Windsor Park Mall in the San Antonio suburb of Windcrest, Texas, is a classic example of the upheaval, disruption and innovation retail real estate has experienced in the past 20 years.
Windsor Park opened in the 1970s as a typical American suburban mall. Although successful during the ‘80s and ‘90s, a string of exits by its anchors, starting with Montgomery Ward in 2001, eventually led to its closure in 2005. The rise of e-commerce created new challenges for brick-and-mortar retailers, ultimately killing off several chains — the lifeblood of the mall.
In 2007, San Antonio-based cloud-computing firm Rackspace, in a deal with the city of Windcrest, bought and renovated the 1.6-million-square-foot Windsor Park Mall as its headquarters.
For many former malls, that would’ve been the end of the story. But the Covid-19 pandemic, and its permanent alteration of how people view the office and work more generally, created a new twist. In 2022, Rackspace said it would vacate the building, move to a smaller location closer to where its employees live and sell the property.
That means the former retail center is on the cusp of undergoing yet another revolution, It’s a transformation that could serve as a litmus test for how office buildings that have fallen out of favor with tenants may be reimagined.
Adjusting to a new reality
As office owners and brokers navigate the turmoil facing the office sector — weaker leasing activity, tenants downsizing or exiting their spaces, value declines, and higher vacancy rates — some parallels are emerging between today’s office buildings and what happened with malls in recent decades.
For one, the success of both malls and office buildings is reliant on people using those spaces — and frequently. The demise of certain malls or office towers is directly correlated to a structural shift in demand. For malls, it was the ease and convenience of shopping online; for office, it’s the ease and convenience of working from home.
The flight-to-quality trend driving today’s office market is also true of retail. Enclosed malls that remain successful have been significantly invested in and have successfully lured the kind of experiential retailers that are needed to bring in foot traffic today. In the office market, trophy towers with the latest and greatest amenities, or ones that’ve been significantly renovated, are the ones drawing the most interest from tenants.
Chad Knibbe, a longtime retail broker and principal and co-owner of Foresite Commercial Real Estate in San Antonio, said the owners of the largest, emptiest office properties should be concerned. As people were predicting the death of retail in the late aughts as Amazon.com Inc. (Nasdaq: AMZN) gained market share, that largely applied to Class B malls heavily reliant on big-box anchors.
Despite those properties being a small portion of the market, he said the institutional ownership of those assets was what the public paid attention to most at the time.
“Those are big and that’s a huge percentage of the market if you look at square footage or dollar volume, but just in the number of properties, the institutional market is pretty small. So, although things looked really bad and dire for indoor malls, that wasn’t an overall reflection of the entire retail industry,” Knibbe said.
The stakes may be even higher with the aging, older office stock that’s fallen out of favor with tenants.
The value destruction of several office buildings in one concentrated area could have negative ripple effects for nearby hotels, retailers and other businesses, said Phil Mobley, national director of office analytics at CoStar Group Inc. (Nasdaq: CSGP).
San Francisco, which had an office vacancy rate of 31.6% at the end of the second quarter, according to CBRE Group Inc. (NYSE: CBRE), is a stark example. Because of less daytime traffic from office workers, not to mention crime and public-safety concerns, several retailers have decided to close stores in once-prominent retail submarkets. The owners of Westfield San Francisco Centre — the city’s biggest shopping center — stopped making debt payments this summer and said they were returning the property to its lender. A Whole Foods Market flagship store in San Francisco’s Mid-Market neighborhood, open for a little more than a year, closed permanently in April. Park Hotels & Resorts Inc. (NYSE: PK) also stopped making debt payments on the 1,921-room Hilton San Francisco Union Square and the 1,024-room Parc 55 San Francisco hotels this summer, citing sluggish business travel and weaker-than-expected convention business in the city.
“People want to do the same thing from a different place,” Mobley said. “In retail’s case … the rise of e-commerce is real, and certainly impacted the sector, but it turns out, we still want to go to stores to buy things. (We’ve) adapted the use of retail to accommodate that structural change but also accommodate people wanting to buy things in stores.
“It’s going to be really fascinating to see if and when that plays out in office,” he said.
Office conversions are not an easy undertaking
Conversions are frequently touted as a strategy to address the glut of office space coming to market as companies exit leases, downsize and trade older buildings for the newest towers.
It echoes a tactic employed for dilapidated malls in years past, many of which have found new life as mixed-use developments or have been entirely reimagined as last-mile distribution centers.
But it’s taken a long time for mall owners, not to mention government officials keenly interested in the future of an abandoned retail center in their jurisdiction, to figure out how to successfully revamp those properties. Those who closely track the commercial real estate industry think both the public and private sectors may need to be more proactive when it comes to reimagining office space.
And it’s a hefty economics problem to figure out, with $1.5 trillion in commercial mortgages coming due in the next three years, according to Trepp LLC. A repositioning, investment or sale of a poorly performing commercial property is typically triggered by a capital event, such as a loan maturing.
“The economics of the deal have to work,” said Brandon Svec, national director of retail analytics at CoStar. “There has to be a reuse case and a strategy/cost structure that works upon exit. In the mall world, that proved very, very challenging, but I think it’s probably even more challenging for (central business district) office.”
