Vacancy rises, rents fall in suburban offices

(Crain's) — The suburban office vacancy rate edged up in the third quarter and asking rents fell as new projects added supply to the market while some mortgage companies and others continue to downsize.

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SUBURBAN OFFICE MARKET
The suburban vacancy rate, including space available for sublease, edged up in the third quarter. The rate eclipsed 20% for the first time since the first quarter of 2006. Asking rents fell after rising for three straight quarters.
	Vacancy rate
Submarket	3rd qtr. 2007	2nd qtr. 2007	3rd qtr. 2006
North Corridor	18%	16.2%	15.1%
East-West Corridor	21.2%	21.4%	20.8%
O'Hare Area	19.1%	17.7%	17.3%
Northwest Corridor	22.2%	21.3%	20.2%
Total	20.5%	19.7%	18.9%
	Asking rents (per sq. foot)
Submarket	3rd qtr. 2007	2nd qtr. 2007	3rd qtr. 2006
North Corridor	$20.56	$20.20	$19.83
East-West Corridor	$20.38	$20.12	$18.95
O'Hare Area	$19.63	$19.74	$20.22
Northwest Corridor	$20.23	$20.12	$19.17
Total	$20.26	$20.88	$19.21
Source: Studley Inc.

The market's overall vacancy, including space available for sublease, climbed to 20.5% from 19.7% in the second quarter, according to a report from Studley Inc., a tenant representation firm. The last time the vacancy rate was more than 20% was the first quarter of 2006.

Asking rents, meanwhile, dropped almost 3% in the quarter to $20.26 per square foot after increasing for three straight quarters.

The movements suggest the suburban market is remaining tenant-friendly, even as a flurry of investors have recently paid big premiums for office complexes, betting that vacancies would fall and rents rise, says Richard Schuham, executive vice-president with Studley's Chicago office.

"Tenants definitely have the upper hand in the suburban market," Mr. Schuham says. "I think they have for a while. The investment sales community was very hopeful that would change, and so far it hasn't proven out."

A record volume of office buildings were sold in the suburbs last year, totaling $1.91 billion, eclipsing a record set in 2005. The pace continued only slightly abated during most of this year.

The direct vacancy rate in the suburbs, which doesn't include sublease space, isn't a much prettier picture for landlords. That rate in the quarter stood at 17.2%, up from 16.1% in the prior period and 15.8% in the third quarter last year.

Still, vacancies in the suburbs have generally been declining since 2001, following the last recession.

Top-quality, so-called Class A buildings have the lowest vacancies, prompting developers such as Duke Realty Corp. and Opus North Corp. to start putting up new speculative office buildings without first having tenants.

Indianapolis-based Duke, for instance, is marketing two speculative office buildings, in Lake Forest and Rosemont. The developer also just acquired land in north suburban Gurnee with plans for another such project.

The north suburban and O'Hare markets have the lowest vacancy rates in the suburbs, according to Studley data.

"We've seen a pretty good tick-down in Class A vacancy rates, and we think the tightening will continue," says Ryan O'Leary, vice-president of leasing and development with Duke's local office. "New product has been limited, and has been well-leased as it comes online."

Existing properties in the suburbs have taken a hit from the slowdown of the housing market and the fallout in the subprime mortgage industry, particularly in the northwest suburbs — which has the highest vacancy rates.

Two subprime lenders, Ameriquest and Argent, emptied out a total of more than a half-million square feet of office space at three complexes in Schaumburg and Rolling Meadows. Another such lender, Fremont Investment & Loan, emptied about 90,000 square feet of office space in Downers Grove when the business was shut down, according to Jason Volpe, a Studley managing director who concentrates on the suburbs.

But a stronger-than-expected government jobs report issued Friday may be an encouraging sign that those vacancies may be absorbed by other tenants. The U.S. Labor Department said 110,000 jobs were created nationwide in September, 10,000 more jobs than had been predicted. The government also revised upward its job estimates for August and July, with August showing a gain rather than the loss that had been initially reported.

Mr. Volpe says increased vacancy will stop the inching up of asking rents. He points out that when rents hit their peak in 2000 at $22.64, the vacancy rate was about 15% compared with 20% today.

"I think the landlords were hoping they saw the light at the end of the tunnel, but the fundamentals don't really bear that out," Mr. Volpe says.