Barriers to Entry Limiting Downtown Construction
For the last 20 years, the barriers to entry to build Downtown office were not very high. That’s all changing, one reason we're excited to present Bisnow’s A New Downtown: Leasing, Development and Investment event May 14, starting at 7am at theMart.
Hines senior managing director Tom D’Arcy (a panelist at our event) says the last few decades were flush with capital, and developers focused on numerous Downtown sites. Now there’s a much smaller pool of groups able to raise $200M of equity to build a 1M SF tower. Tom believes this will lead to fewer and smaller buildings and extended development cycles—only two new buildings are delivering in 2017 (including Hines' River Point, rendered below) and they're the first since ’09. That’s leading to more adaptive reuse, smaller developments (Hines is targeting a 415k SF development at Madison and the Beltway), and developers branching into other product groups so they’re not relying solely on large office towers Downtown (like Hines entering multifamily).
Availability of top-tier development sites zoned and shovel-ready is a growing barrier to entry today, which makes land one of the more interesting investments now, Tom says. Development can only spread so far east with the parks and lake, land use makes it hard to build large office north, and Congress has been a barrier to the south except for residential. He believes Chicago will have to start acting more like NYC and assemble parcels to build. Land prices here are well below the rates in NYC or San Fran, but he thinks that gap will be smaller in a decade.
John Buck president Blake Johnson, also a panelist, is seeing true rent growth this cycle, something that hasn’t historically been the case. (Tenants typically move around to keep rates low.) Rents have stabilized above $30 net for Class-A-plus product, but landlords need to maximize efficiency or amenities to get the boost. As offices get denser—one of Blake’s tenants is 135 SF per person—companies are relying more on their building and area for comfort.
High prices in existing product has pushed Buck to development, and it’s casting a wide net across property types. On the office front, 151 North Franklin (rendered here) has one LOI out and more in the works. Buck’s also building out the amenity floor now on 33 North LaSalle, a creative office property that was less than 50% occupied when Buck bought it but has pending deals that’ll nearly bring it to 70%. Blake tells us that property is benefiting from a tightening Class-C office market. 5M SF of office space has been converted into multifamily and hotel lately, and dwindling office supply has skyrocketed Class-C rents 20% in the last three years. (Good luck finding space below $25 gross.) Buck’s also building hotel (recently, Virgin and Loews) and multifamily (two sites are in entitlement now).
Tom, MBRE EVP and managing director Mark Buth and Blake all stressed the growing importance of outdoor space in office buildings…even if tenants can only use them a few weeks out of the year. Hines’ River Point is delivering in early 2017 with outdoor balconies. It’s already 60% pre-leased, Tom tells us. O’Donnell’s 150 N Riverside (rendered here) has a green roof and 1.5 acres of plaza and park space, Buck’s planning a winter garden at 151 N Franklin, and Tishman is planning a park on the north side of 130 N Franklin.
The move to Downtown is widespread—NGKF vice chairman Melissa Copley (another panelist) sees it happening in Detroit, Milwaukee, San Francisco and Chicago. In Chicago, NGKF has tracked sizable leases totaling 3.3M SF of deals since 2009 from major companies relocating to Downtown or opening satellite offices there for recruiting or "work anywhere" purposes. Companies are drawn to the concentration of young residents, Melissa says—they want to live Downtown to be near city amenities and public transportation.
Melissa is particularly watching big changes in two industries: tech and law. There’s been over 4M SF of larger tech leases signed in the last five years. Tech companies often come out of nowhere and start with small leases, but it’s not unusual for them to double within 18 months. They like unique properties especially like what’s seen in River West and River North. As the Internet of Things grows (Goldman Sachs predicts 28 billion things will be connected by 2020), she expects a major impact on real estate. On the other hand, many law firms in Chicago still have excess space and are looking at what to do with it. Melissa represented Seyfarth Shaw in its recent lease at Willis Tower (pictured); it’s shedding 100k SF in a 200k SF move. As technology advances, all industries (including legal) will continue to evolve and change, directly impacting their real estate requirements, Melissa says. Join us for Bisnow’s A New Downtown: Leasing, Development and Investment event May 14, starting at 7am at theMart. (Sign up here.)