It’s nice that we no longer live in the reality of pandemic-related shutdowns and restrictions, but a glance at commercial real estate numbers tells you we’re still dealing with the ripple effects and may never return to the “old normal.”
As of the first quarter of 2023, the national office vacancy rate soared to 16.1%, with cities like San Francisco reckoning with a 24.8% vacancy. New York City also had a cavernous 76 million square feet of vacant office space as of April 2023.
Meanwhile, the overall value of real estate plummeted, with a staggering $77.5 billion nosedive, according to Colliers, a commercial real estate services company. That figure marks a 64% decrease year-over-year in August 2023. And here’s the kicker: global real estate giant Cushman & Wakefield projects things will get worse, with a jaw-dropping 1 billion square feet of vacant office space by 2030, a 1.5-fold leap from pre-pandemic levels.
However, amidst this somber landscape, retail emerges as a ray of hope, with vacancy rates below the previous year’s and pre-pandemic benchmarks. These spaces, especially those anchored by supermarkets, have become more than just shopping destinations; they’ve evolved into community cornerstones. While this real estate segment has its challenges, these spaces do more than just drive commerce. They weave the very fabric of society, offering tangible experiences in a predominantly digital world as invaluable assets for both consumers and investors.
The commercial real estate market stands at a pivotal juncture, influenced by a confluence of factors that have reshaped our daily routines, living spaces and consumer behaviors. On one hand, the industry faces a looming debt crisis, evolving work habits and the surge of e-commerce. Yet, these challenges also present opportunities for urban transformation and novel approaches to space utilization. As we examine these profound changes, it’s clear that our familiar urban environments are in flux, with the potential to redefine the future of our lives as we know it.
The Mounting Debt Situation
The commercial real estate sector has undergone a seismic shift in recent years, attributed mainly to escalating debt concerns. This shift is likely why Alan Rosinsky, a commercial real estate tenant broker in New York City and principal of Manhattan Metro Office Space, emphasizes, “From a tenant’s perspective, the financial strength of a potential landlord has become much more of an issue than it was five years ago.” At the heart of this anxiety is the staggering $270 billion in commercial real estate debt due this year, coupled with $1.5 trillion due by 2025, according to reports in Business Insider, a news website. Rising interest rates and declining property values amplify concerns about this debt getting repaid.
The landscape became even more uncertain after a series of banking collapses in 2023, which led to a rapid tightening of credit conditions, further intensified by the Federal Reserve’s aggressive interest rate hikes. Rosinsky was also sure to highlight the consequential impact of Signature Bank’s collapse, noting its longstanding role as a major real estate lender. This overall turbulence has pushed banking giants like JPMorgan, Goldman Sachs and Capital One to try and offload commercial real estate loans. However, securing buyers has been a challenge.
If this trend continues unchecked, it could set off a wave of defaults reminiscent of the subprime mortgage debacle that spiraled into the 2008 financial crisis. With warnings of declining downtown property values potentially impacting banks and bondholders and Bank of America’s cautionary note of an impending “toxic recession,” the gravity of this escalating debt crisis cannot be overstated. Columbia Property Trust’s recent default on $1.7 billion of mortgage loans, with Goldman Sachs, Citigroup and Deutsche Bank as its lenders, is a warning sign.
The Changing Patterns of Work, Life and Shopping
The past few years have unveiled a transformative shift in the world’s prominent cities. According to a report by McKinsey, the effects of the pandemic could have long-lasting implications on the dynamics of work, life and shopping.
Firstly, with the emergence of hybrid work models, many employees prefer suburban dwellings over urban centers. This shift affects urban vacancy rates, causing city centers and downtown areas to lose their appeal for employers and residents. However, Rosinsky offers a unique perspective. “Commercial real estate in New York City is at its most affordable level in a decade. Tenants have a broader selection, and landlords are extending enticing concessions.” This sentiment suggests that the current era could present opportunities for rejuvenating cities, emphasizing diversity and adaptability, and steering away from traditional monotony.
