Commercial real estate brokers are often the industry bellwether for all that’s good and bad. It is no surprise that the Dealmakers Outlook panel of retail leasing brokers assembled for Connect Retail West shined a light on the current trends they see driving market activity and pointed out where the opportunities are likely to be in 2024.
The panel was moderated by Urbanlime Real Estate’s Lorena Tomb and included The Econic Company’s James Chung, Crexi’s Andrew Hotchkiss, Matthews Real Estate Investment Services’ Michael Pakravan, and Kennedy Wilson Brokerage’s Justin Weiss.
The discussion opened with a state-of-the-market overview that noted how the pandemic has shaped retail markets. Those shifts have driven changes in space utilization, the types of uses with restaurants and bars taking center stage, as well as the times of the day when increased foot traffic is experienced. Remote work patterns have reduced lunchtime business for restaurants, but they are doing more dinners.
The Econic Company’s Chung noted that from a macro level, retail vacancy levels historically have hovered in the 6.8% range across the property class spectrum. The national vacancy rate is currently pegged between 5% or 5.5% to 7% or 8%. “But we have some markets in the Bay Area where we’re in the low 2’s,” he points out.
The interesting part of the conversation is, depending on which end of the vertical is being examined, it can be a “tale of two worlds. Yes, are there struggling parts of it? No question. But when you get to the top and you’re trying to penetrate and are representing the more desirable assets, there is this natural flight to quality,” coming out of cycles like the current one, Chung noted. “There is so much pressure that is put on that product type that it’s not even so much about pushing the rents, but it’s the thoughtful merchandizing. It is the art of [retail].”
Matthews’ Pakravan echoed the perspective that the retail market is facing two circumstances. “The good news is there’s not much vacancy out there. There is still lots of retail tenants that are expanding, growing. The bad news is I don’t think we’re getting the type of traction that we were a year ago.” He believes now is the time to define the entire spectrum of retail from lifestyle centers to grocery-anchored to strip centers to high street retail and mixed-use because they are each performing differently. “I think we have to be thoughtful in how to navigate through the challenges that small businesses have,” he said.
Crexi’s Hotchkiss shared that the “Gold Star” on Crexi goes to retail leasing. “It’s been our top searched asset with activity on the up and up in every state across the West Coast. And then in terms of the leasing activity in California itself, from Q2 to Q3 this year, we saw still steady activity in terms of leases getting signed, but maybe a slight decrease in the number of square footages getting done.” He attributed that more to tenant right sizing efforts to make sure occupancy costs are in line.
The time required to execute transactions is increasing, though, noted Pakravan, who compared today’s timeframes to 20 years ago when he first got in the business. Back then, the process quickly progressed from a property tour, initial deal write-up by hand on the tour, a couple rounds of edits culminating a couple weeks later in an agreement. Once permits and build out were completed, typically the store opened within six months or sooner and “everyone was happy. These days it’s just a grind to get anything over the finish line from the complexity,” he said. “I think LOI’s have gotten more complex. We find ourselves as brokers negotiating things like permanent transfers and things that we shouldn’t be doing as brokers, and that’s adding complexities to the deals.”
Additionally, Pakravan pointed out the permitting and construction process is increasingly challenging with cities and buildouts are taking significantly longer for a host of reasons. That is one reason he advises brokers to do more to guide tenants and provide the tools to help them get open. “It’s worth the investment,” he said, especially when project managers and tenant coordinators help make sure that tenant gets open in a timely manner.
But Chung notes the lengthy and complex permitting process is largely confined to California. He says they aren’t facing those types of challenges markets like Dallas or Scottsdale. “They’ve also been very pro-business. They’re staffed better. They’re just prepared to receive the business community better and the attitude towards it,” Chung said.
Hotchkiss added, “Investors are going to continue to look in states like California, but also, we’ve seen an uptick in activity on Crexi in states like a Dallas, Arizona, and Utah. There’s still going to be investment sales done in those markets as well as in California. I think there’s always going to be capital plays [in California].”
Increased retail rents are not likely causing issues for tenants either, notes Pakravan. “I don’t think rent is an issue,” he said. “Tenants are able to pay market rents and there’s rent growth. I think the challenge right now is time in capital.” Lengthier opening processes can cause issues with securing capital and the cost of that capital for retailers.
The year ahead that Chung envisions is one in which lower construction volumes, inventory contraction and sustained tenant demand will place pressures on existing space. “What we are seeing in Northern California specifically, is a lot of creative repositioning and re-imagining of projects,” Chung said, citing several power centers that are being transformed to life sciences, or being converted to multifamily, or high density residential.
The repositioning or revitalization of existing retail space will require distinct approaches compared to first generation space or new retail construction. Weiss advised landlords to “make the investment early on when delivering a warm shell. That may mean delivering space with restrooms, plumbing, drains and separately metered AC distributed throughout the space. He said, “It makes it easier for tenants to come in because ultimately, they want to see that space, whether it is a pop-up tenant for month or a one-year deal.”
Weiss noted it is important to keep in mind that first generation space may have been vacant for five years and to bridge from a temporary tenant may require an investment in order to secure a long-term deal.
Pakravan noted a “major delta” exists between first generation retail space and second generation space that has even further differences between shopping center space or mixed-use settings. “For second generation restaurants space specifically, we used to have a saying in our office, if it’s got grease it will lease and if it’s got a hood, you’re good.” That sentiment still holds today, largely because if the infrastructure is relatively new, there is high demand for restaurants, though the tenant expectation for TI allowances has expanded as well, notes Pakravan.
The assets that are performing better today include life centers and anchored centers. However, the definition of an anchored center has changed, pointed out Pakravan. Today, that might be a project that has a pickleball court or a department store or a center that features plenty of open space and grass where families can gather with their kids. “The definition of anchor has changed over the years and it’s critically important to have some type of anchor, whether that’s a restaurant, a movie theater or open space,” Pakravan said.
The better performing properties, according to Weiss, are typically those with restaurants. But in second generation space he’s starting to see service based retail as well fitness, beauty, wellness, and wellness related tenants. He’s not seeing apartments and soft goods retail. Though they are seeing some athleisure, athletic brands, and sneaker brands, along with neighborhood services, restaurants, and experiential retail, like the Jean-Michel Basquiat Exhibition at The Grand, Related’s mixed-use project in DTLA.
Chung concluded they are also seeing tenants aggregate into open air environments, whether on a suburban high street, or a Lido Village in Newport Beach or other types of environments. “Overall, what we are watching happen before our eyes is also this influx of retail adjacent uses,” he said of the active retailers fueling his bullish perspective. “There’s always somebody active in each category. There’s fewer big rollouts, but very selective executions. It just depends on who’s rising out of the ashes.”