Lululemon – 1201 S Main
Walgreens – Tuscon, AZ
The Crisis-Proof Shopping Center
While an anxious national media reports on the retail apocalypse, spiking vacancy rates and big-name bankruptcies, perhaps it’s time for cooler heads to shift their focus squarely to the winners in the present disruption. Doom and gloom sells newspapers, but the list of prospering brands is long, and growing, as consumers adapt their shopping habits both to e-commerce revolution, and the current COVID crisis. Big wins by clever and opportunistic brands is the most under-reported story in retail today.
Indeed, the current state of affairs in the economy has created a new set of darlings in retail, as select retail and dining brands have demonstrated themselves to be both essential and internet-resistant. Expect that savvy commercial owners will be re-positioning their tenant mixes going forward to maximize the stability and success of their assets around these winning brands.
Grocery stores have clearly re-established themselves as the most essential and implacable of anchor tenants, posting soaring sales and record profits as consumers pare back travel and dine at home. Look for a broader and deeper array of grocery store offerings, in smaller sizes and unconventional locations to play out in retail in the 2020’s.
The classic grocery store co-anchor, the pharmacy, has demonstrated itself to be equally internet resistant, while the elevated safety and security that their frequent drive thrus offer have made pharmacies an easy winner in the COVID era. Prescription and over the counter medicines, as well as paper products and cleaning products all represent regular visits to the local pharmacy.
Hardware stores, home improvement big boxes and large format general merchandisers have all qualified as essential, while also benefitting from consumers staying at home, working from home, and consequently working on an array of home improvements, home office set ups, etc.
Drive-thru restaurants, coffee shops and QSRs have proven themselves able to generate as much, or in some cases even more revenues, than they were achieving in the pre-COVID paradigm. As traditional dine-in establishments have closed or reduced capacity with outdoor dining only, drive thrus have filled the void with hungry consumers and kept their cash registers ringing.
Likewise, brands that have adopted mobile ordering and smartphone apps, or marshalled proximate parking space for the mobile customers and delivery drivers have been able to differentiate themselves and align with the needs of consumers in the changing market environment. Dunkin’, Sweetgreen, Chipotle and Chick-fil-A are among the long and growing list of brands that have nimbly met changing consumer habits.
Other winners in retail? Garden centers and outdoor furniture retailers have benefitted as consumers spend money on their homes, instead of flying to Hawaii or Europe this summer. With less flying comes more driving, and gas stations and their C-stores and car washes have kept on humming. Add to these other crisis-resistant concepts including banks and credit unions, urgent care clinics and collision repair, and a picture starts to form on how tomorrow’s landlords will curate the internet-resistant, crisis-resistant tenant mix.
Dramatic and fast changing market conditions are quickly serving to sort out the new winners in retail. Look for savvy REITs, investors and owners to re-position their assets around these new winners to collect a bigger slice of tomorrow’s commercial rent stream.
Kenworthy Crossing – El Paso, TX
Reynolds Ranch – Lodi, CA
Kenworthy Crossing – El Paso, TX
Reynolds Ranch Sale – Lodi
Glass Half Full
Setbacks. Trials. Disappointments. As we digest the manifold challenges facing our families, businesses, schools and communities, athletes offer a valuable lesson for a time of trials. Athletes and sports leagues have been much in the news of late, navigating their way, like the rest of us, through the myriad of challenges besetting the economy and nation.
We often marvel at our athletic heroes, whose talents, competitiveness and resilience are frequently a source of both inspiration and instruction. While we may be tempted to credit the athlete’s success to genetic advantages of size or speed, every successful coach or athlete will attest that their achievements are the result of hard work, dedication and a fighting spirit. Not only does every successful athlete encounter loss, pain, sweat, tears and obstacles, they will tell you that these relentless challenges are their most reliable pathways to success.
Champions, those whose work stands the test of time, illustrate to us how there are no shortcuts to lasting success. The great ones have trained themselves to seize every challenge head on, indeed to seek them out. They welcome the adversity before them and keep on fighting, no matter how many times they are knocked down. They teach us how winning is not a result, but a way of life.
In our business lives, a mighty foe has risen, one that threatens the mastery we felt that we had over our craft and our careers. As our industry shudders and shifts, as businesses flop and the media howls, our heroes remind us that the hurdles that have arisen in our business lives are nothing less than opportunities to get better at what we do – these are our pathways to success.
