What a difference a year makes, especially in the Chicago office investment-sales market. By mid-year last year, $9.4 billion of properties had changed hands, according to Real Capital Analytics, as investors who bought properties during the market's downturn in 2004 and 2005 sought to take profits. That volume nearly equaled the $9.5 billion of investment activity for all of 2006.

But the credit crunch, which took hold last summer, put the brakes on investment activity. Only $3 billion worth of properties, roughly a third of what was sold during the first six months of the year, traded hands for the rest of the year. "The funny thing about 2007 is that it started with investors being downright cocky and ended with them in a total panic," said one Chicago broker.

That panic has continued into the first half of this year, as only $2.2 billion of properties have changed hands. In addition, pricing, which peaked last July at $245/sf, has dropped to $190/sf, according to Real Capital, but that could be more a function of the smaller size of properties that are actually selling. Property owners continue to put their trophy downtown office buildings on the sales block. But their efforts have been met with tepid results, at best. Roughly 3 million square feet of downtown office properties that hit the sales block this year have been pulled from the market.

And suburban properties are not faring any better, with landlords pulling roughly 2.3 million sf of suburban office space from the sales block. Park Central I & II, a 640,000-sf complex in Lisle, Ill., was the largest such casualty. Tishman Speyer Properties was shooting for a $130 million sale price, but aborted its sales efforts when offers fell short. "Some landlords are stuck in last year's thinking, that quality tenants and strong rents dictate a property's value," said the broker. As such, owners had offered their properties at prices resulting in capitalization rates of roughly 5.5 percent. But prospective investors, squeezed by conservative lenders, would offer prices at cap rates as much as 20 percent higher than that.

Only two Chicago-area buildings have commanded more than $100 million this year. Hines paid $540 million for UBS Tower, a 1.4 million-sf building in the city's West Loop, while Amtrust Realty paid $190 million for 135 S. LaSalle, with 1.2 million sf. In contrast, last year 10 properties sold for more than $100 million each, with four properties selling for more than $300 million apiece.

The Chicago area's office-market fundamentals have remained steady, despite the city's above-average 6.4 percent unemployment rate, according to the Illinois Department of Labor. The office vacancy rate for the region is 16 percent, down from 17 percent a year ago, according to Grubb & Ellis. The city's suburbs have a 21 percent vacancy rate, while the downtown vacancy rate is 11 percent.

Several large tenants have made lease commitments to Chicago in the first half. Baker McKenzie, a legal firm, is leasing 300,000 sf at River Place, BP Global is leasing 225,000 sf at Mercantile Exchange, and Marsh signed for 134,000 sf at 155 N. Wacker Drive. In addition, Ernst & Young, KPMG, Commonwealth Edison and MillerCoors are all said to be seeking significant amounts of space in the city.

Such competition has boosted rental rates, which now average $36/sf in downtown, up from $33.69/sf a year ago, and $26/sf in the suburbs, compared with $25.69/sf.

And the region's fundamentals are expected to remain strong. So far, 600,000 sf has been absorbed, meaning previously vacant space has been leased. At the current pace, absorption should exceed the 1 million sf of space that was absorbed last year. Meanwhile, 4.5 million sf of space is expected to be added this year.
But some estimates have as many as 4 million sf of class-B and -C office space being removed from the market for conversion to rental and condo apartments.

For example, Walton Street and Glenstar Properties paid $234 million last year for 55 E. Monroe, a 1.6 million-sf, class-B building that is slated to be converted into residential condominiums. Such a move by developers is forcing office tenants to find other quarters and many are expected to relocate to class-A space in the city.
Meanwhile, suburban tenants are increasingly looking to move into downtown space. "BP is a great example of a company that is seeing the benefits of moving its operations to downtown, class-A space," said a broker of the oil and gas company, which was previously based in Warrenville, Ill. "It helps with both recruiting and employee retention."

Copyright © 2008 Courtesy of  Commercial Real Estate Direct, a service of FM Financial Publishing LLC. All rights reserved.