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September 1, 2016

Only the Shadow Knows

By Jonathan Zimmerman

Not a day goes by without someone asking me the question, how is the leasing market?

The short, easy answer: it’s a matter of perspective.

Presently, it is quite good if you are a landlord. There is as much activity as I can ever remember and rents are at all time highs. The rapid expansion of tech businesses, rise of co-working space, continued suburban migration downtown and a generally strong economy have contributed substantially to this growth.

Determining whether it is a tenant or a landlord market is relatively simple. However, that question is often followed up with another, more difficult question: how much longer will this last? If I possessed superhuman powers to see into the future, I would be in Las Vegas right now, sliding large stacks of blue, green, and black chips across a green felt poker table.

While I work on those superhuman powers, the best thing I can do to predict how long this market will last is to look at past trends and signs of change.

One telltale sign of what might lie ahead is the concept of shadow space. Shadow space is defined as blocks of currently leased space that will be vacated upon lease expiration and are actively being marketed. The speed in which shadow space leases is a genuine indicator of market strength. If it leases quickly, that is a sign of the landlord market being here to stay but if the spaces sit empty for a while, it is an indicator that we are returning to equilibrium or potentially shifting back to a tenant market.

Currently, there are approximately 6 million square feet of shadow space on the market in downtown Chicago. 333 South Wabash takes the title for the most shadow space with 759,000 square feet, due to CNA’s planned relocation to 151 North Franklin in 2018 where they will be downsizing to 275,000 square feet.

Trailing Big Red is The Franklin complex at 222 West Adams/227 West Monroe, which will have 442,000 square feet of shadow space in play when McDermott, Will & Emory head to 444 West Lake and William Blair to 150 North Riverside. Hyatt is heading there as well, leaving their namesake tower at 71 South Wacker after only 12 years.

Though the spaces being vacated are spectacular in their own right, the truth is that it is difficult to compete with new construction. The new space is often more efficiently designed, thereby enabling tenants to lease less square footage and in the process, save money.

Because of companies like CNA and William Blair that take part in the “out with the old and in with the new” school of thought, old buildings, even with their added shiny amenity packages, are often left behind for new development: the factor most responsible for creating shadow space.

For example, two of the office towers presently under construction, 444 West Lake and 150 North Riverside, are coming out of the ground nearly 80% occupied with tenants relocating from A class buildings nearby.

Collectively, these new towers demonstrate the strength of the market and how much pent up demand there has been for new buildings; so much demand that while multiple towers are still on their way up, developers are actively pushing several other sites for new buildings. As more are built, shadow space will continue to increase and tenants may see the market turn in their favor.

Future deal terms negotiated by many tenants will be directly influenced by the speed in which the shadow space leases, as will owners deciding whether or not to sell, and developers determining whether or not to proceed with new construction. And so the cycle goes.

There’s the long answer.

My prediction for what’s to come? All I know is that it promises to be a wild ride as we witness the latest chapter in downtown Chicago real estate.