revitalization. The investment market is also likely to remain stagnant until there is more certainty about the future of demand and rent levels.
TODAY: The physical challenges of showing space during a pandemic were largely overcome in 2021 thanks to abundant supplies, technology, greater knowledge of how Covid-19 spreads, and vaccines. Still, the commercial real estate recovery will be slow and steady and may be hampered by coronavirus mutations, vaccination rates, and vaccine efficacy.
Furthermore, investment sales continue to lag. Though the pandemic is currently the most substantial influence on investment sales, property reassessments led by Cook County Assessor Fritz Kaegi were met with investment hesitation following his 2018 election win. Though Kaegi’s office has released downtown reassessment estimates, these numbers reflect a pre-pandemic market. We will only get a glimpse of the future of investment sales after the post-pandemic market has stabilized and assessments have accordingly been updated.
WHAT DOES THE FUTURE HOLD FOR RETAIL, RESTAURANTS, AND HOTELS?
IN JANUARY, WE SAID: The hospitality and tourism industries were the hardest hit by the pandemic. With indoor dining off-limits during Chicago's long, brutal winter, we are sure to see a dismaying number of restaurants close doors for good. Hotels are also in distress as tourism reaches unfathomable lows. Retail was already facing unprecedented challenges before the pandemic, and coronavirus has pushed many past the point of no return. Once it is safe to travel again, tourism is sure to experience a renaissance, but it will be too late for many hotels, restaurants, retailers, and entertainment destinations. What will it take for these industries to be able to rebuild? And will they look the same after the recovery? Some believe the recovery may be a chance for more diversity among small-business owners, something Chicago has been criticized for in the past. Of course, this is dependent on how recovery aid from the government develops and is distributed.
TODAY: In 2021, the Delta variant took the wind out of retail’s sails as mask mandates and space restrictions were suddenly reinstated. But the businesses that made it through the first year of the pandemic have proven resourceful and resilient. The restaurants currently operating have leveraged QR codes, contactless delivery, and other tech-assisted solutions to stay in business. Of course, staffing problems and inflation are hampering the success of restaurants and retail locations.
The number of people shopping at brick-and-mortar stores on Black Friday was also encouraging. Sales were down that weekend, yes, but only because fears of stock problems led retailers to offer superb deals earlier in the year—some as early as October—and many customers made sure to get their holiday shopping done earlier than ever. Also, tourism gave downtown restaurants and retail a boost in 2021. The number of visitors from neighboring cities and states willing to visit downtown Chicago’s Millennium Park, Maggie Daley Park, and Chicago Riverwalk was impressive and continued to provide customers to the businesses whose doors were open. As for hotels, investment sales remained low compared to pre-pandemic numbers but are slowly rising. Leaders in the industry remain patient and confident about an impending rebound.
IS THIS THE END OF THE SUBURBAN EXODUS?
IN JANUARY, WE SAID: Just before the beginning of the pandemic, the stampede of suburban companies following the coveted millennial workforce to downtown Chicago had just started to subside. An uptick in suburban residential sales and a glut of downtown apartments and condos suggests that Covid-19 may have inspired aging millennials to give up their city slicker dreams for a more spacious life in the 'burbs. Will corporate tenants now pick up and follow them back to the suburbs? We will not know until coronavirus settles down enough for office leasing activity to restart. A suburban CRE revival is a possibility, though.
TODAY: The prophesied millennial exodus from the city to the suburbs has yet to happen, and Covid-19 fears haven’t inspired companies to move to spacious suburban buildings. Multiple large corporations have gone as far as to ink deals for satellite companies in the city in 2021. Exceptions are few and far between, but United Airlines is one big one—they plan to move 900 employees from downtown Chicago’s Willis Tower to the Northwest Suburb of Arlington Heights.
Tech continues to drive new lease deals to the central business district, prominently Fulton Market. Tenant sentiment, as long as the pandemic continues, will remain indecisive. Once the dust settles and tenants from all industries feel confident enough to plan for the future, new trends will reveal themselves.
