A short anecdote embodies the conflicted nature of Chicago's office market nowadays. Last December, Drew Nieman, principal at locally based John Buck Co., seemed satisfied with the company's outstanding results for 2000. Leaseup was nearly finished at One N. Wacker Drive, Buck's new 1.25 million sq. ft. speculative office tower in Chicago's Loop. The company had completed the long-awaited North Bridge project, a retail development on Michigan Avenue that took years to finalize because of protests by preservationists.

“It's a good time to be done with big projects,” Nieman said at the time. Almost as an afterthought, he mentioned how he hated to turn away prospective tenants because One N. Wacker was already leased. Yet he wasn't quite prepared to put up another new building that might prove more difficult to lease.

Several weeks later, Buck announced its intent to purchase a parcel at the southeast corner of Wacker Drive and Monroe Street, with plans for a 700,000 sq. ft. office tower. Few market observers believe the project can get built now without substantial preleasing. But despite signs that the local economy has slowed and investors and tenants alike are sitting on the sidelines, the desire lingers in the development community to keep the good times rolling.

“Corporate America can't make decisions two years ahead of time right now,” said Greg Van Schaack, vice president of Houston-based Hines Interests LP. “Layoffs and poor corporate earnings have led to “decision gridlock,” he said.

Hines has a 700,000 sq. ft. office tower under way at 191 N. Wacker Drive. The 37-story building will be complete in October 2002. The anchor tenant is law firm Gardner Carton & Douglas, which will take 200,000 sq. ft. Van Schaack, who heads Hines' Chicago office, admits that preleasing is a big challenge these days. But he remains optimistic because his building is the only one hitting the market in 2002.

Despite market uncertainty, a few other big buildings will get built. Last December, Chicago-based Hyatt Hotels Corp. announced plans to anchor a new 1.2 million sq. ft. office tower to be built on the northeast corner of Wacker Drive and Monroe Street. The project is a joint venture of Prime Group Realty Trust and the billionaire Pritzker family, owners of Hyatt.

Locally based Bank One Corp. has decided to take 618,000 sq. ft. at the new Dearborn Center, 131 S. Dearborn St. Meanwhile, locally based Quaker Oats will proceed with plans to anchor a new building at 555 W. Monroe St., despite fears the project might be scrapped after the buyout of Quaker by Purchase, N.Y.-based PepsiCo Inc.

“We won't do a spec building now,” said Matthew Ward, vice president of The Alter Group, Skokie, Ill. The developer owns a parcel at the southwest corner of Illinois and Clark streets. Plans call for building a more modest 400,000 sq. ft. office facility, but Ward demands preleasing before proceeding with the project. “You have to be honest about the market,” he said.

Office: the big picture

The downtown office market posted a year-end availability rate, which includes space vacant or being marketed, of 13.1% for existing buildings, according to the local office of New York-based Insignia/ESG. This figure reflects a decline of more than two full percentage points compared with year-end 1999.

The downtown office market absorbed 4.1 million sq. ft. in 2000. Most telling, perhaps, net absorption was negative during the fourth quarter. In other words, the big leasing activity last year took place in the first three quarters.

The worry now is the growing presence of so-called shadow or sublease space. The dot-com companies that leased 3 million sq. ft. of space over the past two years are essentially out of the market. No one knows how much space these companies will dump.

With new projects coming on line, some big buildings will have large vacancies to fill. Quaker Tower will be left almost empty by the end of 2002 after the move of its two big tenants — Quaker Oats and Gardner Carton & Douglas. By the end of 2001, Aon Corp. will complete its move from 123 N. Wacker Drive, leaving behind about 500,000 sq. ft. of empty space.

The prospect of more vacancies is giving investors pause. “There's a logjam in the market,” said Stephen R. Quazzo, managing director and CEO of Trans-western Investment Co., Chicago. He pegs cap rates on downtown office buildings at 8.5% to 9%. The few buildings traded have sold for $160 to $200 per sq. ft.

Michael A. Duncan, managing director of the Chicago office of New York-based CSFB Realty Corp., believes the investment market will remain slow in the near future. He said owners of trophy properties with high rents and occupancies don't want to sell right now. Also, the buildings that are for sale have serious issues, such as impending vacancies.

Interestingly, 200 W. Madison St., the building currently occupied by Hyatt, was recently sold to a joint venture led by New York-based Tishman Speyer Properties LP. The building will become 25% vacant when Hyatt leaves for its new building, but Tishman is betting it can lease the space at a higher rate.

