Posted on October 24, 2020
Introduction: What is highest and best use?
In real estate appraisal, the concept of highest and best use (HBU) refers to how the use of the property interacts with the value. During the appraisal process, professionals try to determine if the current use of the building is the HBU. If it’s not, there may be value left on the table that could be capitalized on by a buyer.
COVID-19 has greatly altered the real estate landscape. Apartment landlords are struggling to find tenants in apartments that normally sign early. Owners of office buildings face an unprecedented level of uncertainty as their tenants (perhaps unwillingly) experiment with the idea of remote work. Will these leases renew when their terms are up?
Small businesses have been hit especially hard by the pandemic. These small businesses aren’t leasing hundreds of thousands of feet of office space in the downtown of whatever large city you’re nearest to. They’re leasing smaller areas, often on ground level to access foot traffic. These unique tenants bring the feel of the town to life. They make your area feel different from every other area. These places, as we know them, are dying.
Many small businesses will move online. Why pay for retail space when shopping is going online at an increasing rate? Others may cease to physically exist. Any small business retailer that provides little more than a showroom experience will be trounced by Amazon, Walmart, and other large players who enter the online retail space. They will either adapt their business so it can survive online, or change their physical space so that they become a retail experience, separating themselves into a different market segment from the online giants.
All things considered, the pandemic has caused the single-tenant retail market to contract. These types of spaces are sometimes leased by independent landlords rather than property management companies. According to a landlord demographic study in 2014, nearly half of all landlords were above the age of 44, which means a notable percentage of the market may be desperate to fill their spaces to keep up income later in life. Additionally, an older landlord isn’t someone who will be reentering the job market, especially in such a shaky economy – 49% of landlords surveyed didn’t have a full time job.
Small “mom and pop” type landlords such as these have two main options:
Option One: they could sell off their properties and live off of the proceeds. The property management companies I described above would be happy to invest in places they’ve already bought properties (unless they are also trying to exit the market). However, if landlords are trying to exit in a hurry, which could happen if they are living with high expenses or low savings, then their selling prices would be relatively low. Thus, Option One is not favored by landlords who ultimately want to stay in the game as long as possible.
Option Two: The landlords could look for new creative ways to lease their properties. These new ways would represent the new HBU of the property. I believe the COVID pandemic will catalyze a wave of change in the HBUs of real estate, Main Street USA included. Option Two is a widespread reevaluation of the industry’s HBUs. It’s also what the rest of this blog post is about.
There are a bunch of new and creative ways that make up Option Two. Some of these are more viable than others.
Public Community Development Spaces
Collective consciousness of the importance of local community is on the uptick. Some local governments and foundations provide grants for community building spaces that could use a landlord to partner with. Private landlords in prime downtown locations can work with these public tenants to build community spaces where people can come together. As New Urbanism takes hold across the country, these types of spaces are going to be in demand. Landlords can work ahead of the curve to actively prepare their spaces for this type of development.
Private Community Development Spaces
Online communities are on the rise – if you can make a space that people get value from, they’ll spend more time in that space. Then, they’ll be more likely to purchase something from you.
As the online community market continues to saturate, communities will start looking for ways to further differentiate themselves. These communities could start renting physical spaces in locations that they have the most members to further this sense of community and provide a physical presence for people to connect with. These types of spaces may not be rented for the traditional year-long lease – rather, landlords could work with online community managers to organize space for shorter periods. While this provides a less-steady stream of income than a traditional client, a landlord that becomes known for being the go-to online community host in an area could start to charge a premium for their experience.
Retail Experiences rely on the tenants cultivating an experience in the space that the landlord provides. This is a very tenant-reliant solution (aka the landlord can’t just make their space into a retail experience without a tenant leading the way), so it may not even count as a solution on this list. Even so, it’s worth noting what these are, as they’re going to lead us into the future of retail.
Retail experiences include augmenting your store with Augmented Reality (AR) software. There are firms that work with different companies to create AR experiences, some of which don’t even require a headset. You can just scan a QR code and use your phone as a way to see into another version of reality. In the context of retail, using this technology to establish a deeper connection with the customer will be a game changer.
Other retail experiences include full Virtual Reality setups, where the customer is transported into a different space entirely using a headset or other hardware. Retail experiences can also include gamification, where the purchase of the product is turned into a game.
While it would be unconventional to live in a ground-floor glass-fronted retail space, some people would be willing to give it a shot for a year for the right price. If a landlord is looking for some level of income rather than nothing, advertising this as an option would likely go somewhat locally viral (even in an ironic way) and could result in a tenant.
The Redefining of Space
Space as a whole is going to be redefined in post-pandemic America. People will regard the act of gathering in different ways. While some landlords and tenants have struggled throughout this tumultuous time, humans always find new ways to innovate given tough constraints. This non-exhaustive list of creative solutions is just the start of a general brainstorming session for both landlords and tenants to make the best of our current situation. The world will continue to evolve – we just have to be ready to evolve with it.