It’s smart people that win in the long run, and now is a time for thinking, or re-thinking how we approach our industry, our customers, partners and clients. The rules of the game are being rewritten daily in our business, clearing the way for new leaders like you and me to chart a path that sees a glass that is half full, and reimagines and then rebuilds a broad new road to prosperity.
Chaos breeds opportunity in every marketplace. The dispassionate and seasoned real estate investor knows in his bones how a window is now opening to play offense, while others play defense. The smart service firm CEO understands that the current disruption is an opportunity to differentiate itself as a leader, and add market share that will bear fruit as the market stabilizes and reboots.
If you are of my vintage, you’ve just started to play the fourth quarter of the game in your career. Until recently, the scoreboard was looking pretty good – but the game has suddenly changed rather dramatically. One thing I know for certain is that the game will be played very differently in the fourth quarter than it was in the first three. And I’m ready to grasp hold of that challenge and partner with clients and coworkers to re-think what we do in commercial real estate. We are already aggressively setting about studying who is winning, where the opportunities are, and who is going to lead the way in this paradigm shift. While the media is fixated on the losers, our focus is on the new and emerging winners.
We are going to collaborate, listen, teach, learn and grow. And yes we are going to stumble and fall. But hard work, dedication and a fighting spirit are not the inheritance of athletes alone, but of champions in every arena. Let’s embrace the new challenges in our business lives and let them become our pathways to success.
Fitness 19 – Jarvis Ave, Newark, CA
Hampton Inn (aka: Inns of America)
Five Points Shopping Center – Redwood City
Caliber Collision – Fresno
Five Points Shopping Center – Redwood City, CA
Caliber Collision – Fresno, CA
10 Golf Club Road
El Pollo Loco Site – Vallejo, CA
Walgreens 1031 Exchange – NY
Walgreens, NY – 1031 Exchange
Ceres Crossings Now Pre-Leasing!
Repurpose, Rezone or Replace
The overbuilt US market for retail space was one crisis away from a major correction. That correction is now upon us.
The COVID-19 pandemic has brought into sharp relief the costs and consequences of the overbuilt nature of US retail real estate. Pre-COVID the US already had double the amount of retail space per capita of Canada, and quadruple the amount of Germany. The US inventory of retail space was historically over-developed, yet national occupancy levels remained steady for the past several years, supported primarily by a buoyant national economy that enjoyed an unprecedented bull run.
However, the relentless rise of e-commerce has been systematically dismantling scores of once proven retail brands while stunting the brick & mortar growth of others. The lethal combination of this retail paradigm shift to e-commerce with the COVID-19 pandemic’s shuttering of non-essential businesses is leaving in its wake a large and fast-growing inventory of vacated retail boxes. What was initially seen as a siloed infection to Department Stores and Regional Malls, has methodically spread to the Power Center arena, as sporting goods, home improvement, consumer electronics and other categories of large format retail stores shutter.
The COVID-19 pandemic has accelerated a growing national inventory of vacant big box space (JC Penney, Neiman Marcus, Stage Stores, etc) that has an increasingly bleak outlook for re-leasing, as the tenant pool of high-credit, active users seeking to grow brick & mortar locations continues to shrink. Forward thinking retail brands are largely pivoting instead to seeking their growth through online platforms.
This rapid and unfolding change will inevitably confront owners, investors and municipalities with vacant retail boxes for whom there is no strong retail replacement. Like it or not, an era of Retail Pruning is likely upon us, in which the path forward for big box assets will be to Repurpose, Rezone or Replace.
Let us remember that the most foolproof way to increase Demand…is to reduce Supply. Extracting boxes, or in some cases entire failed shopping centers, from the retail inventory is a sobering but pragmatic course to re-balance supply & demand, keep rents firm, discourage the re-use of vacated boxes by worst-in-class uses, and move our national ratio of retail space per capita to a healthier and crisis-resistant level. No doubt many owners will resist the need for this change, preferring to re-lease a vacated box with a down-market replacement, rather than spend the capital needed to reposition the asset. Likewise, many municipalities will cling to an unrealistic old-paradigm model for sales tax revenue based on an inventory of retail space that was only expected to grow over time. Yet as John Adams famously observed, facts are stubborn things, and the fact is that swelling vacancy will cause Supply to swamp Demand, bringing myriad blights in its wake. A community cannot ignore a retail vacancy problem indefinitely.
