What’s Driving Suburban Office Investment in Chicago?
- Aug 14, 2018
Chicago’s thriving Central Business District has been a hot topic for several consecutive quarters. Benefiting from a strong urban migration trend set in 2016 by corporate giants like Google, McDonald’s and Motorola—a dynamic that has become increasingly visible in the majority of the largest metros across the nation—the city’s downtown area is currently boasting vacancy rates around 10 percent. Meanwhile, vacancy rates in Chicago’s suburbs range from 20-25 percent. Next to the large spaces left behind by large tenant move-outs, Chicago’s suburbs have also been struggling with weak employment growth, which is impacting most submarkets.
Industry forecasts, however, highlight the possibility of a suburban office market revitalization in the near future. Zach Fox, senior vice president with Transwestern, points out that many large employers have kept their presence in these areas and opted only for a satellite office in the CBD. He believes that in a stable market like Chicago, a complete revitalization of the suburbs will eventually take place as Millennials are aging and landlords continue to upgrade office properties.
What kind of returns can suburban office investors expect from the Chicago market?
Zach Fox: We’re still seeing high cash yields in suburban markets based on higher cap rates and significantly lower tenant improvement packages as compared to downtown. Downtown cap rates are still a couple hundred basis points lower than suburban markets, and the tenant improvement packages are anywhere from $20-$35 per square foot higher. Because of this, we have seen a spike in investment activity in suburban markets with buyers looking to assume more risk for better returns. The key to suburban investing is to have an in-depth understanding of the different submarkets to identify opportunity in markets that other groups are not looking at. As long as cap rate compression continues in downtown markets and value-add buyers are priced out, we would expect a strong outlook on suburban sales activity.
What are the advantages of leasing suburban office space in a market like Chicago?
Zach Fox: The suburbs have always offered tenants the opportunity to lease space close to home while minimizing rent overhead compared to downtown markets. With its combination of available housing, abundant dining and shopping, as well as geographic diversity, suburban properties have always been able to offer tenants something for everyone.
What’s in store for the suburbs, now that the CBD migration has started to cool off?
Zach Fox: Migration to the CBD has been a hot topic, but what is often overlooked is the suburban presence these companies are maintaining. The nature of businesses today is more nimble and ever-changing, so for suburban companies to have an outpost in the city to offer employees a different work setting makes sense, but a significant portion of these companies that are making headlines for their downtown offices are also renewing, expanding and staying in suburban markets.
If we are to talk about a suburban resurgence in Chicago, which are the emerging submarkets at this point?
Zach Fox: Transportation has become a significant piece of the suburban office puzzle. As floor plans densify, tenants are looking for either higher parking ratios or alternative means of transportation. Submarkets such as O’Hare, with limited in-place parking, have been able to thrive due to their proximity to public transportation. CTA Blue Line and Metra access have allowed tenants to bring more employees to the submarket (without) stressing the parking of these properties.
What do you think can bring back companies to the suburbs?
Zach Fox: This is certainly an interesting question, and I think the simple answer is time. There is no doubt that Millennials make up a significant portion of the workforce, and this makes sense given that, during a recession when jobs are being shed, the older and more established employees have a tendency to exit the workforce after the loss of a job. This group represented the older families that were more concentrated in suburban markets.
As the economy began expanding and job creation increased, Millennials were there to backfill open positions. As their average age is 30.5 years old, many are still living in the city, and companies have followed them to downtown markets. As Millennials continue to start families, the demographics will once again shift to more of a suburban-based workforce. Companies will continue to follow the talent and establish office locations where they are best able to recruit. Given time, and a suburban migration of aging Millennials, companies will once again focus their efforts on locations that are near their employees.
What are your predictions regarding suburban office rents going forward?
Zach Fox: Suburban markets where access to downtown and public transportation are in place, such as O’Hare, will continue to see moderate rent growth, while markets farther from downtown, such as the Schaumburg area, will remain flat based on in-place vacancy. As a whole, suburban rents should remain flat with pockets of growth where vacancies and development opportunities are limited.
Across the CBD, redevelopment of older, historic buildings is a major trend right now. What can you tell us about office development trends in the suburbs?
Zach Fox: Downtown markets have a major advantage in redevelopment as the markets have historically significant properties that offer timeless beauty you simply cannot replicate in today’s environment. Suburban properties, on the other hand, were developed anywhere from the 1970s-2000s with very little architectural significance, and not a lot in the way of cost-benefit balance in redeveloping these properties into newer office space.
Redevelopment in suburban markets has been much more focused on adaptive reuse of antiquated campuses or transitioning properties to highest and best uses. Developers are looking at projects that were developed as a “city within a city” in the 1980s and 1990s and coming up with creative new life for these sites that are incorporating more than just office space. Municipalities are also more interested in creating new entertainment and dining options for their residents, so there is a synergistic harmony in a lot of these projects.
Image courtesy of Transwestern