Chicago - August 18, 2000 - Like all great cities, Chicago is always reinventing itself. Today the Windy City's central business district is going through its biggest development spurt in nearly a decade. The new construction is being accompanied by massive redevelopment and the conversion of older Class B and C offices and industrial lofts into a variety of new uses, including high-tech office/flex space and residential units. The influx of new downtown residents is bringing with it a number of upscale retail outlets and creative retail projects, too. And all this activity is changing not only the face of downtown Chicago, it is also expanding the CBD's geographic boundaries-pushing Class A office space west as far as the Kennedy Expressway and north as far as Goose Island.
The last quarter of 1999 saw the completion of the first speculative office space in downtown Chicago since 1992. Both Walton Street Capital's 332,000-square-foot Union Tower, at 550 W. Van Buren St. in the West Loop, and The John Buck Co.'s 115,000-square-foot office component of the North Bridge mixed-use development off of Michigan Avenue opened virtually fully leased.
"The demand for Class A office space is incredible," said Dan Arends, senior vice president & director of corporate advisors for Colliers, Bennett & Kahnweiler Inc. "Vacancy rates for Class A are below 4 percent for the second quarter of 2000. That's spurring new development." He pointed out there are 15 new sites in downtown Chicago slated for office development, representing a potential of 13.5 million new square feet, including the plans of Scott Toberman of European American Realty L.L.C. to build what would be the world's tallest building at 7 S. Dearborn St.
Insignia/ESG Inc. reports a total of nearly 3.5 million square feet of office space currently under construction at four sites, two of which broke ground this year. Forty-three percent of the space under construction (1.5 million square feet) has already been pre-leased at an average of $31.62 per square foot, a new high for Chicago. One N. Wacker Dr., 131 S. Dearborn St. and 550 W. Monroe St. are leading the way in the pre-leasing surge.
"The difference between now and the '80s is that back then we would build spec office buildings with no anchor. We'd find a piece of space and a lender and build," pointed out David Latvaaho, senior managing director of Cushman & Wakefield of Illinois Inc. "All that has changed thanks to revisions in the tax laws and other restraints on the capital market. Now we build with the tenant in hand. All the new buildings going up have anchors and are at least partially pre-leased."
Julien J. Studley Inc. reports that downtown Chicago set a new leasing record in the first quarter of 2000. The 4.5 million square feet leased up during the first three months of the year surpassed the previous high set in 1998 by 1.3 million square feet. According to Colliers, Bennett & Kahnweiler's mid-year report, the biggest leasing transactions so far this year are those signed by Bank One, which leased 620,000 square feet at 131 S. Dearborn St.; Quaker Oats, which took 360,000 square feet at 555 W. Monroe St.; and the law firm of Gardner, Carton & Douglas, which rented 280,000 square feet at 1919 N. Wacker Dr.
"Leasing continues to be very strong downtown; the absorption has been phenomenal," said Michael Klein, executive managing director of the Midwest region for Insignia/ESG. "Through mid-year 2000, net absorption climbed to 3.5 million square feet as compared with mid-year 1999, when the downtown market experienced negative net absorption of 1.1 million square feet. That's a remarkable improvement of 4.6 million square feet over the past 12 months."
Although downtown rents have remained flat since the first quarter-CB Richard Ellis Services Inc. reports that most downtown Class A office space is currently going for between $20 and $25 per square foot, Class B for between $15 and $20-there is clearly a landlord's market in the making. "For owners, there's a tremendous opportunity over the next 18 months," predicted John Dempsey, senior vice president at CB Richard Ellis. "None of the new development will open until next year, and most of that is pre-leased. In addition, many of the tenants taking up the new space are expanding, so they won't be leaving behind as much space as they take up. Any landlord who does have space can really exploit this situation to maximize rental strength."
"We're seeing bidding wars for space for the first time," added Mark Robbins, executive vice president of Transwestern Commercial Services. "Multiple firms are not only accepting asking rates on leases and subleases, they are actively trying to beat out other firms for the space. That's new to Chicago."
Given the ground swell of demand, it is not surprising that the investment community has been bullish on downtown Chicago. However, the favorable investment market, argued Greg Van Schaak, vice president of Hines Interests L.P., has more to do with the city's steady growth than with a sudden surge of demand. "Over the last 10 years, the Chicago market has absorbed an average of 1.7 million square feet per year. Until now, that hasn't fluctuated much at all," he said. "We're characterized by steady growth. The international investment community has recognized that about our city and has remained very interested in opportunities here."