While skeptics may scoff at the notion of retail centers exiting the landscape, our firm has already been approached by savvy investors and developers that have asked us to target broken retail centers as target opportunities for mixed-use redevelopment. Re-imagined retail centers can still include retail uses, but on a right-sized scale that is perhaps 50% or less of the original retail footprint in size. The opportunity to densify these projects with vertical housing product, hotels, or office, medical and civic uses will enable developers to take advantage of the great fundamentals that good retail real estate provides for alternate non-retail users (location, proximity to transit and employees, etc).
Sometimes less is more. As we look ahead to what will become a national big box vacancy problem of unprecedented scale, the answer is extremely unlikely to be found in the form of expanding big box users that will absorb the supply. The answer instead is far more likely to be found in pruning existing inventory back to healthy and sustainable levels. Repurpose, Rezone or Replace.
In the March elections, San Franciscans approved Proposition D, a new tax sponsored by a member the Board of Supervisors that targets landlords of vacant retail space. The sponsor believes that these owners are intentionally keeping their properties vacant, despite tenant demand. The Supervisor commented that the tax is “about changing certain bad actor landlord’s behavior” and “creating a disincentive for long term vacancies.” Disincentive? Hmmm. Don’t mortgage payments already provide that stimulus, every 30 days?
Note that San Francisco is the same municipality that led the nation when it adopted its anti-chain store “formula retail” policy, which subjects proposed leases to a retailer or restaurant with more than 10 units to a discretionary approval or disapproval by the city. Virtually every other city in the nation (over 99%) allow private property owners to lease their retail and restaurant space to tenants whose use is consistent with the zoning. Not so San Francisco. By restricting brands with 10+ units, the city has done something far worse than limit “chain stores”; it has restricted high-quality, high credit brands with proven business models from serving the community, investing in their properties, paying rent to landlords, and creating jobs. Among those most impacted by these restrictions are entry-level workers and those who lack higher education – two cohorts that historically leverage employment opportunities with retail chains as an entry point into the workforce and steppingstone to higher employment. Having limited the field of quality users that landlords can lease their vacancies to with the formula retail policy, the city has now imposed a punishing tax for the very vacancies they have helped to create.
But the anti-chain store policy is only one of an array of challenges confronting landlords, retailers and restaurants hoping to do business in the city. San Francisco already imposes one of the highest minimum wage requirements in North America. Add to this the soaring costs of healthcare, and a picture starts to form about how single-party rule in California and San Francisco has legislated away the retailer’s and the restaurant’s already tiny profit margin. Retail and dining businesses are highly labor dependent, and the already cutthroat business of retailing winnows out the weak, forcing entrepreneurs to operate on razor thin margins. Despite the impacts of wage and insurance costs on profitability, and the restrictions on leasing spaces to multi-unit credit tenants, the city government now attacks the landlord facing these headwinds, when he and a tenant can’t solve for an economic solution.
But wait, there’s more. Ask any resident, visitor or employee who spends their workday in San Francisco, and they will all lament with disgust the out-of-control litter, graffiti, homelessness, panhandling and crime that characterize today’s San Francisco. The very city government who is responsible to address these blights, but is outmatched by them, is culpable for the disintegrating social environment that has made leasing retail space an often impossible task. Ask the City’s Board of Supervisors just how many of them would open a business where the sidewalks are filthy, the homeless sleep in their doorways and the sights and smells graffiti and urine greet the shopkeeper each morning.
Beyond the wage & healthcare burdens, the formula retail ordinance, and the litter/graffiti/homeless issues, a still larger macro-economic challenge to both retailers and their landlords has exploded in recent years. The unrelenting rise of e-commerce has created a paradigm shift in how consumers purchase their goods and services. No doubt each and every member of the San Francisco Board of Supervisors uses Amazon and other web-based platforms for some of their purchases. The ongoing shift of retail dollars away from bricks and mortar retail to e-commerce sales is a reality that confronts San Francisco and every other city in the nation.
Instead of assisting their landlords to cope with this paradigm shift in retailing, and the growing list of hurdles to consummate a lease, the Board of Supervisors has demonized them. The notion that the city’s landlords are “bad actors” because they have been unable to lease their spaces during an e-commerce revolution in retail, and in the face of myriad city-mandated challenges to doing business, could only be conceived in an ivory tower. The bad actors here are those who create the continuous roadblocks to growth, not the entrepreneurs or investors unable to overcome them.
