The desirability gap between Chicago's Class-A and B office buildings is becoming increasingly apparent, driving rental rates for top-flight properties higher even as overall rental rates tick down, according to a new downtown office report.
Class-A asking rents increased 1.5% year-over-year, while overall asking rents ticked down 0.1% in Q4, according to Savills' latest data on downtown office performance. The data showed a widening chasm between top-of-the-line newer properties and older, less amenitized ones as tenants' flight to quality continued to leave a mark.
The largest gap between building types in asking rent by submarket was far and away in Fulton Market, where Class-A buildings cost roughly $24 more per SF than Class-B buildings. Fulton Market is the newest office submarket in the city, and the Class-A properties are largely newly constructed buildings, Savills Chicago Region President Robert Sevim said.
A lot of the Class-A properties in Fulton Market have new-construction prices attached to them, while many of the Class-B properties in the submarket are older buildings that owners haven’t fully updated with amenities and may be smaller loft buildings, Sevim said.
“Those aren't going to be priced nearly in the same manner as the new-construction assets that you see in Fulton,” he said. “That's why you see that disparate spread of pricing.”
North Michigan Avenue had the lowest rent spread between Class-A assets and Class-B because it is a less dynamic submarket, which leads to more price competition, Sevim said.
Overall availability in Chicago’s downtown office market stood at 27.6%, rising 170 basis points year-over-year, largely driven by an exodus from Class-B buildings, according to the report. That was largely driven by Q1 2023 departures that emptied large blocks, like Katten Muchin Rosenman contracting its footprint by 7.3% and Enova International reducing its office space by 24.2%, according to Q1 2023 Savills data.
The market’s availability rate, the percentage of vacant space that is immediately available or on the market due to expiring leases, has basically held flat over the past three quarters, signaling potentially less turbulence for the downtown office market.
In the first quarter of 2024, Sevim said he expects the trend of stable availability numbers to continue, and there may be new leases signed, in contrast to some 2023 predictions that American cities were on the brink of an urban doom loop.
“We have activity in the market and ... a lot of the spiraling that we read about, we hear about is not as draconian as the statistics are actually showing us,” Sevim said.
Not all properties are seeing equal levels of stabilization on availability, with the A-B gap again rearing its head.
The largest gap in availability between Class-A properties compared to Class-B properties was in River North, with about a 13% difference. The East Loop was right behind with a 12% availability differential between classes.
The gap between these building classes may continue to rise, without necessarily impacting overall availability numbers, as tenants continue migrating from Class-B to Class-A space, Sevim said.
The only submarket where Class-A buildings and Class-B buildings had a similar level of availability was North Michigan Avenue, and there was slightly less availability in Class-B space, at 20.7%, than in Class-A space. This is due to North Michigan Avenue being a relatively smaller office submarket with little new product, less differentiation between Class-A and Class-B properties compared to other submarkets, and a tenant base that tends to stay put, Sevim said.
Sevim said an uptick in lease transaction volume was an encouraging sign to close out the year, with 2023 deal activity totaling 8.2M SF, up 5.2% from 2022.
“There's activity on all fronts,” Sevim said. “Yes, it's more concentrated in the Class-A world, but we're seeing activity, and we're seeing decisions being made.”