If the investment market for downtown office buildings has been slow, the suburban market has been practically on life support. “Buyers have pulled back,” said Paul Lundstedt, executive director at the Chicago office of New York-based Cushman & Wakefield. In 2000, there were only three transactions valued over $30 million. The suburban investment market dropped from $1 billion in 1999 sales to $350 million in 2000. “There's real concern about overbuilding and the economy,” Lundstedt said. He thinks institutional investors were also over-allocated in suburban office properties.

For now, the suburban office market is showing signs of a slowdown after a year of healthy absorption and new construction. The Chicago office of Los Angeles-based CB Richard Ellis reported absorption of 3.7 million sq. ft. in 2000. About 3.8 million sq. ft. of new space is coming on line in some 38 suburban buildings this year.

“We have to allow the market to catch up a little,” said Jeffrey S. Barrett, managing director, CB Richard Ellis. “The new buildings will lease, but it will take a little longer than it did before.” Barrett expects suburban vacancies to rise from 10.1% to 11.3% this year.

The largest suburban submarket, the East-West corridor, should see its vacancies rise from 12.2% to 13%, according to CB Richard Ellis. The east end of the market, close to downtown, will be tighter than the outlying areas farther west.

“Rents will remain flat,” predicts John R. Homsher, principal and sales manager at Podolsky Northstar Realty Partners, Riverwoods, Ill. He pegs Class-A rents in the East-West corridor at $17.50 to $18.50 per sq. ft.

Of concern is the economic future of big suburban tenants, such as Motorola Inc., Schaumburg, Ill., and the Schaumburg office of Sunnyvale, Calif.-based Lucent Technologies Inc., both of which have announced layoffs and cutbacks. In previous years, these companies and several others had been key drivers of suburban office space demand.

Barrett predicts that in the north suburban market, corporate mergers and layoffs will raise vacancies by as much as two percentage points this year. Moore Corp., Fort James Corp. and Tenneco Automotive Inc. all announced plans to sublease large blocks of office space. “The north market will be challenged,” he said

Bullish on industrial properties

With one of the nation's largest industrial property bases, comprising nearly 800 million sq. ft. of space, Chicago continues to draw the interest of institutional investors, REITs, private funds and entrepreneurs. “There is pent-up demand for good Chicago area industrial properties,” said Steven L. Roth, partner, Cohen Financial,Chicago.

For example, Opus North Corp. of Rosemont, Ill., sold its new 458,620 sq. ft. Melrose Business Center at 1600 North 25th Ave. in west suburban Melrose Park. The speculative project faced a number of sensitive development issues, including soil remediation and demolition of existing structures. Opus had leased the $22 million facility to three tenants. ORIE Real Estate Fund, a Minneapolis-based investment arm of Opus, purchased the project last year. The sale price was not disclosed.

Capital is also readily available, according to John Fontaine, Midwest regional manager of real estate at Heller Financial Inc., Chicago. “Our underwriting standards haven't changed,” he noted, emphasizing that Heller has always been choosy about which properties to finance. However, Fontaine added that other lenders have recently become more selective about industrial properties.

The overall year-end vacancy rate for industrial buildings was 6.58%, compared with 6.29% at the end of 1999, according to Colliers, Bennett & Kahnweiler Inc., Rosemont, Ill. Gross absorption of industrial space was 45.6 million sq. ft., compared with 50.2 million sq. ft. in 1999.

However, net absorption was a negative 3 million sq. ft. in 2000. This result was due to the millions of square feet of speculative construction, the year-end report by Colliers, Bennett & Kahnweiler stated.

“Things have slowed down,” noted Jack Rosenberg, senior vice president of Colliers, Bennett & Kahnweiler. “The deals that had momentum will get done, but new prospects have dropped off.”

John F. Cash, executive vice president at NAI Hiffman, Oakbrook Terrace, Ill., agreed that the market has slowed, but that leasing activity is still quite positive. “It's like going from 80 mph to 55 mph,” he said.

Rental rates are expected to hold firm. A year-end report from Cushman & Wakefield showed average net rental rates at $4.56 per sq. ft. for warehouse/distribution space. The figure was an 11% increase over year-end 1999 rental rates.

Speculative building has been concentrated in the southwest suburbs, along the Interstate 55 corridor. Here, developers find an abundance of available land, good access to roads and transportation, and a favorable tax climate. About 1.7 million sq. ft. of spec construction was completed in 2000, according to Insignia/ESG.

The southwest submarket continues to attract logistics firms and distribution companies. For instance, Duke-Weeks Realty Corp., Indianapolis, developed a 500,000 sq. ft. build-to-suit distribution facility for Sears, Roebuck & Co. in the Crossroads Business Park in Romeoville, Ill.

