When Sidley Austin began searching for a new Chicago headquarters, the global law firm discovered a surprising problem: There weren't many places left to go.
The firm wanted hundreds of thousands of square feet, direct access to public transit and the kind of amenities needed to attract more than 1,500 employees back to the office. After an extensive search, it concluded that the best option wasn't moving into an existing office tower but helping launch a new one.
"It can be challenging to find the kind of space we want and as much space as we need," Brian Fahrney, a Sidley partner and chairman, told CoStar News. "Chicago is one of our largest markets, and even after we did a thorough search, we found limited options. We could move to an existing building or stay where we are, but both would have meant a lot of work. So, we concluded that the solution for us was to build a new building."
Sidley's decision to anchor Related Midwest's planned 45-story tower in the fast-growing Fulton Market neighborhood — kicking off Chicago's first office skyscraper in more than six years — reflects a growing reality across major U.S. markets: While much of the office sector continues to grapple with elevated vacancy, demand for the newest and highest-quality buildings has become so intense that tenants are increasingly working to spur the stalled development pipeline.
Companies in New York, Miami, Dallas, Washington, D.C., and Chicago are competing for a limited supply of premier office space, driving rents to record levels and shifting leverage back toward landlords. In some cases, tenants are taking matters into their own hands by preleasing space in projects years before completion or directly pursuing new developments.
As far as Sidley's decision to commit to the proposed 1 million-square-foot development, "there are so many advantages to it," Fahrney said.
For Sidley, those advantages include helping to design the building before it breaks ground.
"We get to work with the crafting of the building and make it bespoke," Fahrney said. "We are now firmly back to work in an office, and we want our people to show up. Having a building that we've designed that will be specific for us means that we'll have the space that people feel good in and want to work from."
Office development still remains near historic lows nationwide. High interest rates, rising construction costs and cautious lenders have kept most developers on the sidelines for years.
Yet this growing push for new space is bolstering developer confidence while highlighting one of the clearest trends to emerge in the post-pandemic office market: a widening divide between trophy properties and everything else.
The office market's growing divide
There is a little more than 49 million square feet of office space moving through the U.S. development pipeline, according to CoStar data, a level near the lowest on record. Over the past year, only about 30 million square feet of new office space was completed nationally, less than half the long-term average.
Yet many landlords and brokers say those broad statistics obscure what is happening at the top of the market. In many cities, the supply of premier office space is shrinking as tenants flock to the newest and most amenitized buildings, leaving some occupiers with few viable options.
Companies including JPMorgan Chase, CoStar Group, Endeavor Real Estate and the law firm Cooley are either developing projects of their own or committing to large blocks of space before construction begins.
"It's a market where people are starting to talk about building new buildings," said BXP Executive Vice President Rodney Diehl. "That seems strange with some vacancy left, but the reason is because there is a limit on premier workplaces."
If a company these days is searching for 50,000 to 100,000 square feet of elite office space in many major cities, "you're not going to have many choices," Diehl said.
That scarcity is beginning to support new construction, particularly in select neighborhoods such as Manhattan's Hudson Yards, Miami's Brickell district, Washington's downtown core and Chicago's Fulton Market.
Tenants willing to pay almost any price
The resurgence of office construction is being driven by blue-chip tenants that increasingly view premium space as a strategic investment rather than a cost to minimize.
Some companies are developing projects for themselves. American Express recently began construction on its planned 2 million-square-foot tower at 2 World Trade Center in Manhattan. In Miami, investment firm Citadel is helping drive development of an approximately 1.7 million-square-foot office tower; and Spain's Santander Bank is building and will occupy a large block of space in a 1.6 million-square-foot tower.
Others are serving as catalysts for new projects through massive prelease commitments, including Deloitte's deal at 70 Hudson Yards in New York and law firm Simpson Thacher's agreement to anchor Extell Development's tower at 570 Fifth Ave.
Those commitments are helping support rental rates that would have been difficult to imagine only a few years ago.
In Chicago, Sidley is expected to pay more than $115 per square foot for space in the planned Fulton Market tower, according to people familiar with the transaction. Previous top-of-market rents were generally in the $70-per-square-foot range.
"I haven't seen a market that's been this divergent, where you've got rents over $110 at the top and $40 to $50 at the bottom," said longtime Chicago office tenant broker Bob Chodos of real estate services firm Newmark.
That divergence may be the defining characteristic of today's office market.
While many older buildings continue to struggle with vacancy, the best-located and most amenitized towers are increasingly attracting tenants willing to pay record-setting rents, industry executives said.
"Now, the number-one thing is location and access," said Mike Watts, president of office investor leasing in the Americas for real estate services firm CBRE. "They're not willing to compromise on that."
The top end goes even higher in New York, where landlord Vornado Realty Trust expects rents of roughly $350 per square foot at a tower it is developing with equity partners Rudin and Citadel, where a 1 million-square-foot lease commitment helped spur the project.
"Big tenants that are growing are deciding that they want what they want, and it's almost at any cost," said Trey Morsbach, debt platform leader for real estate services firm JLL.
As demand intensifies and new supply remains constrained, more projects are beginning to pencil out.
"You have no supply and accelerating demand, so now you can make the math work," Morsbach said. "It's Developer 101. Rents have just gotten to where they can justify the cost of new construction."
The largest anchor deals demonstrate that tenants in sectors such as law, private equity and financial services are viewing high-end space as a necessary expense, industry professionals say.
That includes Sidley’s marketing-changing deal, said office tenant broker Robert Sevim, the leader of Savills’ Chicago office.
“Yes, the rents will be at the highest end of the office market in downtown Chicago,” Sevim said. “The question is, what are we comparing that to? Is it other buildings in Chicago? Or is it more applicable to think about that rent as it relates to what Sidley pays in other markets? It’s all relative. It’s the price of new construction.”
Why so few projects will move forward
Despite the renewed interest, industry professionals do not expect a construction boom.
Financing remains difficult, lenders remain selective and many projects still require major preleasing commitments before construction can begin.
"Assume that every box needs to be checked: high-quality sponsorship, location, quality preleasing and ultimately a set of economics that meet return thresholds," Morsbach said. "If you don't have all of them, it's very difficult to get something capitalized."
The financing environment remains far less predictable than before the pandemic, according to Jeff Altenau, vice chair on Cushman & Wakefield's debt placement team.
"In years past, there were levels that were a rule of thumb, depending on the building, location and sponsor," Altenau said. "Today, it's certainly more opaque. There are only a few large towers being developed."
He said projects are likely to need at least half of a tower preleased, and likely more, before construction can begin. Without one massive tenant in hand, preleasing takes on added challenges.
“You either need one large tenant or you need to club tenants together, which is a nightmare,” said Adam Showalter, Stream Realty Partners' managing director of national office investor services. “The way I think of it is, is it easier to go to dinner with your wife or to plan a dinner with six other couples? You know the answer to that.”
Not every market is positioned to support a wave of new construction, either.
"The fundamentals just don't justify new construction" in markets such as Chicago, Atlanta and Houston, Showalter said. "In Chicago, the fundamentals don't justify that development. The tenant justified that development."
Even developers that secure financing may need to contribute a larger share of equity than they would have before the pandemic.
"It also comes into play, what is the advance rate, or the loan to cost?" Altenau said. "The advance rate will be lower than in years past."
Morsbach estimates only a fraction of proposed developments will ultimately move forward. Still, he expects competition for premier office space to remain intense.
"It will continue to be a supply-constrained market in the coming years for top-tier space," he said.