The Chicago office market continued a slow but steady recovery in the first quarter of 2013, foreshadowing possible new construction in select submarkets. Local improvement comes amid lingering economic concerns facing corporations and investors across the country, such as future job growth and the implications of sequestration. The findings were reported in Newmark Grubb Knight Frank’s newly released research reports for the Chicago market.

Chicago Skyline“Demand for commercial space hinges on job growth, and through February, Chicago has recovered only 51% of jobs lost during the recession, lagging the U.S. recovery of 67%,” said Michael Sheinkop, executive vice president, regional managing director. “The state’s daunting financial challenges and Chicago’s competitiveness when it comes to attracting and retaining business are among a number of important local issues that will continue to affect the region’s labor market. Added to this are macro forces, including foreign exchange rate fluctuations altering the relative costs of labor, and fundamental changes to supply chain logistics, such as the widening of the Panama Canal, all of which make real estate decisions increasingly complex.”

In the first quarter of 2013, the overall office leasing market experienced 746,000 square feet of positive net absorption and vacancy dropped 20 basis points to 18.6%, down from 19.7% one year earlier. By the end of the quarter, tenants had re-absorbed all 5.3 million square feet of office space vacated during the recession. In the CBD, the office vacancy rate ended the quarter at 15.0% and Class A average asking rental rates climbed 0.5% to $35.51/sf, gross. In the suburban market, the office vacancy rate lowered 50 basis points to 22.6% and Class A average rents crept up 0.1% to $23.08/sf, gross.

[pullquote]In the CBD, only six options – four of which are above the 20th floor – remain for tenants requiring over 200,000 contiguous square feet of Class A space on a long-term basis.[/pullquote]Although the CBD and suburban office markets both saw positive net absorption for the third consecutive quarter, activity in the two was remarkably different. The CBD recorded three of the area’s four largest first-quarter leases, and saw speculative building downtown. In the suburbs, performance was spottier. Submarkets such as O’Hare and the North are benefitting from growing tenant demand in industries such as pharmaceuticals and insurance, whereas submarkets such as I-88 West and the Northwest have suffered from corporate consolidations and tenant relocations. In these submarkets, improvement is more asset-specific.

Research Manager Tim Van Noord explained that dwindling availability may lead to more office construction downtown: “In the CBD, only six options – four of which are above the 20th floor – remain for tenants requiring over 200,000 contiguous square feet of Class A space on a long-term basis. Numerous tenants with requirements of this magnitude are currently searching for space in the CBD, and the lack of available quality options, alongside Mayor Rahm Emanuel’s efforts to strengthen the city increase prospects for growth.”

While uncertainty in the labor market may stand in the way of robust growth in the medium term, the Chicago market should continue to see tepid improvements as companies ramp up leasing decisions and user purchasing remains an attractive alternative for expanding good-credit tenants seeking to invest capital.