Retail’s Knife Already Fell, Sam
A frequent guest of Squawk Box and other financial news shows, I often agree with Sam Zell’s financial and/or real estate takes. Yes, he has occasionally used some pretty crude, sexist and inappropriate language that leaves you shaking your head. The 80-year-old real estate mogul and philanthropist is nothing, if not cantankerous. For better and worse, he is a throwback to another era. But usually, I find myself agreeing on most his real estate takes. I try to keep track and usually he ends up being pretty dead on.
Except for last week. This past Tuesday, Mr. Zell was a guest on CNBC where he made a bold case in favor of office recovery over retail recovery. In his Squawk Box interview he stated, “Everything between the top mall and the corner grocery anchor mall… (there’s) a serious question as to its viability.” Also, “I think retail is much more of a falling knife than office, and I think that office is likely to recover much quicker than retail.”
There were things he said that I agree with.
He expects the office market to rebound once Covid becomes “less of a risk,” albeit with hybrid work becoming part of the norm. And that the speed of recovery will depend on thriving industries hiring more workers to come into the office. “Ultimately,” he said, “the amount of time people spend in their office is gonna be very much related to the demand for their time.”
But the “falling knife” statement really got me going. Hate to say this, but NEWSFLASH… the knife already fell for retail. Frankly, for some retail categories and some property types, it has been falling for two decades.
For commercial real estate, it was retail and hospitality that took the knife full force… we tracked over 75 major chain (100 unit plus) retail restaurant and health club bankruptcies in 2020—twice the previous record. I tracked 27,000 major chain closures (same categories) that same year.
But something strange happened. First, PPP loans and landlord workouts kept the substantial pain from being even worse. Second, consumer spending began to skyrocket (the uneven economic impact of the pandemic, federal aid, and the shift from service to goods spending all were factors). Third, bankruptcies and store closures cleared much of the deadwood away. Low interest rates and lenders willing to work with concepts, meant massive reworking of debt.
There are other factors I could spend hours discussing, but the gist of it is that retail’s ugly bandage was removed at once with immense pain. But the market now is in far stronger financial health. We are seeing the highest planned growth numbers this year that we have seen in nearly a decade. Likewise, we also see the lowest planned closure numbers currently than in seven years. Based on current credit ratings, 2022 is likely to see the lowest number of retail bankruptcies in seven years as well.
For the first time in a long-time, I would have to say that the greatest threat to the retail real estate market this year is not the structural impact of eCommerce, but your typical cyclical economic threats. I haven’t said that since 2008/2009 when the economic collapse was happening.
I’m not the only one seeing a remarkable turnaround. Check out this week’s top ten articles; plenty there to substantiate a strong rebound in the retail sector. In fact, my data suggests that, on the whole, both grocery-anchored and power centers market will be back to 2019 vacancy levels within the year.
But when I look at the office market, I see a market in the initial stages of exposure to what retail has been adapting to for the better part of two decades: digital disruption. There is no way that , on the whole, office vacancy is returning to 2019 levels this year.
The pandemic opened the Pandora’s Box of remote work for the entire office sector. Sure, roughly 10% of the office workforce already worked remotely or had hybrid schedules, but I think the biggest shock for many office-using CEOs in 2020 was at how little productivity was lost when we were forced to immediately move to remote work. Not to underestimate the difficulty of that near-overnight pivot, but workers overwhelmingly came through for their organizations.
By early 2021, consistent polling across dozens of organizations indicated that while one third of remote workers struggled with productivity issues, the other two thirds were more likely to struggle with disconnecting. In other words, work-from-home became work-all-the-time and was a factor driving burnout.
Nearly all of these polls showed the same thing; workers wanted more flexibility and control over their schedules. And they were more likely to place flexibility high on their list when seeking new jobs. Even before “The Great Resignation” began—roughly 40% of polled workers said they planned to change jobs in 2021.
Fast forward to now; unemployment is at 3.9%. We still have about three million fewer employed people than before the pandemic. But approximately that same number has dropped out of the workforce. We had about 10.7 million jobs available according to the last labor department report. The worker shortage is dire and not going away soon. Though the retail and restaurant sectors are now short a little over one million workers, the numbers are nearing two million for office-using employment.
Remote work and workplace flexibility has become a negotiable perk that is not going to go away any time soon. It has also started to emerge as a salary hedge, with many workers willing to take less pay in exchange for offsite and remote work, particularly across geographies. Meanwhile, with every new pandemic variant wave we have seen workplace returns disrupted or postponed.
Do not get me wrong. Work-from-home and hybrid work is never going to be a fit for some companies, individuals, and jobs. Some office jobs just cannot be done from home while others (those dependent on creative teams) may struggle to reach full potential. Some workers will never thrive working from home; this is for self-starters only. Plus, management of staff from afar is much more difficult and time consuming. Training of new personnel is hugely difficult; both for management and the employee. Meanwhile, it has its own set of issues for workers. Isolation, lack of camaraderie and missing out on work relationships hurts job satisfaction. Training and mentorship suffer as does the loss of unstructured idea sharing (IE water cooler talk). Remote workers may find greater challenges in climbing corporate ladders and higher risk of layoffs.
But it is a safe bet that if 10% of your office worked flex or offsite before CoVid, it will probably end up being 20% a few years down the road when the new normal fully emerges. The Cushman & Wakefield take last year was that this would result in a 10% to 15% reduction in office demand for existing users and that economic growth would eventually make up the short-fall. I completely agree with that take.
The challenge for Mr. Zell’s outlook is that the office right-sizing is still underway. That knife is still falling. Sorry Mr. Zell, retail is beating you to the rebound.