Simultaneously, shopping trends are increasingly favoring e-commerce. Data from an AlixPartners survey indicates that nearly half of the consumers have permanently altered their buying behaviors due to the pandemic. E-commerce sales could hit a staggering $6.3 trillion by the end of 2023, according to Forbes, a business magazine. Moreover, 80% of consumers now anticipate same-day deliveries, with 63% viewing delivery speed as a vital determinant in their purchasing choices. Despite these shifts, the retail sector remains surprisingly resilient. Omnichannel and unified commerce approaches are gaining prominence, with many consumers still valuing the tactile experience of in-person shopping, as seen in venues like grocery stores.
The Rise of Empty Spaces and Hybrid Places
Skylines across U.S. cities narrate a tale: vast stretches of vacant offices, remnants of the pandemic’s upheaval. Yet, a fresh urban concept emerges from this desolation — “hybrid places.” Highlighted by McKinsey, these mixed-use areas seamlessly combine work, residence and retail. Flourishing even before the pandemic, they withstood the pandemic’s turbulence better than their office-dominated peers, and they seem set to grow in popularity in the coming years.
This scenario underscores the pressing need for urban transformation. Take, for instance, the vision of New York City’s Mayor Eric Adams. He advocates a daring shift, aiming to rezone 42 blocks in Midtown South Manhattan, converting deserted offices into homes. While bureaucratic challenges loom, his ambitious vision, targeting housing for 40,000 New Yorkers, serves as an example for cities pondering similar adaptations. However, Rosinsky raises a pertinent question other cities will inevitably face: “Implementing this rezoning plan is pivotal for the future of the Midtown Manhattan Business District. But will these new residences predominantly be luxury condos, or will there be a focus on affordable housing?”
With its rapid technological advancements, the digital age has ushered in a new paradigm for shopping, making adaptability the watchword for brick-and-mortar stores. As the rhythm of consumer habits changes, certain pillars of the retail world, such as supermarket-anchored real estate, have demonstrated their staying power. This unfolding scenario presents not just challenges but also opportunities. It’s a testament to the resilience and innovation inherent in the retail sector and a reminder that some fundamentals remain constant even amidst change.
The brick-and-mortar retail landscape has dramatically evolved amid shifting consumer behaviors and increased digitization. While a Harvard Business Review article notes 60% of consumers are frequenting stores less than in pre-pandemic times, recent data by Usacast, a data provider, reflects a 15% year-on-year increase in Q2 2023 foot traffic. This resurgence, however, is not uniformly felt. By May 2023, shopping centers added 2.1 million square feet of occupied space, while malls saw a reduction of 0.15 million square feet. Moreover, restaurant foot traffic grew by 18% year-on-year in March, while grocery stores saw high visitor numbers.
Survival in this volatile environment has sparked a range of strategies among retailers. Some are doubling down on creating compelling in-store experiences to attract consumers, while others are building robust online platforms. Retailers and real estate owners alike realize the need for a recalibrated strategy that could include multi-purpose shopping centers, customized tenant mixes and new leasing models that adapt to emerging trends.
Investors Love Supermarket-Anchored Real Estate
Ron Dickerman, president and founder of Madison International Realty, calls investing in grocery-anchored retail the “most popular place” to invest in retail. A Forbes article titled “Why Grocery-Anchored Real Estate Has Become So Attractive To Investors” adds further substance to his claims, identifying three key attractions of this retail real estate sub-sector. First, grocery stores offer life’s essentials, from food to household items. This fact positions them as resilient anchors in the ever-changing retail landscape, shielding them from many disruptions. Second, the grocery experience is deeply human-centered, whether due to individual tastes, the perishability of items or the regularity of weekly shopping trips.
Lastly, their noteworthy performance during challenging times stands out. For instance, in the pandemic’s early days, many stores saw a surge of in-person visits from panic buying, underscoring their role as vital community anchors. Reports from JLL Income Property Trust, an investment company, and ACROSS Magazine further underscore the enduring resilience of grocery-anchored real estate, emphasizing its stability in rents and occupancy, even during market upheavals.
Since the onset of the pandemic, grocery-anchored retail has magnetized investors. The main driver? Its ability to attract foot traffic consistently day after day. As a testament to this trend, Westwood Financial boasts over 124 such developments nationally. Mark Bratt, Westwood’s chief executive, called it “a clear winner coming out of the pandemic, from the retail perspective.” The grocery sector thrives with an influx of new customers, heightened monthly expenditures, rising prices and the expansion of online delivery. Consequently, in the real estate domain, leading tenants prioritize multi-channel distribution, adept management and prime locations in thriving markets.
