Analyzing the Long-Term Outlook of the Chicago Office Market

The Chicago office space market has been absorbing the effects of the nationwide transformation of the office sector. Many office buildings are selling below the levels from two years ago, and the only major project under construction is a mid-rise tower in the prime Fulton Market district. The office vacancy rates are among the lowest in the United States, and the office construction pipeline has not been particularly active for months.

Despite the current market conditions, the Commercial Edge report mentions a few bright spots that suggest Chicago will roar back with new office construction projects in the next few years. Before looking at these positive factors, it is important to understand how the American office market has been changing.

The Windy City is not the only market dealing with the ongoing transformation of American workplaces and working arrangements. Phoenix and San Francisco also show high vacancy rates. Before the COVID-19 pandemic, more than a million square feet of new office space was added in Chicago annually. New construction volumes skyrocketed after the pandemic, reaching 3.4 million square feet two years after the lifting of lockdown and social distancing restrictions. The office pipeline currently shows 828,000 square feet under construction. Developers and investors seem to be in a holding pattern instead of striking new deals.

Going from a 5.3% vacancy rate to more than 20% in less than two years has been difficult for stakeholders in the downtown districts. The rest of the Chicagoland region is faring better, but the local economy keeps its finger on the pulse of downtown development, and there aren't plans for major projects like the Salesforce Tower, which was delivered on time despite the challenges presented by the pandemic. It is unusual to see such high office vacancy rates at a time when the American job market and Wall Street are thriving; nonetheless, there's an explanation that points to some of the effects of the pandemic, particularly the work-from-home (WFH) arrangements.

Remote work, outsourcing, and retaining independent contractors have been rising trends in the corporate world for over two decades; they not only reduce operational costs for companies but also alleviate shortages of office space. When the pandemic added WFH to the mix, many offices in Chicago and other major markets were partially emptied. Some organizations made WFH permanent for many positions; others issued back-to-the-office mandates that were received with some backlash and criticism. The historically low unemployment levels motivated some employees to embrace WFH and make it a crucial aspect of their careers; those who did not return to the office got new WFH jobs or became freelancers.

The pandemic also forced a market cycle in Chicago. After the initial economic shock, which featured two Black Mondays and one Black Thursday for Wall Street, the unemployment rate shot up to 14.7% as layoffs and company closures reminded many Americans about the Great Recession from the previous decade. Then, a fast period of stabilization and recovery lowered the unemployment rate back to 4%, and the subsequent economic recovery grew much faster and stronger than what market analysts anticipated. After two years of pandemic restrictions, the levels of new office construction in Chicago quickly got back to normal before expanding by more than 200%.

A significant portion of the 4 million square feet of office space added to the Chicagoland market in the 18 months after the pandemic went to the suburbs. In the downtown districts, there were more redevelopment, renovation, and conversion projects like One E. Wacker Drive, a 41-story tower in the Loop district, which was expanded, remodeled, and upgraded to welcome Skyline Construction, a California-based company with a strong presence in Chicago. Skyline moved from an office on Jackson Boulevard to the larger building in the Loop because it is expanding to handle its busy regional pipeline. We mention Skyline because the company is dedicated to the interior design and layouts of major commercial development projects, and most of its current business in the region involves the renovation and remodeling of downtown corporate spaces.

The rush to add more Class-A office space was motivated by the economic expansion and high productivity levels of the post-pandemic period. As it often happens, many developers banked on the economic indicators to deliver new projects before their competitors. Construction activity flourished even as the "return to the office" mandates were challenged by employees who fully embraced the WFH approach. Some companies reacted to this change in corporate work culture by implementing hybrid and flexible workplace arrangements; this reaction had an immediate effect on the Chicago market, which by then had already added 4 million square feet of new office space. In just a few months, the situation turned from promising to oversaturating, and vacancy rates began climbing.

Under the current market conditions, prospective office tenants are at an advantage. With an abundant supply of new and renovated office space, landlords have been trying to attract new tenants with retail concessions and amenities, particularly in the downtown districts. During the pandemic, many Chicago-based companies changed their ownership structures and corporate boards; when this happens, the office market often goes through a slowdown as executives plan their next moves.

When looking at the retail sector of the Chicago commercial market, there's a sharp difference in terms of new construction. Upscale outdoor brand Fjällräven recently opened a new store in the Fulton Market district, and a new structure was built in River North for the new Ina Spa. Notwithstanding the pesky consumer price inflation impacting the U.S., the economic activity around Chicagoland is at optimal levels, which means that conditions for the office space sector will improve.

We may not see a frenzy of new construction projects, certainly in the downtown districts, for a few months. It should be noted that some downtown office towers are undergoing conversion into mixed-use structures; these projects will subtract office space, thus reducing vacancy rates and increasing the return-on-investment potential. The Chicagoland suburbs will likely get more new construction projects than downtown, at least for a few quarters, as the business sector adjusts to the evolving economic conditions.

All in all, the high vacancy rates of the Chicago office market can be attributed to the same effects of economic readjustment that Phoenix and San Francisco have experienced. It may take a few months before we see an improvement, but all the economic elements for a positive outlook and a turnaround in the market are present.