"This is really a modest amount of speculative activity that we're seeing in Chicago," agreed Matt Ward, Midwest regional vice president of The Alter Group. He maintained the reason for the new construction is pent-up demand. "It's demand driven, not supply driven, and that makes for a healthy market."
Among those who have taken advantage of Chi-town's healthy market is SHORENSTEIN Co., which in June purchased the 2 million-square-foot Prudential Plaza office complex at 130 E. Randolph St. in the East Loop from Prudential Life Insurance Co. of America and Nippon Life Insurance Co. for $375 million. This is the second Chicago trophy for SHORENSTEIN, which in late 1998 acquired the 100-story John Hancock Center.
"In terms of relative value, Chicago is very, very hard to beat," explained John Grassi, SHORENSTEIN's managing director & chief investment officer. "Equivalent space in New York City is double the price. In San Francisco, it's more than double. Yet with high-quality assets, we can get returns in Chicago that are equal to or even better than in those other two cities."
While Prudential Plaza was the biggest sale of the first half of 2000, it was only one of seven significant downtown building trades since the year started. After SHORESTEIN's big buy, Julien J. Studley Inc. reports that the two biggest deals were the purchase of 333 W. Wacker Dr. from the Overseas Capital Corp. by The John Buck Co. for $145 million, and the sale of 200 W. Monroe St. for $60.5 million to Charlesbank Capital Partners by CIGNA Investment Management.
"I see building sales continuing in the second half of 2000," predicted Tom Grace, vice president in charge of leasing for PM Realty Group in Chicago. "The downtown market is going to see several more buildings change hands before the year is over. Investors remain very interested in Chicago; it's going to be an exciting 24 months coming up."
As vigorous as it is, the Class A market is not the only force reshaping the feel and function of downtown Chicago. An equally dramatic story is unfolding in the arena of redevelopment and creative infill.
"There's no question that all the new space will be filled and will be the first choice of high-end tenants," said Van Schaak. "The question is infill. What will happen to the space left behind? So far high-tech and e-commerce firms have taken the space. The demand for Class B and C space has really been remarkable. The New Economy firms have propped up the floor of the market so that the ceiling can be raised." In fact, according to CB Richard Ellis, the highest level of absorption in the first half of 2000-1.25 million square feet-was in Class B buildings.
One of the largest redevelopment efforts under way is of the old Insurance Exchange Building at 175 W. Jackson Blvd., which was bought by Intell Management and Investment Co. from Helmsley-Spear Inc. two years ago. Built in two stages in 1912 and 1928, with 1.7 million square feet, it remains the fifth-largest office building in the city. "For 30 years there was very little maintenance and non-aggressive leasing," explained Lucien Lagrange, principal in Lucien Lagrange and Associates, the architectural firm overseeing the renovation of the once Class C building. "When we began working on it, only 300,000 square feet were leased."
All 4,000 windows are being replaced, as are the original elevators. All the public spaces-the lobby, wash rooms, elevator waiting areas on each floor-are being redesigned. A new indoor parking lot is being built in what had been the cavernous coal bins in the 80,000-square-foot basement. The building is also being rewired with all the latest in broadband and fiber optics. There will be 20 watts per square foot, which demands a new, stronger air conditioning system. The building's makeover will be completed in stages, with the new lobby opening in the fall.
"It's becoming a very postmodern building. The outside will keep its early 20th century look, but as you enter the building, you enter a very contemporary world," said Lagrange, who added that the refurbished building is attracting many high-tech companies as tenants, a trend common in many of the renovated buildings. Alain LeCoque, senior vice president & head of brokerage operations for Equis Corp., reported that over 50 percent of all leasing activity this year has involved high-tech companies.
The tight market is bringing ingenuity to the fore. For example, Mark Goodman and Associates is adding 14 stories to an existing four-story building at 550 W. Jackson Blvd. "We've owned it for a lot of years and (our) original plan was to demolish the building and build a larger one. However, the ground floor is a telephone switch center for MPI and the cost of moving was prohibitive for them and for us, so we decided on this alternative," said Mark Goodman, the firm's principal. "We haven't even finished the curtain wall yet, and, counting letters of intent, we're almost 50 percent leased. I'm surprised and pleased by the intensity of the leasing interest."
Another creative renovation of a Class C building is the recently completed restoration of the Allerton Hotel at 701 North Michigan Ave. to its original 1924 grandeur for Bristol Hotels & Resorts by Eckenhoff Saunders Architects. The transformation of the long-vacant eight-story industrial building on Goose Island-not really an island but a peninsula at the junction of Chicago River and the North Branch Canal-into a state-of-the art headquarters for the Sara Lee Corp. has pushed the boundaries of the city's CBD.
