Office real estate rebound is ‘more of a stair-step recovery,’ CEO explains

JLL Americas Markets CEO John Gates sits down with Yahoo Finance Live to talk about the outlook on office and retail real estate, the future of U.S. shopping malls, tech companies' role in office real estate, and how inflation and interest rates impact return to offices.

Video Transcript

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- Welcome back to Yahoo Finance Live on this Friday. Employees across the country, much like us, returning to work this spring, returning to the office. But is the commercial real estate market returning to pre-pandemic levels? Let's talk about that with John Gates, CEO of JLL Americas Markets. John, good to see you. Broadly speaking, from the numbers you've looked at, how well has the commercial real estate market bounced back from the pandemic?

JOHN GATES: In the office product-- thanks for having me, by the way. It's great to see you. The office product not fully, but it is methodically getting there. We've seen an uptick in occupancy for five consecutive quarters now. So it's more of a stair step recovery that's, say, 80-85% back and growing monthly.

- And let's separate those and talk about the retail as well. I know there was a big story about Westfield Mall's shutting down or selling all of its properties by next year. What is the retail market look like?

JOHN GATES: Retail is mixed. So suburban retail open air has made a dramatic recovery and did so quickly. We had a flight to the suburbs, as we all know, so more people just living in that environment. So suddenly that was under retail. You-- malls in the US fall into sort of three broad categories. There's too many of them. So some perform well, some need to be repositioned, and candidly, some probably don't need to be malls any longer. So it's maybe a tale of two different types of retail product.

- Indeed. So let's get back now to the office portion of this. You had some numbers that showed badge scans show a nearly 40% average occupancy. How fast is that number rising, and what do you expect is a new pandemic ceiling? How far will we get back to work?

JOHN GATES: Great question. Again, it's methodical. It's happening faster in certain geographies. So the Sunbelt cities across the South generally have higher occupancies. Austin, I think, is the highest, Houston, Dallas. But if you move across the Carolinas into Florida, it's rising. Will it be as high as it was? Probably not on a daily basis. Anecdotally, rush hour traffic is up.

On the first business day of April, of Q2, we saw an increase in rush hour traffic in many, many markets except on Fridays. So it probably depends on the day and the geography, but yes, it is coming back. And we, in talking to our clients, widespread reports of it's working and people are excited to see each other again.

- And you talk about those Sunbelt markets. Are you seeing a corresponding increase in rates and prices?

JOHN GATES: Yes. They're in migration markets, as you know. So the population is growing materially on an annual basis and has been for a decade or even more in virtually every one of those cities that go across there. So yes, we see land values increasing. We see rental rates rising, and we see asset values increasing to levels that I, candidly, didn't think I'd see in my career.

- And what about those big cities-- Chicago, LA. We are here in New York.

JOHN GATES: They're still lagging. The gateway cities that are heavy commuter markets, you know, a lot of time in your car or on public transportation, do not have as high of occupancy levels. The badge swipe levels are not as high, but they're getting better there as well, and we do see improvement. Of those three cities, I would say New York would be leading, and street level activity is much higher. And then Chicago, downtown LA, San Francisco, lagging. Seattle probably lagging a little bit as well.

- Whether it's commercial or residential real estate, the big talk is, of course, these increasing interest rates. How do you expect them to impact the entire market?

JOHN GATES: Well, eventually it impacts cap rates that people will pay and, therefore, value assets. Because as you know, commercial assets have a fairly high degree of leverage. And so if the cost of that leverage goes up, then the value of the building is going to be impacted to some degree, and cap rates start to move. Not because of inflation really but more because of the interest rate movements.

- And what would you say is the biggest shift, the biggest lesson learned from the pandemic that we'll see evolve over the next year or two or even five years?

JOHN GATES: That workplace environment matters, and it matters a great deal. So we see it-- and, again, in the office product, we see a dramatic flight to quality, if you will. Newer space, cooler space, if we want to use that term, highly amenitized space. Bringing food in is a real factor. Really need outside areas that people enjoy, workout facilities. You have concierge services. All those things matter, and those assets are the ones that companies are moving to. And that's where their people are coming back to.

- And I mentioned rates, obviously, one of the headwinds, but you have construction costs. You have supply chains. You have a very tight labor market. Are you seeing a lot of larger projects put on hold at the moment, or are they moving forward?

JOHN GATES: No, they're moving forward. They're moving forward maybe at a pace that's slower than you would like, and it varies across product. As you would know, industrial is very-- they're moving as fast as they can there. Suburban retail is going well. And office construction, where it's merited and appropriate, is happening. But everything is happening slower now for the very reasons you just stated-- supply chains, not enough labor. So it's moving. It's just not as fast as you'd like.

- Well, we're seeing some positive momentum. Appreciate it, John Gates, JLL Americas Markets CEO. Have a good weekend, sir. Thank you.