The broad shift to working from home during the pandemic may haunt the commercial real estate market for years to come, making it harder to fill vacant office buildings that were once brimming with tenants.
Wharton real estate professor Joseph Gyourko said it’s too early to predict exactly how the demand for office space will decline because commercial leases generally last five to seven years. But it’s clear that when those leases finally expire, the market will not be the same.
“I strongly suspect what will result is a move to concentration, a flight to quality,” he said during an interview with Wharton Business Daily on SiriusXM. (Listen to the podcast above.) “Over the next few years, as tenants start to rethink space needs and their leases rollover, they’ll go into better buildings, and the [worse] buildings will be in trouble.”
Office vacancy rates increased significantly during the COVID-19 pandemic, reaching a high of 17.2% in the third quarter of 2021. While many companies are calling workers back into the office this year, full occupancy is unlikely. Workers have proven they can function remotely, and they are demanding their employers keep the option of remote or hybrid work.
“There will be huge variation, but I think people and families want the flexibility of at least a day [at home], and I think bosses are going to have to give it whether they like it or not,” Gyourko said. “I don’t think we’ll go back to pre-COVID. I just don’t.”
“As tenants start to rethink space needs and their leases rollover, they’ll go into better buildings, and the [worse] buildings will be in trouble.”–Joseph Gyourko Companies offering flexible work will need different office space configurations, so the best buildings will win. Older buildings with poor ventilation systems and a lack of amenities will struggle to recruit and retain tenants.
The professor said policymakers need to start planning now for a post-COVID future in their cities. Older buildings that go dark will become expensive eyesores. A reduction in workers flooding into office districts each day will squeeze city wage tax revenues, mass transit ridership, and the local economy. Restaurants, boutiques, and businesses within walking distance of an office will lose the daily foot traffic that keeps them in the black.
“Cities are going to have to think about what are they going to do with the empty office buildings, and what they do when the real estate, the retail, the restaurants, the Starbucks around those buildings aren’t needed anymore,” Gyourko said. “They should start thinking of this as their responsibility to rehabilitate those areas now, and not later.”
A Different Kind of Downtown
The changing makeup of office space will vary by location, Gyourko said. Big cities like Philadelphia, San Francisco, and New York should be able to withstand the shock because they can absorb the flight to better buildings. Again, those landlords will need to reimagine the spaces they offer.
“It’s going to be a complex dance,” he said. “It will keep the building owners and managers busy and out of trouble for a while, trying to figure this out.”
“I don’t think we’ll go back to pre-COVID. I just don’t.”–Joseph Gyourko
On the positive side, cities that have strong job growth may become more affordable as rents fall. It’s possible that building owners will convert the glut of office space into apartments and condos, providing more housing in places without enough and perhaps drawing families and others who change the demographics of the city. The transition will be expensive, Gyourko said, but those cities should be fine in the long run.
He’s more concerned about smaller and mid-sized cities that are already in decline. That decline will be accelerated by the loss of revenue from unoccupied office buildings.
“Think about the Rust Belt, where I happened to grow up in southwestern Ohio, upstate New York, and the like,” he said. “It may not be viable to convert anything from office to residential. This could lead to a real downward spiral in weaker office markets that don’t have much natural growth to them.”
The downturn in office occupancy has corresponded with a slump in commercial construction. With low demand, nothing new is being built. Gyourko doesn’t expect that sector to rebound soon.
“That’s not going to change, not for the next three to five years until we figure out what the new demand is.”
Clothing stores are disappearing across America by the tens of thousands, yet even the so-called retail apocalypse isn’t enough to scare away Amazon from the apparel business.
The company announced it will open its first clothing store, called Amazon Style, later this year at a shopping center in suburban Los Angeles. The 30,000-square-foot space will offer men’s and women’s clothing from well-known and emerging brands at prices up to $400. While that sounds like a typical department store, what’s different is the use of technology. Amazon Style customers will use an app to facilitate most of their shopping.
Santiago Gallino, a Wharton professor of operations, information and decisions, said a physical store is an important next step for Amazon, but there’s no guarantee that the company will succeed where so many other retailers have failed, especially lately. More than 80,000 stores are predicted to close by 2026, devastated by financial woes, declining sales, high rents, and pandemic-related problems.