In 2021, a staggering 735 transactions underscored the significance of grocery-anchored retail properties. Moreover, the acquisition volume exceeding $13.3 billion led all retail property investments for the third consecutive year, according to a report by Jones Lang LaSalle, a global real estate services company. By 2022, despite a slight decrease in transactions, investments soared to another new record of $14.7 billion.
Contrary to early pandemic predictions that anticipated a decline in these retail centers due to e-commerce growth, persistent consumer habits highlight the importance of weekly supermarket visits. Moreover, with urban retail facing uncertainties, suburban grocery-anchored sites, particularly in the burgeoning Sun Belt regions, are set for remarkable growth.
The future of commercial and retail real estate resembles a puzzle, where each piece uncovers either a new challenge or a unique opportunity. As businesses grapple with debt concerns and the surge of online shopping, there’s a simultaneous wave of innovation reshaping our cities and shopping behaviors, paving the way for a reimagined landscape in the coming years.
Potential Challenges for the Retail Sector
The U.S. retail sector stands on the brink of numerous cascading challenges, with looming commercial real estate debt topping the list. Retail businesses and commercial landlords are under immense pressure, especially with Morgan Stanley projecting valuations of some office and retail properties will plummet by up to 40%. Amid soaring interest rates and constricted credit conditions, a pressing question arises: who will lend to them in such a climate?
Adding to the complexity, a mix of old hurdles and new factors like surging prices and waning consumer spending could herald a spike in retail bankruptcies, exemplified by brands such as Bed Bath & Beyond and Party City. The fallout is more than just numbers — more potential store closures, job cuts and ripple effects on local economies and supply chains come as consequences. Shadowing these age-old challenges is the colossal influence of e-commerce, pushing many traditional retailers to adapt to evolving consumer behaviors and reassess their business models.
Opportunities Amidst the Crisis
In the wake of 2023’s commercial real estate headwinds, leading virtual real estate expert Marco Kozlowski draws parallels with the 2007-2009 crash and suggests that those with a keen market understanding stand to profit substantially from emerging opportunities.
One rising trend is the transformation of vacant retail spaces into retail incubators, offering budding entrepreneurs affordable spots coupled with financial and technical aid. This era also witnesses a surge in retail creativity, with brands leveraging immersive omnichannel experiences driven by memorable brand interactions and gamification.
Further diversifying the landscape are mixed-use developments, reflecting post-pandemic preferences. These projects command a premium, with office tenants willing to pay nearly 25% more for mixed-use locations. Additionally, the adaptive reuse of malls, particularly vacant B and C-class properties, into fulfillment centers signals the flexibility of real estate.
Moreover, brands initially digital-only are now opting for brick-and-mortar presences, betting big on unique in-store experiences. This gamble calls for retailers to reinvent, offering enthralling online and offline experiences.
Lastly, supermarket-anchored real estate presents an enticing investment opportunity, given the consistent demand for daily essentials. Their resilience, combined with adaptability, makes them a formidable player. Adding appeal are the value-added opportunities, such as introducing new tenants to vacant anchor spaces, revitalizing small shop spaces or swapping outdated retailers with innovative concepts at competitive rents. The potential to develop pad sites or expand existing properties makes these centers particularly lucrative. Moreover, the grocery sector is primed for growth with an influx of new customers, rising monthly expenditures, escalating prices and the booming online/delivery segment solidifying its appeal.
Clearly, the aftermath of the Covid-19 pandemic has left the commercial real estate sector facing significant challenges. With city offices experiencing high vacancy rates, the bright spot in this scenario is retail real estate, particularly supermarket-anchored properties. These spaces have evolved from just shopping spots to vital community hubs, standing strong despite the rise of e-commerce and changing consumer habits.
While there are undeniable challenges, like increasing debt and changing work trends, they also pave the way for new opportunities. We are witnessing urban areas adapt and evolve, creating innovative solutions for empty spaces and reflecting changing needs. Adaptability and innovation will be key as the commercial landscape continues to change. Ultimately, the resilience and reinvention of this sector underscores the indomitable spirit of commerce, ready to face any storm and emerge stronger on the other side.