CenterPoint Properties Trust, Oak Brook, Ill., announced a multi-billion-dollar redevelopment of the former Joliet Arsenal in Joliet, southwest of Chicago. The renovation should result in more than 17 million sq. ft. of industrial space anchored by an 800- to 900-acre intermodal freight yard. The first tenant in the park is DSC Logistics with a 1 million sq. ft. distribution facility.

“We hear talk of recession, but the industrial market is still healthy,” said Mike Mullen, COO at CenterPoint Properties.

Other developers active in the southwest market include Pizzuti Cos., Columbus, Ohio; IDI, Atlanta; and Amli Commercial Properties Trust, Itasca, Ill.

“We think the I-55 market is a little overserved and overbuilt,” said Michael W. Brennan, president and CEO of First Industrial Realty Trust, Chicago. As an active investor, the company currently prefers properties in the city of Chicago and near O'Hare International Airport. First Industrial also likes buildings in the west, northwest and north suburbs.

Looking ahead, Chicago's diversified industrial base should help cushion any economic slowdown. “Demand is still there,” said Walter Murphy, senior vice president, Grubb & Ellis Co., Northbrook, Ill. But Murphy, like many other industrial property executives, doesn't expect this year to be as robust as 2000. “It's a more selective and more cautious market these days,” he said.

Retail construction boom

“The new construction numbers look huge,” said David Bossy, president of Mid-America Real Estate Corp., Oakbrook Terrace, Ill. A recent report from the company predicts the completion of nearly 20 million sq. ft. of new and expanded retail space in the greater Chicago area by the end of 2003.

In 2000, 27 new shopping centers and 12 existing center expansions added about 5 million sq. ft. of retail space to the market, an increase of 25% over the past two years. Another 7 million sq. ft. is projected for 2001.

Bossy isn't worried, though. “The market is amazingly resilient,” he said.

New development is being spurred by discount retailers and food stores that anchor new community shopping centers. Meijer SuperStores, Grand Rapids, Mich., plans to open four to five stores a year for the next several years. Target, Kohl's and Wal-Mart have new stores in the area.

Ten food store developments were completed in 2000 and 15 are scheduled for completion in 2001. “There's real competition for good sites,” noted Bossy. Retailers and developers alike prefer outlying suburbs with growing populations, such as those along Randall Road in the western suburbs and along I-55 in the southwest suburbs.

Woonsocket, R.I.-based drugstore chain CVS plans 10 to 15 new area stores, challenging local powerhouse Walgreens. “CVS has a real opportunity for expansion in the area,” said Edward Zifkin, Zifkin Realty & Development, Chicago.

With consumer confidence waning and the bankruptcy of Montgomery Ward, shopping center vacancies may rise in 2001, according to Todd Caruso, managing director of retail properties for CB Richard Ellis, Lincolnshire, Ill. The vacancy rate at the end of 2000 was 8.1%, up from 7.8% the previous year, stated a year-end report from CB Richard Ellis.

General Growth Properties Inc., the giant Chicago-based REIT, expects a strong market performance in 2001. The company's portfolio includes two Chicago-area properties: Spring Hill Mall in West Dundee for middle-market shoppers; and Northbrook Court, an upscale center in the Northbrook neighborhood. Northbrook Court is currently undergoing a re-tenanting and re-merchandising process, which includes more restaurant offerings.

“We have found people want a better sit-down restaurant,” said Robert Michaels, president of General Growth. An upscale Italian restaurant, Bice, recently opened at Northbrook Court.

Michigan Avenue, which had experienced a higher than normal vacancy rate last year, will show a 2% rate this year. “The market will return to more normal conditions,” said Bruce Kaplan, president of Northern Realty Group, Chicago. “Michigan Avenue will be tight.”

The Gap leased 42,000 sq. ft. of vacant space at Michigan Avenue and Ohio Street.

The new Nordstrom-anchored North Bridge shopping center opened last fall. The project adds about 500,000 sq. ft. of new retail space to the Michigan Avenue market.

Asking rents on Michigan Avenue are up about 15% for the year, Kaplan said. Ground floor space rents range from about $250 to $275 per sq. ft.

Along State Street, the other main downtown shopping district, Sears will open a store at State and Madison streets next summer. Meanwhile, the $250 million, 1.3 million sq. ft. Block 37 development, a mixed-use project located on North State Street, has received planning office approval, and construction is slated to begin in the fall.

Jane Adler is a Chicago-based writer.