One July day last year, three office buildings in Chicago’s Loop business district sold, highlighted by a $105 million sale of the James R. Thompson Center. How times have changed.
Those three 2022 purchases, all by a joint venture of Chicago firms Prime Group and Capri Interests, were a hopeful sign as interest rates were starting to climb and remote work persisted more than two years into COVID-19. As part of the three-pronged deal, Google agreed to eventually buy and occupy the Helmut Jahn-designed Thompson Center.
Since that day, though, no major office building in the Loop — or anywhere in the broader downtown Chicago office market — has sold. The ongoing, 12½-month drought is the city's longest without an office property sale of more than $50 million since the Great Recession virtually shut off real estate deals throughout the country. That 14½-month dry spell lasted from late July 2008 to the middle of October 2009, according to CoStar data.
Chicago stands out from New York or Los Angeles, which have seen some sales, though smaller cities have experienced a similar lack of activity.
The current freeze-up, and the resulting plunge in property values, have mostly limited the pool of for-sale buildings to those with maturing loans or that are otherwise in financial distress.
“As a seller, the question is: Why would you sell an office building right now unless you have to?” Matt Garrison, CEO of Chicago developer R2, told CoStar News.
In some cases, there are several owners and lenders weighing in on a potential sale, further slowing the flow of deals. For buyers, Garrison regards the drought as the best opportunity since 2009, and maybe even a more lucrative opportunity this time, because many deep-pocketed investors are on the sidelines. But he concedes the idea of buying low is easier than it sounds; raising funds can be difficult.
“The paradox of distressed investing is at the point of maximum opportunity — no one will want to give you money,” Garrison said. “You’ve got to find it.”
Office Sector Shunned
Though the duration of Chicago’s downtown sales slump stands out among the nation’s largest cities, it is emblematic of the sharp drop in office sales volume everywhere. Low office utilization, continued interest-rate hikes, corporate layoffs, and a dearth of debt and equity in the sector have led to little liquidity in a real estate sector once prized — but now widely shunned — by huge institutional investors.
In a typical year, there are about 27 U.S. office sales of more than $250 million, said CoStar analyst Chad Littell. Through the first seven months of 2023, that number is four, he said.
The total volume of all U.S. office sales so far this year is almost $21 billion, on pace to fall well short of last year’s $80 billion, according to CoStar data. In 2019, before the pandemic's arrival, $117.5 billion was spent on office sales nationally.
The largest deal this year has been SL Green Realty’s sale of half its ownership interest in a 44-story Manhattan tower that valued the building at $2 billion.
Mori Trust’s high-dollar purchase in New York was a rare exception to what is otherwise playing out in major cities everywhere, said Littell, CoStar’s director of U.S. capital markets analytics. Often, properties are selling at a huge discount from their previous, pre-pandemic price.
“It’s staggering to see the discounts that are taking place,” Littell said. “It’s not just a lack of deals that's concerning. When you dig into the few deals that are trading, you can see that office values are eroding quickly.”
In Chicago, the last sales were on July 28, 2022.
Prime Group and Capri Interests bought the spaceship-like Thompson Center from the state of Illinois for $105 million, with Google agreeing to buy it after an initial phase of redevelopment by the buyers. On the same day, those Chicago firms paid about $118 million for neighboring offices at 111 W. Monroe St. and 115 S. LaSalle St. Title to the latter building was then passed to the state as part of the developers’ Thompson Center purchase price.
The lack of deals in Chicago since then has left brokers and investors with no current sale comparisons to guide pricing. Instead, they’re taking the unusual step of looking at deals in cities such as Minneapolis where there have been recent deals for fresh data points, real estate professionals said.
With most institutions hitting pause, many prospective buyers are backed by private capital such as high-net-worth individuals and family offices.
“It’s contrarian money, for sure,” said Cody Hundertmark, a Cushman & Wakefield office sales broker in Chicago. “It’s people looking at what they view as generational buying opportunities.”
Financing Strategies
R2 is one example of a firm taking multiple approaches amid the chaos.
The firm is working with Athene on a turnaround of the historic Chicago Board of Trade Building. The Apollo Global Management fund was the 44-story building’s lender until December, when previous owners Glenstar Properties and Oaktree Capital Management walked away from their investment.
Other high-profile buildings, including the 44-story Civic Opera Building, the 22-story building at 175 W. Jackson Blvd. and the 41-story tower at 150 N. Michigan Ave. overlooking Millennium Park, have been handed back to lenders, sent into foreclosure or are otherwise in distress.
R2 in June struck a preliminary deal to buy 150 N. Michigan for about $70 million, far below the nearly $121 million that owner CBRE Investment Management paid in 2017 before pouring in another $35 million on upgrades.
If R2’s deal is finalized, the price will fall short of the value of the $86.5 million loan that a fund managed by MetLife Investment Management made when the tower was purchased in 2017.
As part of a fast-growing trend, MetLife is expected to provide a new loan to R2. Seller financing at attractive loan terms is a way for sellers and lenders to secure buyers who otherwise might struggle to finance a deal. Doing so allows a lender to achieve a higher sale price and reduce their losses on the previous loan.
“The cost of debt today for an office building is expensive," said office sales broker Jaime Fink, co-head of JLL's Chicago capital markets office. "An owner or existing lender can choose not to provide financing, but that means someone else will do it at a much higher price. The higher cost of capital is going to affect pricing.
“I think there will be more office transactions. The market has embraced seller financing or existing lender financing, which will facilitate more transactions.”
Garrison declined to comment on the pending 150 N. Michigan deal. But he said R2 continues to look for potential deals in markets such as Chicago where it already invests, as well as in high-priced coastal cities where it previously believed prices were out of reach, such as San Francisco.
“We’re looking everywhere because I think it’s approaching a point of maximum opportunity,” Garrison said. “You have to be careful of the value trap, where it looks cheap but at the end of the day, it isn’t.”
‘Painful Nothingness’
The U.S. market is still in a so-called price discovery phase, with investors trying to determine how much higher the already record-high vacancy rate can go, which is driving rent declines, Littell said. Often, a wide gap remains between buyer and seller expectations.
"There’s capital ready to buy, they just don’t want to pay these prices,” Littell said. “When prices adjust low enough, which could be in 2024 or 2025, capital will flow in and deal volume will re-accelerate. We’re still in that period of painful nothingness where today's office owners want to avoid selling at all costs."
In the meantime, Chicago brokers continue shepherding complicated, ongoing deals toward a drought-ending sale.
“It does feel like things are starting to loosen,” Hundertmark said. “Anytime you need to re-calibrate so significantly in a short period of time, it’s going to lead to a pause. Everything has changed in the past year-plus.
“But I’m a firm believer that transactions breed other transactions. We and our competitors are cheering for each other to get deals across the goal line.”