Many malls have been able to densify what are frequently large sites, providing multiple, unique ways to add cash flow to a property to help make a complicated deal work, Svec said. Former big-box department stores have been brought back to shell condition to become offices, medical space or other operations.
While sprawling suburban office parks may have a similar opportunity, central business district office towers are typically on small, tight parcels. It’s also tough to convert existing buildings into housing or other uses because of floorplate sizes, infrastructure requirements and other limitations.
But the land on which malls and office buildings sit is usually attractive to developers. Malls were built in locations with high traffic counts and close to lots of residential development, while center city offices were built on valuable downtown real estate, said Ermengarde Jabir, senior economist at Moody’s Analytics. In fact, some former malls have been demolished and rebuilt as industrial parks, as many are near interstates and other key transportation corridors.
Jabir said that when city officials are crafting incentives or other tools to try and spur office conversions or redevelopment, it’s important for all parties to be willing to consider multiple reuse cases.
She cited the former Landover Mall in Maryland as an example. The 1970s-era mall was demolished in 2007. The property now is a contender to land the FBI’s new headquarters. Local officials, however, are already planning for an alternative use of the site — data-center development — should the FBI pick a different location in Greater Washington, D.C., for its needs.
“What we’re seeing is, municipalities are actually much more amenable about being flexible about zoning, which is typically a big impediment to conversions,” Jabir said. “They’re trying to be much more flexible about zoning because they want to maintain their tax base, and they’re recognizing certain properties are no longer suited for being a mall, for example.”
In the past, developers have been hesitant to pursue conversions or major redevelopment projects, including former malls, because of cost, the complicated nature of those deals and a lack of regulatory guidance to help make those projects a success, said David Caputo, a data scientist at Moody’s.
Despite all the chatter around converting existing buildings for a new use, ultimately, for a lot of properties, demolition will be the only realistic outcome, Jabir said.
There’s generally more cooperation between various stakeholders — lenders, real estate owners and municipalities — today to try and solve for the number of office properties facing distress, in part because of lessons learned from the mall fallout story, said Dirk Aulabaugh, executive vice president and global head of the advisory services group at Green Street, a commercial real estate research and advisory firm.
“(Office is) a big, giant sector; there’s a lot of institutional ownership and there’s a lot of exposure in a lot of cities across country,” he said. “It behooves all of the stakeholders to get this figured out quicker.”
Still, the office market is widely perceived as a risky endeavor today, and price discovery — figuring out how much office buildings today are worth and sales actually transacting — has yet to happen for much of the market, Aulabaugh said. That was similarly the case for malls four or five years ago, when they were the most complicated valuation assignment across commercial real estate.
“In order to be able to buy an asset and execute a plan, you’ve got to know how to project your returns,” Aulabaugh said. “Nobody wants to sell their asset for land value, especially when it’s got a 250,000-square-foot building on it. The price-discovery question is really the biggest hurdle right now in this space, to getting to some of these answers. It’s paramount.”
Changing strategies for commercial real estate
For many office buildings and malls, a wholesale reimagining of a property won’t always be needed.
Knibbe said that while e-commerce was the major transformative factor for retail years ago, there were already signs of wear and tear in the sector. The ability to order anything at the press of a button — and have it show up to your door shortly afterward — was just the latest prompt that brick-and-mortar retail was due for a change.
“The majority of the market just shifted from traditional hard- and soft-goods retailers to service-based,” Knibbe said, citing as examples restaurants, hospitality, entertainment, personal service, nail salons and hair salons.
Retailers and retail landlords have subsequently had to figure out how to bring people to their shopping centers for a haircut, a drink, a bite to eat — or, as retail brokerage Weitzman’s Senior Vice President of Communications Ian Pierce said, even a trip to the dentist or doctor.
“One of the big changes that brought a lot of medical tenants to shopping centers was when Blockbuster went out of business,” he said. “DVDs were a commodity; you didn’t care whether you went to Blockbuster or Netflix.”
Blockbuster’s real estate ultimately proved to be the perfect size for a dentist’s office or urgent-care clinic, Piece said.
A similar shift is taking place in the office market. As businesses are learning about what their workers want in an office, Pierce thinks the key is to give employees a reason to want to come to their workplace more often. If they have that option, there needs to be a reason for workers to pick the office. Instead of, for example, mandating workers to come to an office five days a week, using amenities to incentivize them to come into the office has been a common tactic.
“To make it work, you’re going to have to do what retail did — I would think — which is offer options to where you feel like you have a choice,” Pierce said.
And even though change is inevitable, not all Class C office space is necessarily going to be demolished, Aulabaugh said.
Knibbe believes, like the retail turmoil of the past 20 years, a familiar adage will be the best way through for office: location, location, location.
“Our belief is that if you have a great property — even if it’s aged — that can be modified to have a competitive amenity set, then you’re probably going to be fine,” he said. “If it’s a 1980s midrise Class B office building with low ceilings, a limited ability to improve and you’re not next to an attractive amenity set, you’re probably going to struggle.”