While progressives like to slap themselves on the back and justify their policies as helping out the “little guy,” they have conveniently forgotten that some little guys are little property owners, little retailers, or little restaurateurs. Rather than coming to their aid with policies that help make their livelihoods possible, and thereby stimulate jobs, services, sales tax revenues and neighborhood vibrancy, San Francisco has determined to punish them with a tax. In essence, the new tax codifies the notion that landlords are to blame for the wage and healthcare costs that tenants can’t afford, for the homelessness, litter and graffiti that discourages retail investment, and for the inexorable rise of e-commerce. San Francisco’s progressives have determined to tax away these stark realities, rather than come alongside the community’s landlords and business owners to solve them.
No doubt an unintended consequence of this new tax will be the decision by owners to lease their spaces to just about any tenant, rather than wait for a good one. A tax like Proposition D is an economic incentive designed to spur action, and it will. When the vape shops, tattoo parlors, liquor stores and other worst-in-class concepts that sell everything from smut to tobacco products to hard liquor begin to open, the city will see the rise of a new brand of bad actors and learn what kind of incentive it has really chosen to create.
1902 N Texas Street – Fairfield, CA
Game of Loans
In a fast-changing retail landscape in which retailers of all shapes and sizes — big box stores, department stores, and other retail brands — are regularly shuttering due to the shift to e-commerce, lenders will increasingly find themselves in the uncomfortable position of owning retail real estate that was underwritten in the pre e-commerce paradigm.
In order to fund their original loan, a lender’s underwriters determined that these assets met the institution’s conservative requirements. That meant, in part, that if the loan failed to perform, the bank would find itself with an under-leveraged and fundamentally sound asset on its books. But some 9,300 store closings in 2019 alone, the most ever, are putting that claim to the test. According to Coresight Research, closures jumped an astounding 60% from the 5,844 the firm tracked in 2018. This is some of the most under-reported and unsettling news in a national economy which keeps grabbing headlines for a roaring bull market and low unemployment.
Worried? Consider this: UBS reports that another 75,000 stores may be lost by 2026, as online shopping continues to expand. Rest assured that lenders are paying attention to these trends. While the impacts on employees, shoppers, landlords, and communities will all be painful, perhaps the audience that will be hardest hit are the lenders that risked the capital investment into the real estate that these brands have abandoned.
So what will this mean for the rest of us? Here are a few observations.
- As traditional retail continues to struggle vs. e-commerce, lenders will deemphasize retail real estate in their portfolios. Some may abandon retail altogether. This disciplined approach will likely translate to higher underwriting standards and more challenging loan terms.
- Like many investors, lenders will likely focus on more conservative retail investments, such as single tenant net leased properties occupied by credit tenants.
- Look for lenders on retail real estate to put more pressure on borrowers, thus limiting the risk on the lender, with more recourse requirements. This pressure will inevitably slow down transaction volume in the retail space.
- When loan terms and loan-to-value requirements become more conservative as lenders look to offset the risks associated with e-commerce, we forecast the rise of non-institutional mezzanine debt. This more expensive source of financing will seek to bridge the shortfall between a borrower’s capital needs and his primary lenders maximum loan exposure. But more expensive mezzanine debt will raise the hurdle on the return needed for a borrower to achieve positive leverage in a given investment, further slowing down transaction volume, and adding to upward pressure on CAP rates.
The early 2000’s were known as the dot-com era. While this chapter in the national economy is remembered derisively as a posterchild of boom & bust, characterized by too many investors rushing into a fledgling industry before it had learned how to properly execute on its lofty business plan assertions, clearly the seeds of today’s e-commerce bounty had been successfully planted.
With e-commerce having hit its stride today, a new paradigm in retail real estate is being created in real time. Lenders, investors, retailers and other market participants must make fundamental changes to adapt to this new paradigm. While surging e-commerce makes the case for slowing traditional retail real estate development and investment, lenders will likely respond with increasingly conservative loan requirements. The current low-interest rate environment has effectively masked the impacts that growing e-commerce is having on retail real estate lending. When interest rates move higher over time to more historically normal levels, the limitations of traditional lenders will become far more apparent.
But just as these still nascent market conditions will dampen private investor activity, a simultaneous opening will occur for buyers that don’t need to rely on lending institutions, such as REITs, users and investors with access to public markets, hedge funds and other institutional investors. Indeed, they may benefit if CAP rates rise while traditional lenders de-emphasize or exit retail.