HOW WILL THE GOVERNMENT AID RECOVERY?
IN JANUARY, WE SAID: Covid-19 has exacerbated the already dire financial situations of the State of Illinois and the City of Chicago. Governor Pritzker has warned state agencies to prepare for "nightmare scenario" budget cuts. Public entities such as the CTA and CPS will face unprecedented challenges in the coming years. Perhaps the incoming Biden administration will be more willing and able to help local governments through these trying times?
TODAY: Despite the coronavirus pandemic, Illinois’ debt forecast has been lowered and increased its credit rating. Recently, the state has opened applications for $300 billion in rent and lease assistance for renters, homeowners, and landlords. Chicago also expanded rent and utility assistance. With that said, federal, state, and city assistance for individuals and small businesses alike are not as significant as it was in the first half of 2021. And the Advance Child Tax Credit Payments assisting families throughout 2021 remain up in the air for 2022.
One promising program for businesses is the American Rescue Plan, which earmarked $10 billion for the “State Small Business Credit Initiative.” These investments and loans are intended to be augmented by $90 billion in private funds from participating lenders. How much of these funds will be dispersed to Illinois businesses is currently unknown, and it’s difficult to say how much of an impact these funds could have on the commercial real estate world. And while the Infrastructure Investment and Jobs Act and Build Back Better Act do not directly benefit the CRE industry, many aspects of the plans will have indirect value. Though a few years away, the public transportation improvements within these acts will be a boon for Chicago CBD businesses.
HOW HAS THE PANDEMIC CHANGED THE FUTURE OF COWORKING?
IN JANUARY, WE SAID: The coworking industry is about to undergo a massive transformation as the most successful platforms align themselves with traditional commercial real estate entities to survive. Some coworking platforms will not make it through the pandemic, and those that survive are likely to do their best to shed any underperforming spaces, leaving many landlords holding the bag. The true test of coworking will come once the Covid-19 dust settles. It is conceivable that tenants searching for flexibility will turn to coworking to combine old office needs with new habits picked up during the pandemic.
TODAY: Covid-19 arguably forced coworking through some growing pains as the industry struggled to stay alive in 2021. Thanks to several factors, coworking’s learned some hard lessons and will live to see another year. Management agreements instead of leases, partnerships with established CRE heavyweights, and CRE companies creating their own coworking programs are just a few of the ways coworking has stayed alive.
WILL CHICAGO'S LIFE SCIENCES INDUSTRY EXPLODE?
IN JANUARY, WE SAID: Chicago's life sciences sector has renewed aspirations amid the pandemic. Though Chicago's pharma industry lost its luster due to longtime regional leaders, such as Takeda, leaving for the coasts, many see biotech and life sciences as key to the city's future. Chicago has all the ingredients needed for the sector to thrive: world-class research institutions, a highly-educated labor force, university hospitals, and existing pharma and medtech companies. Until now, life sciences has been lacking the real estate infrastructure to support industry growth.
Enter the pandemic, a situation that has made space more abundant and inspired developers to invest in the type of lab space the industry needs to thrive. The three mega-developments with the most momentum (Lincoln Yards, The 78, and Bronzeville Lakefront) have all pivoted to a focus on life sciences. In Fulton Market, a new lab development is being built, and an office development is being converted to lab space. Sterling Bay recently launched a business accelerator for companies in life sciences, healthcare, and technology.
TODAY: Not much has changed since the beginning of 2021. The life sciences industry is still well on its way to being one of many strong industries in the Second City—a diversity of industry sectors is one of Chicago’s greatest weapons against economic downturn. Will life sciences explode in Chicago? Chicago won’t overtake Boston anytime soon, or even San Francisco or San Diego. And life sciences has grown across the country at such a rate the past couple years that it’s hard to throw a rock without hitting a city that hasn’t benefited. But that competition doesn’t change the fact that the life sciences space in Chicago continues to be extremely strong and growing, and the city is happy to have life sciences among its patchwork of lucrative industries.
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