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Return of Commuters Is a Wild Card for Downtown Property

Downtown offices are just as empty as the clothing stores next door, but real-estate investors much prefer the former. Part of the bias may be because the challenges facing offices are newer and less understood.

The centers of major cities like London and New York have been ghost towns during the pandemic as workers have abandoned commuting. The West End, one of the U.K. capital’s busiest districts, is currently at 40% of normal footfall, according to local landlord

Shaftesbury.

The hope is that activity will pick up if all U.K. government lockdown restrictions are lifted on June 21, as planned. In New York, office occupancy was just 16.8% of precrisis levels by May 19, according to Kastle Systems’ back-to-work barometer.

Facebook

and

JP Morgan

recently said they would bring staff back to the office from July.

Even with the prospect of more people flowing around urban centers, offices are attracting more optimism than the stores dotted around them. Last week, Shaftesbury said the value of its central-London retail stores fell 18% over the six months through March, while another London-focused real-estate investment trust,

Great Portland Estates,

recently said its stores have lost 27% in value over its latest fiscal year. Their offices slipped a more modest 3%, on average.

Stock investors are notably more bearish. The big discounts-to-book values at which U.K. office REITs trade imply approximately a 15% fall in property values, according to real-estate research firm Green Street.

The divergence between office and store valuations can also be seen in New York, though office values have come down more sharply than in London. A full 16.1% of the U.S. city’s office space is now available to rent, Colliers data shows—higher than during the 2009 financial crisis.

City-center retail probably does face a tougher slog back. Major shopping destinations like Fifth Avenue or Regent’s Street in London depend on overseas visitors for a chunk of sales. Even in its most optimistic scenario, the United Nations World Tourism Organization expects global tourism to be 55% below pre-pandemic levels in 2021.

Deserted streets mean flagship stores on these shopping hubs have lost the marketing power that used to justify high rents. Out-of-town stores proved more convenient for curbside pickup and dispatching booming online orders during the crisis—flipping the pre-Covid trend that rewarded downtown shops.

Still, London’s resilient office valuations look optimistic. Prices are supported by low interest rates and overseas buyers for now: Investors can get an extra percentage point of rental yield on offices in central London compared with other top European cities like Paris. However, long average commutes make London more vulnerable to the shift to remote working. The trend could reduce demand for office space in the city by 15%, compared with 5% in Berlin, Green Street estimates.

Offices are hard to price at the moment. Valuers are trying to understand how the home working trend will play out and what a flood of so-called gray space—excess supply that is sublet by existing tenants—will do to rents. A growing preference for environmentally sustainable buildings among corporate tenants also means older offices will need costly green overhauls or become unrentable.

It is hard to square jitters about downtown stores among real-estate buyers with the relative optimism about offices. The discounts on property stocks give investors a much-needed margin of safety.

Facebook is doubling down on physical office space in New York, signing a major deal during the pandemic making it one of the city’s largest corporate tenants.

Write to Carol Ryan at carol.ryan@wsj.com

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