In Coming Wave of Pandemic-Induced Vacancies, Some See Alternative

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In Coming Wave of Pandemic-Induced Vacancies, Some See Opportunity

The pandemic is expected to drastically transform commercial real estate, leaving thousands of vacant and unused space across the country. However, some developers and investors would like to take the chance to use these properties for other purposes.

For example, Lord & Taylor's flagship Manhattan department store is about to house office workers for Amazon, and a tourist destination in the heart of Hollywood is getting a $ 100 million facelift that includes converting unused retail space into offices.

"Nobody ever lets a crisis hinder opportunity creation," said Sheila Botting of Avison Young, a commercial real estate services company in Toronto, where she is president of the Professional Services Practice for America.

In the past, conversion waves were often localized. For example, after the terrorist attacks of September 11, 2001, according to the Alliance for Downtown New York, more than 13.8 million square feet in Lower Manhattan were converted. But those shifts were nothing of the magnitude expected in the next 18 to 24 months, experts say.

In retail alone, according to CoStar Advisory Services, at least 7,700 stores with a total area of ​​115 million square feet will close this year in early August. Most of these closings will be in malls that were struggling long before the pandemic, department stores like J.C. Bankrupt Penney and Neiman Marcus.

At the same time, 172.7 million square meters of class A office space, usually of the highest quality, is expected to go online this year and next. According to the CoStar data, only 59 percent of it was rented, which is below the average of 74 percent. And nearly one in four hotels across the country faces possible foreclosure as owners fall behind on loans for at least a month, according to the American Hotels & Lodging Association.

Simply put, there will be a lot more space out there.

"If the demand for Cheerios suddenly fell, General Mills would just pull the Cheerios," said Victor Calanog, director of commercial real estate economics at Moody & # 39; s Analytics. "Then there will be less and prices don't have to fall as much. But once you've built an office building, you can't exactly take it off the market."

Some of the causes of the national oversupply of commercial property can be traced back to the pandemic. For example, the switch to e-commerce has brought many stores to the grave in recent years – more than 10,200 stores were closed in 2019, according to CoStar.

Companies that use offices have taken up less space due to increasing digitization and other efficiency gains as well as demographic change – younger generations generally feel comfortable with less office space. The rule of thumb for the commercial real estate industry in the 1980s, according to Moody & # 39; s Analytics, was 200 to 300 square feet per employee. By 2019 the average had fallen to 126.5.

And industries as diverse as real estate, media, technology, and banking have flirted with more teleworking for decades. In addition, a considerable part of the rented space remains largely unused during the working day – estimates are between 30 and 40 percent – because the employees are not in the office for various reasons.

However, the crisis has given some developers an opportunity to rethink their strategy.

"I think this is a moment for the real estate industry to reflect on current wealth, how it will be used and what future options there might be," said Ms. Botting.

The worst example of this approach yet could be Amazon's possible plans to expand J.C. To convert Penney and Sears into distribution warehouses at mall operator Simon Property Group's malls, as reported by the Wall Street Journal. The e-commerce giant is also behind the overhaul of the closed Lord & Taylor store on Fifth Avenue, transforming 676,000 square feet of office space for approximately 2,000 employees by 2023.

Amazon declined to comment on this article.

Last month, DJM Capital Partners, a real estate services company, and private equity firm Gaw Capital Partners announced plans to overhaul Hollywood & Highland, a Hollywood entertainment complex on the same block as the Dolby Theater that hosts the Academy Awards . These plans are to convert existing retail stores into nearly 100,000 square feet of creative office space.

When the companies bought the complex last year, they had little opinion of the future of traditional brick and mortar retail, said Stenn Parton, DJM's chief retail officer. Then the coronavirus shut down thousands of companies across the country.

"I think, if anything, this has cemented our business plan as we saw the record store shut down as a result of the pandemic," he said.

Most conversions won't be that great. Instead, they are smaller and less advertised properties. Nevertheless, a large number of conversion projects are expected.

For example, developers see an opportunity in converting hotels into retirement communities, said David Reis, executive director of Senior Care Development in Harrison, NY. It is cheaper to remodel a property than building it from scratch, he said, especially in expensive markets like New York.

"If you can buy space for the equivalent of 50 cents a dollar less than you can buy a new building, you will definitely be fine with a renovation," said Reis.

According to a report from project management firm Cumming, the average new home build is generally $ 225 to $ 350 per square foot, compared to $ 150 to $ 200 for office-to-home conversion. For industrial construction, the average new project costs $ 125-250 per square foot, but for a move from retail to industrial it can drop to $ 75-175.

Despite the potential for lower costs and the emerging universe of options, commercial real estate conversions present challenges. Zoning and engineering design can hinder some conversions.

And it can be more difficult to raise funding for remodeling during the pandemic if lenders are more risk averse.

"Core and stabilized assets offer funding opportunities," said Eric Rosenthal, co-founder of Machine Investment Group, a real estate investment firm. "Transition stories, or when there is an element of execution that goes beyond buying and managing the property, the environment for funding these assets is very challenging."

Traditionally, the best conversions have been increasingly out of date properties.

"When they're older and past their useful life – reduced occupancy, reduced cash flow – they are usually ripe for transformation," said Ms. Botting of Avison Young.

But even newer properties are on the table. Neiman Marcus opened an 18,000 square meter flagship store in Manhattan's Hudson Yards as an anchor tenant in the country's largest private real estate development just last year. Now the affiliates are swinging the owners of Hudson Yards. Philippe Visser, president of Related Office Development, said via email that the business was going to be "the most exciting office opportunity in New York City."

The move goes back to previous crises that forced a metamorphosis in commercial real estate.

In the 1990s, Lower Manhattan was plagued by high levels of office space and population losses, and William C. Rudin, president of New York landlord Rudin Management, helped rejuvenate the area. From 1995 to 2001, more than 4.6 million square feet were remodeled – including glassy office buildings that no one thought were decent apartments.

"When it gets bad enough," said Rudin, "it forces people to come together and come up with ideas."

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