After a quiet winter for office investment sales, the Chicago market is suddenly flush with available Downtown properties.
There are at least 22 office buildings currently being marketed for sale Downtown, and all have hit the market since January. That includes AmTrust Realty’s portfolio of seven Downtown properties that’s seeking $1.3 billion, the 37-story Citadel Center, and the 46-story 500 West Monroe Street.
After a period of economic expansion and corporate relocations to Downtown, office landlords are looking to cash out en masse. But they might find the task difficult, as new inventory, retooled property assessments and changing tenant demands pose challenges to selling, experts said.
There’s no single reason why the slew of buildings have been listed for sale at roughly the same time, but experts said it does signal one thing for the market: Chicago’s real estate cycle is in a late stage.
“There’s a sentiment among owners that this could be a high point,” said Tom Smith, co-founder of office leasing brokerage Truss.
Other previous real estate cycles have seen a large number of office buildings go on the market at once, but there are new factors at play today.
One is ownership of some office buildings has changed from institutional investors to more of a private equity model, said Tom Gorman, a senior vice president at Colliers International who specializes in investment sales. Those new owners typically look for value-add opportunities where a tidy profit can be realized in relatively short order.
“Ownership in general has become a shorter hold period,” Gorman said. “The strategy has changed a little bit.”
Another factor impacting this selloff is the demand for office space has changed.
The Loop, and especially the Financial District, has been hit with a wave of tenants leaving for newer properties in River North and the West Loop. A number of the properties that will lose tenants are up for sale, including 801 South Canal Street and the Citadel Center at 131 South Dearborn Street. Some landlords may be trying to cash out while those leases are still on the books, Smith said.
“We’re seeing a big geographic switch away from the Central Loop and focused heavily on Fulton Market and River North,” he said. “This is getting in front of that demand change. They want to sell while they still have that occupancy, still have that cash flow.”
That is not to say Downtown office landlords are listing their buildings in a panic. It could just mean that economic and market factors have made it an opportune time to list, said Mike Duncan, principal at Cresa.
Consider the Citadel Center: Owners Hines Interests and Angelo Gordon & Company took control of the 1.5 million-square-foot building in 2016 with a $50 million equity investment, as the previous owners were set to default on the building’s $472 million loan.
Hines and Angelo Gordon then injected $100 million in the property, an investment that helped boost occupancy from 55 percent in 2016 to the current 87 percent.
The Citadel Center will lose two law firm tenants in the next few years, but that likely isn’t the precipice for selling the building, Duncan said. It could just be time for them to cash out on their so-far successful investment. (Hines and Angelo Gordon are seeking as much as $750 million for the property.)
“Do they re-lease the building, or do they cash out?” Duncan said. “They did their job, and now it’s time to reap the benefits of bringing cash flow to the building.”
Whether the Citadel Center, or any of the other buildings for sale, gets its asking price remains to be seen.
Overall Downtown office vacancy has remained relatively flat around 13 percent. Asking rents have climbed 22 percent since 2013 as corporate relocations drove up office space demand, according to JLL. But a new wave of development, changing tenant preferences and shifting political headwinds will likely alter this dynamic, sources said.
Several new developments coming online in the next couple years could put pressure on vacancy rates, including 601W Companies’ 2.8 million-square-foot Old Post Office project, Riverside Investment & Development’s 1.5 million-square-foot tower next to Union Station and the 54-story office tower at 110 North Wacker Drive from Riverside and Howard Hughes.
Another factor complicating the sales is many of the buildings currently listed are clustered in the Loop. The buildings that sell near their asking price will have strong occupancy, efficient management and upgraded facilities, Smith said.
“They can’t differentiate geographically, but they can differentiate themselves by their operating expenses,” Smith said. “The buildings that have made investments in technology, that have kept their operating expenses down, will fetch the premiums they’re asking for.”
But the biggest challenge facing the sellers could be the new method of property tax assessment being rolled out by new Cook County Assessor Fritz Kaegi. Areas of the county are already seeing the effects: Some commercial buildings in Evanston, for instance, saw their assessments double.
Downtown properties have not yet been assessed using the new models, meaning some investors could balk at acquiring buildings before knowing more about their future tax bills.
“There’s some risk with real estate taxes,” Gorman said. “Those are questions that have yet to be answered.”
Since it is the private equity investors who are largely the ones selling off their assets, another class of investor will likely have to step up, Duncan said. He said fixed-income institutions, like pension systems, could be a big buyer this time around.
“The risk-taking, turnaround investor is cashing out,” he said. The fixed-income groups “are investing for safety at a higher rate than they can get from bonds, for example.”
While there are some challenges facing the office market in the Loop, sellers could be boosted by Chicago’s strong economy and the repopulation of Downtown and surrounding neighborhoods..
“Chicago has a vibrant core,” Gorman said. “This is going to test how resilient Chicago is.”