Commercial real estate has become a very risky business thanks to problems in the banking sector. It is due to a combination of many issues, from COVID changing the requirements for how commercial space is used, to the banking crisis and higher interest rates putting pressure on financial costs.
At the same time, these disruptions demonstrate clearly that the entire sector is badly in need of new, innovative solutions. The old office and retail concepts don’t work anymore. Which is why now is actually a great time to build totally new innovations for the commercial real estate space, such as creating new era retail concepts and business models.
Shops must be re-invented
The Guardian reported last week that 40% of shops must be re-invented in the UK in the next five years. This could mean many kinds of new solutions for services, homes, hospitality, leisure, health and more innovative new concepts too.
It’s worth adding that this is not only a worry for retail owners. It’s also a big issue for cities and local authorities: how should cities keep their commercial streets lively and get people to come there? For example, one issue in many cities is that big department stores, traditional retail chains and local shops are disappearing. This is partly because people have become accustomed to shopping online, but also because, even in this post-COVID time, many people still haven’t returned to their offices in the city – they’re still working from home.
So in practice, it’s not enough to get some activities in these free spaces. Sooner or later cities also need activities to support the local economy and increase the amount of taxes paid. Public sector community activities and free spaces to spend time are not economically sustainable solutions.
Real estate finance crisis
As many larger retail owners are finding themselves in trouble, many experts warn that commercial real estate is the next area of crisis. Typically commercial real investors have leveraged their investments strongly (i.e. they use a lot of loans to finance their investments). Now their costs are increasing rapidly as interest rates go up, while at the same time, real estate prices are going down.
Traditionally, this combo of rising interest rates and dropping prices wouldn’t by itself trigger a real estate crisis. But if owners can’t pay their loan interest anymore and are forced to sell their property, that’s the starting point of a crisis. Experts are now saying we are very near that point – in fact, there have already been cases where real estate investors have admitted they cannot make their loan payments.
One metric to indicate the situation is the loan to value (LTV) ratio. The current LTV ratio is still much lower than before the 2007-08 financial crisis – but it has started to grow, only this time the worry is more focused on commercial real estate, not home mortgages. Banks and other lenders need to follow the LTV ratio for their customers and recognize when it goes too high. It can also trigger a crisis when investors need to refinance their properties.
There are also a lot of differences between cities. Also, some very significant cities are suffering from the changed behavior of people. For example, the occupancy rate in office space in New York City is still below 50% after the pandemic increased remote working. And in London, many leading shopping streets have suffered significantly because of the collapse of traditional retailers.
New opportunities for real estate
We can conclude that the commercial retail estate business suffers from several external factors at the moment, including “long-COVID” and interest rates. But at the same time, it’s a fact that there are also longer-term trends that require the commercial retail business to find new concepts. We can also say this is opening a very interesting new opportunity for the real estate business – how to innovate new business models for city centers, high streets and malls?
Even before COVID, we saw new companies looking to innovate in the office space sector. WeWork showed up with big money to build new types of co-working solutions. The owner of the more traditional office hotel business, Regus, also launched a new concept: Spaces. But those were aimed mainly at free-lancers and startups. Most probably we will see more innovations in this sector to serve companies looking for more flexible options for their employees, enabling them to come work in different offices according to needs, and in spaces closer to home.
Actually, the retail space could be the more interesting area. The traditional retail concept has always been to stay in the same place for years selling a typically quite fixed range of products – how does one innovate in such a model? This is not only a challenge for the real estate owners – the stores themselves need new solutions. It has been very hard for many traditional retailers to be competitive in the online business.
Besides, it’s very hard (sometimes impossible) to build high-end brands only online. You can sell some high-end brands online if it’s an established brand, but even then it is important that people can see those products physically too. This is even harder for smaller brands and new brands that want to build their reputation.
Innovations for retail stores
One solution is a showroom-type space or store that is designed and dedicated to building brands, user experience and visibility. Showrooms can work quite well in places like, for example, airports where there is a constant flow of people (and often relevant people). But it can be much harder to create showrooms for malls, city centers and high streets that are losing shops and visitors.
We’ve already seen some examples of new innovative companies in this space too. One of them is London-based Lone Design Club (LDC) which has already operated also outside the UK in some European and Asian cities. Its core is a strong data-oriented platform and the capability to target its pop-up stores for different brands and audiences.
This also means they can offer tools for real estate owners to attract the right type of visitors to their mall or area. It also offers tools to offer products online and combine physical store data with online data.
The future of the retail business
All of this basically gives many ideas of how the retail business will look like in the future. For example:
Many brands need a physical and online presence – there must be a smart way to combine different channels so they can support each other.
New types of data and metrics are needed when the store’s sales and online visits are not enough – but they must be combined. Businesses also need tools to drive visitors to the right channels and locations.
The objective is not just to attract visitors to a mall or a shopping street – it’s important to have better tools find a targeted audience. For example, how do you attract Gen Z fashion people, older wealthy people, or middle-class families to the right places so that they can support other businesses nearby too?
The focus will be not only on selling products in a store, but also how to create unique customer experiences in the retail spaces and online in order to build a new type of customer engagement and brand image.
Crises are often an opportunity – in the case of the commercial real estate sector, it’s an opportunity to create totally new concepts for using office and retail space. Whatever form they take, these concepts need to be more flexible than the old way of using real estate space. They must support hybrid models and be based on data-oriented platforms. The property market has been quite old-fashioned and slow-moving, but now is a time when we could really see successful new innovations in this space.
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