“It’s going to be an interesting challenge for them because the fashion business is one that requires excellent execution,” he said during an interview with Wharton Business Daily on SiriusXM. (Listen to the podcast above.) “We have yet to see if Amazon can do something as great as they’ve done in the online space.”
Fashion is fickle, and so are consumers. Clothing stores need to carry desirable styles in a range of sizes, or they risk customers going elsewhere to find what they want. Availability is a critical component of success for clothing stores, Gallino explained, but so is the shopping experience. In-store customers are looking for great service, personalized attention, and perks they cannot get from shopping on a tablet while lounging on the couch.
“It’s going to be a challenge for them because the fashion business is one that requires excellent execution.”–Santiago Gallino
Amazon certainly has experience with brick-and-mortar stores. The company has opened Amazon Go, Amazon 4-Star and operates Whole Foods. But Gallino said that as a customer in those stores, he’s been “a bit underwhelmed.”
“There’s nothing wrong with those locations, but there’s nothing game-changing that will make me think of Amazon as my first stop when I go to a physical store, like it probably is when I think of my online transactions,” he said. “I’m still wondering how much of a disruption they can create in the physical world, and for me that’s yet to be seen.”
Amazon said in a release that it plans to provide a tech-driven shopping experience in the California store. An app will enable shoppers to request items be sent to a fitting room or directly to the pickup counter, find different sizes and colors, and explore similar items.
“Amazon Style is built around personalization,” the company said. “Our machine learning algorithms produce tailored, real-time recommendations for each customer as they shop.”
The Omnichannel Experience
The professor pointed out that many retailers have realized the value in an omnichannel strategy that seamlessly integrates online and offline shopping. Even digital-native companies like Warby Parker have opened physical stores to expand their reach. Gallino said savvy brands know that it becomes more difficult over time to attract new online customers, so building a brick-and-mortar store is an opportunity to lure shoppers with the promise of an experience.
“I think Warby Parker understood that very well,” Gallino said. “If you are thinking of your company as an omnichannel company, it makes sense to think of the offerings in the same terms. You’re going to be taking care of your customer regardless of whether that customer is approaching you online or in a physical store.”
Amazon Style is also a way for the company to compete in the clothing segment against Target and Walmart, which both sell a significant amount of apparel through hundreds of stores nationwide. That’s a high bar for Amazon to hurdle, Gallino said. But with online retail accounting for only about 13% of all retail sales, it’s smart for Amazon to try.
“I think it’s a move that makes sense, but it’s not an easy one,” he said.
New York (CNN Business)Melinda French Gates may be shifting her approach to how she gives away her vast wealth following her high-profile divorce last year from Microsoft(MSFT) founder Bill Gates.
French Gates is said to have decided not to give the bulk of her estimated $11.4 billion fortune to the Bill & Melinda Gates Foundation, according to a report from the Wall Street Journal, citing unnamed sources familiar with the matter. Instead, French Gates is expected to donate to other charitable endeavors, according to the report, though she may also continue to give money to the Gates Foundation.
The decision is said to have been made official late last year, according to the report, around the time Gates French published her first solo letter for the Giving Pledge, an effort that encourages the world's richest people to give away the majority of their wealth.
"Along the way, I cofounded the Giving Pledge in 2010 and committed to giving away the majority of my resources in my lifetime. Today, I'm reaffirming that commitment," French Gates wrote in the letter. "In the last two decades, I've seen that, at its best, philanthropy plays a unique role in driving progress by taking investment risks that others can't or won't to explore new ways of solving old problems."
The Gates Foundation declined to comment beyond French Gates' remarks in the letter. Pivotal Ventures, an investment firm founded by French Gates, did not respond to a request for comment.
French Gates started Pivotal Ventures in 2015 with a focus on female and family issues in the United States. In 2019, she pledged $1 billion over 10 years through Pivotal to promote gender equality.
Following their divorce, Gates and French Gates announced a two-year trial period during which they would co-manage their foundation. CEO and board member Mark Suzman said this contingency plan was in place "to ensure the continuity of the foundation's work." If after this trial period the duo choose to part ways, Gates will remain head and essentially buy French Gates out of the foundation.
The Gates Foundation is one of the world's largest, with an endowment of more than $50 billion. It has spent the last two decades focused on initiatives including gender equality, global health, poverty alleviation and the global rollout of the Covid-19 vaccine.
Gates and French Gates committed an additional $15 billion to the foundation in July.