Parrish Lauds Redevelopment As Cheaper, Faster Alternative

Chicago?After months of speculation, the first new high-rise office tower in downtown Chicago may be ready for construction. A recent deal to bring Aon Corp. to a 50-story office tower proposed by The John Buck Co. at Wacker Drive and Franklin and Madison streets will allow construction to begin. The two parties reportedly have signed a letter of intent for the insurance giant to lease 400,000 square feet.

John Iberle, a principal of The John Buck Co., would confirm only that the company, with partner Lend Lease Real Estate Investments, expects to break ground on the 1.7 million-square-foot building during the second quarter. The project would be the first such structure downtown since the early '90s.

This comes after vacancy rates for Class A buildings fell to 5.4 percent at year-end, according to CB Richard Ellis. The vacancy rate was 10.7 percent for Class B buildings and 20.8 percent for Class C properties. The overall vacancy rate of 10.6 percent was the lowest in a decade.

Though 12 or so new buildings were proposed last year, only Union Tower was under construction by year-end. The 352,000-square-foot building at 555 W. Van Buren in the West Loop is being built by Development Resources.

The lack of activity can be attributed to increased pressure from lenders to secure 30 to 50 percent pre-leasing prior to construction. Following the financial troubles in Asia and other foreign countries and the devaluation of the stock market, lenders pulled back from exposure to construction lending.

"Wall Street turned the spigot off on real estate when the capital markets became a concern," said Hal Ulvestad, a CB Richard Ellis senior managing director. The financial requirements prompted several developers to delay projects or reduce their size. The Buck building, for example, previously had been proposed with 65 floors.

Tenants' cost concerns are also playing a role in the reluctance to start new buildings. "We start incurring premiums to build that high," Iberle said. "Tenants want the most economical space they can get. The premiums would be nice to have, but we didn't think the market would bear it."

Other developers are filling a niche with new buildings from 300,000 to 500,000 square feet. Developer Steven Fifield, for example, has plans for a 400,000-square-foot office development at 550 W. Washington. The 16-story limestone and glass building is expected to open in the spring of 2000, he said. "Our reading of the market was that it's not 1987 anymore?you can't just go there and have lenders throw money at you. You've got to be much more practical."

With smaller buildings, developers have an easier time meeting pre-leasing requirements and can bring a building to market more quickly. "The smaller the building, the easier it is to get it kick-started by one tenant, and getting one commitment is certainly easier than getting two simultaneously," said Mark Parrish, a senior vice president at Grubb & Ellis Co.

A larger trophy building would take about two years to build, compared with about one year for a smaller building. That shortened time frame often helps alleviate tenants' concerns about committing to space so far ahead of delivery. "That's a long time out in the future," Parrish said. "A lot of tenants don't know where their business will be in 24 to 30 months, so they're hesitant to commit."

Market conditions are also prompting developers to look more closely at older space. "We are seeing a lot of developers buying and redeveloping well-located Class B and Class C buildings," Parrish said. "The cost to buy and redevelop is significantly lower than the cost to build from ground zero, and they can offer occupancy more quickly."

That redevelopment activity has provided alternatives for tenants that want to stay in a certain submarket but do not want to pay the price of new construction. Net rents for new Class A space are about $24 to $28 per square foot, about $4 to $6 per square foot more than existing Class A space.

And tenants are in command in downtown Chicago. While landlords have been increasing rents because of the lack of supply, they can only raise them so much. "Those landlords that are enjoying the market right now because of the lack of supply aren't going to move too fast to the point where it will stimulate new construction," Ulvestad said. Net rents for Class A space are expected to peak in the $20-to-$24-per-square-foot range this year, according to Grubb & Ellis figures.

The rent differential between new and existing buildings is a key factor for tenants, because they are more cost conscious and focused on their bottom line now. "The larger tenants looked very seriously at a few different proposals, but after comparing prices to what they could do in staying in an existing building, at the end of the day there's quite a disparity," explained John Niemi, a senior vice president of Equis Corp. "They don't want it to cost more to house their employees than it costs their competitors to house their employees."

Business concerns also are forcing company executives to re-evaluate their space needs and look for flexible arrangements, Ulvestad said. They want the ability to expand if their businesses grow or reduce their space if needed. "Companies are now saying, 'How much space do I really need, and do I have alternatives?' Competition is such a big factor today that companies are going to be weighing big decisions carefully," he observed.

In other cases, tenants have hesitated to move into new construction because they know they are not large enough to fulfill the pre-leasing requirements. Those most likely to move to new construction have outgrown existing space or exceeded their technological capabilities, according to Jeffrey Samaras, a senior director at Cushman & Wakefield Inc. "A few of the tenants in the market are going to be forced into new construction," Samaras said. "Their existing facilities can't accommodate their needs."

Furthermore, Iberle said, a new building provides efficiency through floor plate design and technological advances. He pointed to the Buck building as an example. "The real key is total occupied space," he said. "Maybe you're paying a few bucks more in rent, but you're using 30 percent less space because of the efficiency." Also, the Buck building will have 27,000-to-28,000-square-foot floorplates with 45-foot lease spans, he said. "Those two dimensions offer the most flexibility to the most variety of tenants."

As for technology, with today's companies reliant on the Internet and communicating electronically, they are looking for the most advanced fiber optics systems, he pointed out.

