U.S. Offices and Malls Will Look Different After Covid-19

Commercial properties will be helped by a coronavirus vaccine, but long-term pressures may accelerate postpandemic

By guest authorTelis Demis from Wall Street Journal

Caption and graphic courtesy by Wall Street Journal

This is the fifth and final column in a five-part Heard on the Street series on how the American economy might look once the Covid-19 pandemic is over.

The office and the shopping mall are two of the things most visibly changed by Covid-19. They also have the most potential to bounce back once a vaccine is distributed, but they could look quite different.

Early indicators suggest that many people want to continue going about their lives more remotely. About a quarter of office workers in a recent survey by Jones Lang LaSalle said they would like to work outside the office full-time post-pandemic. Meanwhile, Walmart Chief Executive Doug McMillon said this month the retailer was convinced that most of the behavioral shift to online shopping “will persist beyond the pandemic.”

Still, it would be overly simplistic to assume landlords are necessarily imperiled. Commercial real estate is a business that can take time to evolve because of long-term leases. A typical retail term is about six years while offices are closer to 10 years, according to CoStar Group. In addition, rent collection has stabilized for offices, with owners collecting more than 96% of the usual rent as of July, according to industry body Nareit, which tracks figures for listed real-estate investment trusts. Even for free-standing retail—think big-box stores—rent collection was about 95% in September.

The outlier is shopping centers, where rent collection has rebounded since the 49 % nadir in May but was still only at about 82 % in September. The closure of more than 11,100 retail stores has been announced in the U.S. this year through November, according to CoStar. Some empty department stores could have second lives as e-commerce distribution centers, though that may be an option for only the very worst-off malls since it can affect the tax treatment of a property.

Before the coronavirus pandemic, many centres were trying to reorient around so-called “experiential” retail such as gyms and restaurants. Those businesses were hit hardest by the pandemic, so the focus might shift to grocery, where foot traffic has held up much better. Even if consumers are shopping and paying online, they may want to physically retrieve their purchases, so outdoor centres based around the traffic generated by grocery is in demand.

In the office category, there are already signs of future pressure on rents. About 1.7% of U.S. office space was available for sublease as of the third quarter, according to CoStar. That exceeds rates during the 2008 financial crisis, suggesting a trend driven not just by recession. Plus, office construction in the pipeline reached a cyclical peak in the third quarter, according to a Newmark Group national market report.

It is premature, however, to contemplate a sea of empty offices. Tech giants such as Facebook are leasing or buying new space even while envisioning more work being done remotely. Job losses in industries that use offices have been lower than other sectors, according to Newmark.

Even if more people work remotely post-pandemic, “de-densification” of the workplace could mean that people who are there will take up more space because of safety measures and efforts to make offices welcoming. This is a “countervailing trend to the remote-working headwind,” says Nancy Muscatello, managing consultant at CoStar Advisory Services.

Another shift might be shorter office leases. More flexible leases but with fewer perks for tenants could actually be a bit more profitable for property owners. But shorter average terms could push the cost of capital for office buildings higher and pressure valuations, notes KBW analyst Jade Rahmani, though that would be somewhat offset if interest rates remain low.

Offices and malls are not going to vanish, but they could be different for both owners and occupants.