There was a time when talk of the “retail apocalypse” was so prevalent that one could assume that every shopping mall in the country was about to close and our only choice for purchasing items would be to order on Amazon. Clearly, that buzz was exaggerated. Many malls closed, but others continue to flourish today. Amazon is ubiquitous, but other retailers are on the rise as well. Yet, it is also true that much disruption occurred between the events that inspired the “apocalypse” rumble and retail real estate standing where it is today. It is helpful to understand the state of American office properties by remembering how these events occurred. The shift to e-commerce was the seismic force that threw the retail sector out of balance. And it didn’t help that the companies built more stores than they actually needed. For office buildings, the pandemic hit hard. The United States may let its COVID-19 national emergency order expire on Thursday, but workers’ hopes won’t easily go back to where they were in March 2020. and New York. The employees there have adopted hybrid and remote working arrangements. The best performing shopping malls as e-commerce has changed consumer behavior share several characteristics. Labeled Class A malls, these properties could fetch nearly $1,000 per square foot from their upscale retail tenants in 2020. By comparison, so-called Class C malls were being paid around $320 per square foot. Many Class A malls were new and built in areas with growing populations. Some had popular designs, such as open-air shopping centers, or mixed entertainment and dining options alongside retail stores. Industry experts are seeing a similar division in office space. Tenants want new buildings, with places where employees can congregate casually. They are also geared towards “green” buildings that have more sustainable features, and can help companies reach net-zero carbon emissions goals. As the value of “obnoxious” malls declined, some real estate developers began retrofitting these properties to attract new tenants. Some went further, repurposing the property for other uses such as a health clinic or warehouse. The same idea is being discussed for office buildings, but one size will not fit all. Developers know that rebuilding an office building will be costly and that a zoning change could stall the project. Peter Merrigan, CEO and managing director of global real estate private equity firm Taurus Investment Holdings, said he has seen many of these cycles in different sectors of the CRE industry. In some cases, the situation has to get much worse before it gets better. In the case of shopping malls, there were times when strip malls could be revamped by removing smaller tenants and redesigning the space to meet the needs of a larger retailer. But, Merrigan explained, there has to be demand for the space so that many different retailers can bid on it. If that kind of demand doesn’t happen, the asset will depreciate and go at land cost. “The old format just didn’t work, so you have to rebuild it,” he said. Merrigan said there could be a parallel to what’s happening in the office, or perhaps labor market conditions will change and companies will find enough benefits to bring employees back into the office. “I think if we go through a major labor market reform and this dynamic persists after that, then I would buy the fact that this work-from-home dynamic is permanent,” he said. For those concerned about the ripple effect that could happen if too many landlords move away from office buildings, there is another lesson to be learned from the bust between malls: It took years to play out. Are. In fact, it still is. In April, the two largest CRE loan losses in Arkansas and Guam consisted of shopping mall properties, according to real estate data tracker Trapp. Risk seeker is still on market alert. Risks can be difficult to quantify because CRE is a vast category and risks will vary widely depending on asset type and location. “While the US office segment faces clear challenges, conditions are very different in London, where there is a supply shortage for West End office space,” Usman Malik, an analyst at UBS, wrote in a recent research note. “Within markets, there is a flight to quality.” Malik cited CBRE data that shows for the US office, 80% occupancy loss between 2020 and 2022, was driven by only 10% buildings. Malik said there will certainly be more defaults in the future as landlords “return the keys” to some properties. And this scenario will play out even if landlords have reliable access to capital and continue to make new investments elsewhere. Credit is hard. Lack of access to capital can make the situation worse. The signs are clear that a tightening is taking place. signal from [commercial mortgage-backed securities] The market, which is, in our view, the most real-time barometer of investor sentiment, clearly points to a slowdown in commercial real estate lending, with tighter terms, punitive financing costs and less appetite for office properties,” Goldman Sachs said. Analyst Lotfi Karoui wrote in a research note on Monday. Karoui said bank data does not yet show a notable change, but he expects financing conditions to remain “challenging,” and that CRE transactions have been seen so far this year. will extend the decline in volume. Goldman research shows CRE transaction volume at the end of the first quarter was $62 billion, down 65% from the same period a year ago. The analyst also noted that the deals lenders are taking less leverage. He said the average loan-to-value ratio since the Silicon Valley Bank failure in early March is 51%, compared to the post-Covid average of 60%. Deals being done? No wonder there has been a sharp decline in the number of loans with office properties as collateral since March. According to Goldman and Trapp research, about 19% of newly issued loans were secured by office buildings, compared to a three-year average of 32%. VNO’O YTD Shares of Mount Vornado have declined more than 38% since the start of the year. Instead, there has been an increase in retail and industrial property loans, which have seen “strong fundamentals” in recent months, Karaoui said. Suffice it to say that after some adjustments the opportunity will come. In late April, Vornado Trust, one of New York’s largest owners of office and retail property, suspended its dividend. UBS analyst Solita Marcelli cautioned that it would not be the only REIT office to take this step. However, Marcelli said investors with a two-year time horizon can take advantage of the “attractive opportunities that are emerging” in industrial, residential rental, self-storage, data centers, wireless towers and grocery-anchored shopping centers. —Michael Bloom of CNBC contributed to this report.