With such advantages, the Buck project could change the Chicago office market. If it proceeds as planned, it will add new leasing options to the market, which could create a resurgence of leasing activity throughout downtown. Now that a large-name tenant has been signed, the smaller tenants that were waiting on the sidelines may follow suit. There remains much speculation, however, about what other development projects will follow and how many the market can bear.

Projects announced last year include 7 S. Dearborn St., an 800,000-square-foot building proposed by European-American Realty; River Bend, a Mesirow Stein/LR Development proposal for 646,000-square-feet at Lake Street and the Chicago River; and 401 N. Dearborn, a 350,000-square-foot project proposed by the Alter Group.

"The absorption we've seen in the last several years has been two-thirds of what we saw in the mid-1980s," said James Purinton, president & CEO of Orix Real Estate Equities Inc. "We have room for one or two downtown projects, but we don't have room for six or seven."

Todd Lippman, executive director of Insignia/ESG Inc., agreed. "If three of the large buildings go, you're going to see the '80s all over again, with too much space on the market," he said.

But most players in the Chicago market do not expect enthusiasm to recreate the boom of the '80s. "I expect there to be staggered development driven by a few anchor tenants," Niemi predicted. "Once a corporate user sees a building go up, it becomes more real and they trust that it's going to happen."

While corporate decisionmaking and a lack of funds available through the capital markets have kept overdevelopment in check, the latter also has had an impact on investment activity. Activity was strong last year, but it was about 30 percent less than in 1997. In 1998, 12.5 million square feet of space changed hands, down from the 17.6 million square feet sold during 1997, according to Grubb & Ellis Co.

1998 ended with a bang, with such noted towers as The John Hancock Building and the Amoco Building selling during the last portion of the year. But many buildings went to market in 1998 and were not sold, including Quaker Tower, IBM Plaza, One Prudential Plaza and Two Prudential Plaza.

"What happened last fall in the capital markets, that's put the brakes on a lot of things, but I think things are coming back," said Michael Newman, president & CEO of Golub & Co. "We're finding that there's certainly still a skepticism about deals, more stringent underwriting, but people are more open to talking about deals," Newman said. "All things being equal, I think by the middle of the year we should be in a more normalized environment."

While the REITS were not as active in buying property by the end of last year, insurance companies, pension funds and other institutional investors likely will take their place, Newman said.

In the retail and apartment sectors, Fifield is acquiring the Medinah Temple on the block bounded by State, Ontario and Ohio streets and Wabash Avenue. He plans to demolish the temple later this year and build a 49-story luxury apartment tower with retail and parking on the lower levels. "We're hoping that because it's apartment and urban retail, the market dynamics are such that we won't have a problem lining up financing," he commented. The property also includes the historic Tree Studios, which will be saved, he said.

The project is situated along the growing River North retail, restaurant and entertainment sector, which will soon include the first Nordstrom in downtown Chicago. The John Buck Co. is building the store at Wabash and Grand avenues. For the past few years, entertainment and theme restaurants have moved into that area, funded by big corporations and Hollywood stars.

"The city has become very vibrant," Fifield said. "You've got this huge resurgence of retail." Among the other planned projects are a Walt Disney Co. "DisneyQuest" virtual amusement park and a Sony 20-screen movie complex.

"The Ontario/Ohio corridor kind of started out with galleries, and now restaurants and residential," said Bruce Kaplan, president of Northern Realty Group. "All the packaged entertainment product is going to end up there. I think that's good because it creates an entertainment zone that's perceived as family oriented and safe."

Fifield originally had planned to include a 400-room luxury hotel on the site but has since removed it from the development package. "We believe the capital markets are very cool about hotel concepts," he remarked.

Other major retail activity is taking place on State Street, which has continued its transformation back into a popular shopping destination since being reopened to vehicle traffic two years ago. The J. Paul Beitler Development Co. has signed a deal with Sears, Roebuck & Co. to anchor 250,000 square feet of the 1 N. Dearborn project. "It means the street has come full circle," Kaplan explained. "They were one of the last to leave."

This redevelopment will bring the veteran retailer back to a street being revitalized with boutique hotels and renovated theaters. The Reliance Building on the southwest corner of State and Washington streets, for example, is being renovated into a boutique hotel.

"With the demographics of the Loop, the new gentrification and the college students through DePaul, Loyola and the Art Institute, there's a different type of retailing on State Street," said J. Paul Beitler Development Co. founder Paul Beitler. He plans to renovate the building, including adding a new lobby for the Dearborn Street entrance, to bring it back to its 1930s-era style. "It's really become a very real alternative, whereas two years ago it wasn't even on anyone's radar screen," he observed.

Beitler also is developing a 900,000-square-foot retail and office project with joint venture partner Prime Group Realty Trust. The property, bounded by Dearborn, State and Adams streets, is the former Montgomery Ward site. Beitler said he needs commitments for 25 to 30 percent of the space before construction can begin.

Elsewhere, leasing is expected to increase along Michigan Avenue as brokers try to fill vacancies left by Viacom, Bigsby & Kruthers and Sports Authority. This is in contrast to the typical climate where space options are created by new development. The vacancy is expected to soften rents on the upper floors and basement levels, but not on premier ground-level sites, said Kaplan.

"It's a wonderful time for a tenant who wants to be on Michigan Avenue," Kaplan said. While high-end apparel stores typically bode well on the Magnificent Mile, home furnishing retailers such as Pottery Barn and others also have been successful.