"There are two basic reasons for all the conversion of Class B and C properties into Class A- and B+ that we've seen over the last 18 months," said Scott Manlin, vice president & regional manager for Fremont Investment & Loan. "First, it's easier and cheaper to buy these assets, and secondly, you can put them on the market much faster than ground-up projects. There's a fairly deep market for these properties."
A relatively new factor in the Chicago real estate mix is the proliferation of telco hotels in and around the downtown area, a trend that is also fueling renovations. Bob Palffly, executive vice president of Grubb & Ellis Co., reported that telco hotels have constituted a significant portion of his firm's recent business. "A factor not usually talked about is the telecom industry, which has seen a drastic increase," said Palffly. "They've taken down several million square feet over the last year or so and they're continuing to grow very quickly."
Rand Diamond, regional president of GVA Williams L.L.C., said the hotels have become a major factor in the periphery of the CBD, where old industrial buildings with high floor-to-ceiling dimensions, large, strong floorplates and good column space can be easily converted to New Economy use. "The city (government) has been very supportive of high-tech industry and innovation. All the major telecommunications firms have opened hotels here," said Diamond. "Chicago is becoming a hub for voice and data transmission."
Another major area of renovation and infill has been the conversion of old industrial lofts to residential use. "It seems like every old building now has a terrace hanging off it," joked Dempsey. "If it's not a condo, it's a telecom hotel."
"There's an unprecedented boom in the downtown residential market," confirmed Kent Ilhardt, executive director of Cushman & Wakefield. He attributes the re-population of downtown Chicago to a combination of young high-tech workers and empty nesters ready to enjoy the retail, restaurant and entertainment amenities of big-city life. "Residential housing now surrounds the Loop in all directions. To the north there are new high-rises, both rentals and condos. To the west and south practically all the lofts have been converted, so we're now seeing loft-look-alikes being built."
Robert Smietana, president of HSA Commercial Real Estate, estimated that 10 million square feet have been converted to residential use over the last four years. Robbins reported that condos are now going for $700 to $900 per square foot, and in a deal that he says is typical of the hot market, a Water Tower apartment that sold for $1 million seven years ago was recently resold for $2 million.
The influx of new office workers and residents has brought with it retail development. In June, Bottega Veneta, one of Italy's leading designers of high-end leather goods signed a lease on a two-level, 4,500-square-footflagship store in the Park Hyatt Hotel. At 800 N. Michigan Ave., it will join Giorgio Armani, which signed a 10,000-square-foot lease in March. The Grand Plaza, not far away at 220 N. Michigan, will open in September anchored by a 240,000-square-foot Nordstrom, the first outlet for the retail giant in Chicago.
"Michigan Avenue is a world-class shopping area, comparable to Bond Street in London, Fifth Avenue in New York and Rodeo Drive in L.A.," said Camille Julmy, vice chairman of U.S. Equities Realty L.L.C. "The trend is for high-end retailers to take bigger and bigger space. It's a statement of confidence by international retailers in Chicago." The Greater North Michigan Avenue Association reports that even with ground floor rents at $200 to $300 per square foot, the downtown retail vacancy rate has held steady for over a year at 3 percent.
Retail growth is not limited to high-end chains along Michigan Avenue, however. Developer Bob Mariano is building what he calls a "new urban market" at the intersection of State and Randolph streets, in the city's theatre district. The new 40,000-square-foot building, designed by Lucien Lagrange and Associates, will have gourmet meat, fish and other specialty shops on the ground floor, a restaurant with an open terrace on the second floor, and a wine and cheese basement. Construction will begin next spring and be completed early in 2002.
U.S. Equities Realty is planning a similar food emporium, the MetraMarket, on Randolph Street between Canal and Clinton streets right across from the Ogilvie Transportation Center, a large suburban commuter train depot in the West Loop. And another project related to the residential influx is the conversion of part of the former Chicago Mercantile Exchange, at 444 W. Jackson St., into a three-story, 70,000-square-foot health and fitness center by the Fitness Formula and Rush-Presbyterian-Saint Luke's Medical Center. The work is being done by The McShane Cos.
So as the broad-shouldered city of Chicago once again flexes its economic muscle, the city's real estate pros agree with Ilhardt that the market is in "pretty good equilibrium," and can readily absorb more development. The one concern expressed repeatedly, as it is around the country, is about the future of the New Economy and its impact on real estate.
"It's not that the high-tech industry will ever die, but some of the current generation of startups are bound to belly-up," said Arends. "I see a danger of oversupply if these guys keep building on the assumption that the high-tech firms will continue to boom indefinitely. They may be stuck with a lot of space on their hands."
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