A SEA OF CHANGE has come to commercial real estate, particularly retail and office space, thanks to a combination of consumers’ shifting shopping habits and the pandemic.
Online shopping has been on the rise for a couple of decades, gradually transforming the broader economy along the way. COVID-19 accelerated this shift, making an even greater impact on physical stores. While many Americans still prefer to shop in person, nearly two-thirds of all purchases begin with online shopping, regardless of if the purchase is actually made online.
Likewise, the monumental shift to working from home—and many companies’ realization that their employees are just as efficient there—has made office space less important for a variety of businesses. In Manhattan in 2020, for example, the number of renewed or new leases for commercial space was half of what it was in 2019. The shift has left many commercial properties without tenants.
With landlords unable to secure such tenants, whether for retail or office space, lenders must be more cautious about borrowers and the use of the property that secures the loan. Many borrowers have been required, as a closing condition, to establish reserve accounts to ensure that the loan will be repaid; in some cases, springing debt-service coverage covenants are built into the loan documents. As a courtesy to borrowers struggling to lease their units, some lenders have granted extensions of existing loans or modified them to permit interest-only payments.
In order to be successful in these uncertain times, a number of commercial-property owners have been forced to find new uses for their space so they can continue to collect rents and avoid vacancies. Many office buildings and big-box stores have been converted into storage units. With existing storage facilities seeing a 90% or greater rental rate, demand has increased for new and additional space in and around major cities as Baby Boomers downsize, small businesses seek to maintain supplies and Millennials use storage services as they accumulate possessions.
Additionally, many commercial properties are being used for supply-chain operations to help ease the crushing backlog of goods so prevalent recently—from storage warehouses to parking lots for the vehicles that deliver them, there’s a greater need than ever for local facilities like these.
Finally, offices and commercial properties are being converted into medical offices, outpatient medical facilities or laboratory space. Lenders therefore must be agreeable to extending more construction loans or credit lines to support borrowers adapting to these new uses.
One way to keep office space filled while maintaining its standard function is to offer it as shared or coworking space. This enables individuals or companies to use, often by reservation of communal space, an office or conference room by paying a monthly fee. For instance, a marketing firm whose employees regularly work from home can maintain a shared space to be used solely when the team needs to meet in person with a client or with one another. Coworking spaces are also increasingly common in residential areas for those who don’t want to work from home but who no longer need to commute from a suburb to a big city.
Not only must landlords adapt to properties’ changing uses, but retailers also need to find ways to boost their online presence while simultaneously attracting more customers to their brick-and-mortar stores. One method is for smaller retailers to join forces with larger ones for in-store collaborations: Sephora at Kohl’s, Ulta Beauty at Target, Toys “R” Us at Macy’s. These store-in-store models enable the smaller retailer to reach a larger and more diverse set of consumers, and help the larger one reach a younger demographic.
The pandemic has upended the very function of office space and given a boost to already ascendant online shopping. To adapt, retailers, commercial-property owners and those lending to both must be open to change in order to revitalize current spaces to fit the needs of today’s workers and consumers in a world transforming itself at great speed.
Lindsay Mesh Lotito is an attorney at Forchelli Deegan Terrana LLP in Uniondale, NY. She is a member of the firm’s Banking & Finance and Real Estate practice groups. She has been listed in Best Lawyers: Ones to Watch in America since the inaugural edition in 2021 in Banking and Finance Law.