And here you have the Game of Loans.
The suburban shopping center business is not in crisis.
But the simultaneous presence of two unsettling dynamics in the industry are unraveling once proven assets, and stunting new development.
The first of these ailments is the interruption (or is it the termination?) of the anchor tenant roll-outs that were the single most important catalyst to new shopping center development over the past forty-plus years. For decades, wave after wave of anchor tenant concepts across an array of retail categories emerged and expanded both regionally and nationally. First there was Target, and then The Home Depot, and then Wal Mart, then Lowes, then Best Buy, Kohls and other major anchors. These brands ranged from 50,000 to 150,000 SF each, and created the opportunity for 10 to 50-acre sites in communities across the nation to be developed as shopping centers. Accompanying these primary anchor expansions were the lesser stars in the retail galaxy, such as the office products, pets, crafts and sporting goods sub-anchors, among others.
The ripple effects that were caused by the expansion of these brands are too many to count. Anchor tenant expansion created enormous business opportunities for developers, contractors, sub-contractors, architects, engineers, brokers, consultants, lawyers, marketing and advertising firms, sign companies, landscapers, and countless other private sector firms and entrepreneurs. Likewise, city and county governments were enriched with sales tax revenues, as well as an array of services, place-making dynamics and employment opportunities that benefitted cities, school districts and the myriad public agencies funded through those tax receipts.
Today, none of the aforementioned brands are expanding, but for isolated relocations and much smaller test concepts. The conspicuous absence of the next big retailer roll-out is sending shockwaves through an industry long accustomed to building around catalyst anchors. Today’s most active anchors are internet-resistant theatres and fitness concepts, or rent-sensitive brands such as Hobby Lobby, TJ Maxx and Burlington, most of which seek to backfill second generation boxes, such as those abandoned by those once expanding brands above.
As if all of this were not bad enough, a second growth-killing reality to the current environment is the constant and merciless elimination of traditional retail anchors from the marketplace. Gone are Toys”R”Us, Orchard Supply Hardware, HH Gregg, The Sports Authority, Shopko, Sport Chalet and others.
The math here is simple. And chilling. As more anchor and sub-anchor space continues to be vacated in an environment in which fewer expanding brands are poised to absorb that inventory, supply will begin to swamp demand. This sobering dynamic is already playing out in markets across the country, but the worst is yet to come.
Answers about how to respond to this unfolding squeeze are hard to define, as owners and developers feel that the ground is moving under their feet every day, and the rules of this new game in retail real estate are yet being written. The embrace of mixed-use solutions to formerly retail-only assets is clearly a part of the answer. And the present boomlet of expansion by theatres, health clubs, entertainment and food uses can only put a dent in spiking inventories of big box space.
While not everyone is ready to admit it, clearly suburban shopping centers are heading down a path that is not terribly dissimilar to the regional mall. Just as big box and discount retail systematically began to dismantle the department store monopoly and menace the regional mall industry in the 1970’s and 80’s, the rise of e-commerce is similarly harassing the Power Center asset class.
But what we have thus far learned about regional malls, is that a relatively small core of “fortress” malls in high barrier to entry core markets have demonstrated the best prospects for survival, or reinvention. Similar real estate fundamentals centered on density and demographics will no doubt align with the Power Centers that survive. At the same time, investors, developers and lenders in the shopping center space will have to aggressively embrace mixed-use solutions, as well as the vertical densification of their core market assets, while likely shedding vulnerable assets in non-core markets.
A critical factor in the success with which the industry faces these radical and unfolding changes will be the way that municipalities embrace the need to change with the times. No doubt many city budgets are built on an old-paradigm sales tax revenue model that worked in years past. Uninformed policy makers that resist the need to allow non-sales tax generating uses into what now are retail-only assets, may fail to understand how market conditions are fast changing. Diversification of these assets with housing or office uses will lend a critical vibrancy that ever-shrinking retail choices will fail to deliver. Alignment between the industry and government policy makers is critical to finding the best way forward for both private and public sector interests.
Yet another crucial variable to these crippling changes affecting the industry is the rising cost of doing business. Fast rising construction costs and a scarcity of affordable labor are both being driven by a low unemployment environment. Changing government labor regulations and rising minimum wage laws have virtually outlawed entry-level employment. These financial pressures further complicate the math around how to make new retail development work.
