Merchandise Mart makeover planned as competition stacks up

Now, with the public health crisis lingering and the rise of remote work pushing some big Mart tech tenants to try to shed space in the building, owner Vornado Realty Trust plans to plow tens of millions of dollars into renovations aimed at giving the building a new competitive edge.

The project—said to cost more than $60 million, according to real estate brokers familiar with the plan—comes just a few years after Vornado completed a $40 million upgrade to the building, illustrating how difficult the pandemic has made life for landlords. And against a backdrop of near-record-high office vacancy, the renovation will serve as a high-profile test of what it takes for downtown buildings to compete with Fulton Market and other emerging hotspots that have defied the pandemic with leasing wins.

Every downtown office landlord trying to spruce up a building for a post-COVID world “is doing the best they can in their own way,” says Glen Weiss, executive vice president at New York-based Vornado. “We just hope that our way is better than everybody else’s, so we can outcompete.”

At the heart of what Vornado touts as “theMart 2.0” is an overhaul of the first two floors, a high-traffic portion of the mammoth building. Brokers who represent tenants say the space needs more than the food hall and revamped main staircase done under the most recent renovation.

Most visible from the outside will be a new “front yard” with green space and landscaping along the Chicago River, according to a presentation from building leasing agency Stream Realty Partners that was obtained by Crain’s.

Inside, Vornado plans a 27,000-square-foot tenant amenity and conferencing space, a “speakeasy” lounge and a 23,500-square-foot fitness center—the building’s second gym—on the second floor. Transformations are coming to the building’s entrance at the corner of Kinzie and Wells streets as well as its main south lobby. Vornado declined to confirm the cost of the plan, but is aiming to begin work this year with the goal of completing the renovation 12 months to 18 months after work begins.

Weiss insists the building has not lost any luster, but that the investment is in response to companies seeking workspace that entices employees to show up in person. “It’s ‘I have to be in a building where my employees want to come to get off the couch and come back,’ ” Weiss says.

Vornado is reinvesting in the property, even though its average rent in 2020 was up 29% from five years earlier, according to the company’s annual reports. The building also last year renewed its lease with 1871 and recently snagged a new tenant in medical-supply company Medline Industries, which signed a 12-year lease for 51,000 square feet. Weiss says Vornado is close to landing another large tenant in the next couple months, adding to a roster that includes the Conagra Brands headquarters and the largest office globally for liquor giant Beam Suntory.

But headwinds are strengthening as new competition emerges and the rise of remote work softens demand. While the property was slightly more than 89% leased at the end of September—outperforming the 80% average for the downtown office market—that is the building’s lowest occupancy rate since at least 2007, its annual reports show. The Mart’s net operating income for the first nine months of 2021 was down year over year by almost 18%, to just under $43 million, Vornado’s latest quarterly financial filing shows.

Then, there are the departures and shrinking tenants: Auto insurance software provider CCC Intelligent Solutions just left its 125,000-square-foot Mart office after more than 25 years for a new office building in the Fulton Market District. That loss came after media conglomerate Publicis Groupe left a similarly sized office in the building in 2018. PayPal, Yelp and software company VelocityEHS each listed some or all of their offices in the building for sublease during the pandemic.

Meanwhile, a bustling mix of restaurants, hotels, and major tenants like Google and McDonald’s has allowed Fulton Market to surpass the Mart as the destination for companies seeking to proclaim their edginess to the world.

The setbacks are troubling for an owner that bet more heavily on the office market over the past 10 years. Offices today account for roughly 60% of rentable space at the Mart compared with 40% of showrooms. Those numbers were reversed a decade ago, according to Vornado.

The showroom business has been challenged, too: Herman Miller, Knoll, Teknion and Allsteel are among the furniture and design companies that have moved or plan to move from the Mart to Fulton Market. Vornado executives say the company has backfilled the losses with other users.

Howard Tullman, who has led multiple Mart tenants as the founder of both 1871 and CCC, says he’s encouraged by Vornado’s plan to make the building “much more navigable and more welcoming” as many companies rethink their workspace needs.

“Hopefully, the Mart will have the (attractions) to serve the people in the building and pull people back” into it, says Tullman, who has a private office on the building’s 15th floor.

The Old Post Office and Fulton Market aren’t the only competition. Other buildings with similarly oversized floor plates but newer amenities than the Mart also offer compelling alternatives to tech tenants. The developer that turned the upper floors of the Marshall Field building into modern offices recently beat out the Mart, among other buildings, for the headquarters of online ticket marketplace Vivid Seats.

“There was a time period where the Mart stood alone in many respects, and there was a mystique about the building,” says John Dempsey, who helped lead the Mart’s leasing team for nearly 25 years until 2013 and is now principal of Vanderbilt Office Properties. “Now that mystique has been captured by many others, so how do you go back and separate yourself from the crowd?”

That’s not just Vornado’s challenge. Owners of many vintage downtown office buildings, including a handful on LaSalle Street, are trying to lure new tenants in a COVID-battered market with features that are much more outmoded than the Mart’s. Those landlords will be rooting for the Mart’s renovation to generate a run of new leasing. If it doesn’t, it’s a bad sign for their prospects.

The Mart has inherent advantages to exploit, such as its namesake CTA station. Brokers say one of the biggest challenges may be overcoming its size. As more companies come to regard offices as places to collaborate, rather than hubs for legions of desk workers, the Mart’s vast floors may be less attractive to prospective tenants.

One way to win tenants is to offer better deals, something Vornado has been willing to do. Brokers say the company showered incentives on Medline, including free rent and cash to build out its new Mart offices. Such outsize concessions are the new table stakes for landlords anxious to fill space in the COVID-softened market.

Weiss acknowledges that it’s “more expensive to make leases right now” as the market recovers. “But we’re prepared for it,” he says. “We’re Vornado. We can make deals. We have the capital and we can meet the market.”