The silver lining? The only constant is change, and the shopping center industry will get truckloads of it over the years to come. The workable solutions will be hard to find, and will vary from one site to the next. But the answers are out there. Fluency in housing, office and transit will increasingly become essential. As will the integration of grocery and other daily needs uses into retail developments.
Just like Sam Walton and other unorthodox pioneers who embraced change in the past, the savviest players in the shopping center industry will find opportunities in this ongoing disruption, and emerge as the new winners and leaders.
Crossroads West Video
2-Acre Retail Development
Amy’s Drive Thru
New I-80 Visible Retail Space
Regency Park Plaza
1885 Solano Avenue
Where Do You Retail?
Retail brands that embrace the Omni-Channel approach to selling their wares seek to create unique silos beyond the retail store where merchandise can be delivered to customers. Catalogues, on-line stores, gift cards and partnerships with credit card companies are among the channels that retail brands use today in reaching customers.
Yet within the old-school world of physical bricks & mortar real estate, an even more aggressive, creative and evolving array of channels continues to evolve. Let’s consider:
- STREET RETAIL: The original and still classic home of retail, which works everywhere from Main Street to Wall Street.
- SHOPPING CENTERS: Country Club Plaza in Kansas City claims to be the first. Defined by anchor tenants and parking lots.
- REGIONAL MALLS: The post war emblem of American prosperity and innovation, which created the enclosed, regional shopping experience.
- POWER CENTERS: Driven by Big Box retailers like Home Depot and Wal Mart, these open-air centers serve communities with a typically discount feel that juxtaposes them to the fashion anchored mall.
- TRANSIT HUBS: Union Station in Washington DC is today a giant shopping and dining venue, as are many train and transit stations across the map. While that may not be how they were originally conceived, retail and dining brands saw a repeatable flow of customers and redefined how these hubs function.
- OFFICE BUILDINGS: While the suburban office building is still an island, its urban peer is usually a logical location for a café, restaurant or bank.
- AIRPORTS: Travelers far from home need to eat, drink and be merry. The added benefit of duty- free shopping has created a profit center for the airport, its’ municipality and the retailer.
- MEDICAL CENTERS: The bigger, the better. Regional medical centers in particular are self-contained ecosystems unto themselves that operate 365/24/7. And there’s no better place to buy a card, flowers or box of candy.
- MULTI-FAMILY PROJECTS: Apartment and Condominium projects in urban markets create opportunities for landlords both to monetize their ground floor traffic, and densify the airspace above.
- HOTELS & RESORTS: Since people who are travelling and vacationing are already accustomed to paying for everything, why not indulge their generosity?
- THEME PARKS: The biggest and best manufacture millions of guest visits annually. The shrewdest of their operators keenly understand how to monetize the traffic that they generate. Downtown Disney has set the bar.
- STADIUMS: In a globally sports-charged culture, outdoor stadiums and indoor arenas have frequently replaced the mall or movie theatre as the go-to guilty pleasure. And the patrons come 50,000 to 100,000 at a time.
- CONVENTION CENTERS: The best ones can move bodies through by the hundred of thousands per week. A perfect target.
- THE BOX WITHIN THE BOX: You can do your banking inside your grocery store or get your Big Mac inside Wal Mart. More of these partnerships are sure to come.
It would be foolhardy to believe that our favorite retail and dining brands are going to sit on their laurels, satisfied with the list above. Retail evolution creates a dynamic that constantly seeks new venues.
Which ones might be next? Let’s consider:
- GOVERNMENT BUILDINGS – CITY, STATE & FEDERAL: To say that the use of these properties is politically charged is, um, an understatement. But given the ever-growing governmental footprint at every level, it sure seems to make sense for retail.
- NATIONAL PARKS: While folks like you and I hope and pray for one last bastion of unspoiled nature, mark my words – someone is going to try.
- BOY SCOUT JAMBOREES: What if your tent starts to leak or you didn’t pack your sleeping bag? All those kids are already carrying smartphones.
- AIRPLANES & CRUISE SHIPS: Virgin Airways has a cool bar in upper class that sells brand name beer and cocktails. Might Coors or Anheuser-Busch lease the floorspace and operate them? Why not?
- TRAFFIC JAMS: Seriously. Have you ever waited in line for four hours at the border? I would pay up big time for a burger and chocolate milkshake.
- SHIPPING CONTAINERS: They are already starting to pop up in the darndest places and they can fit just about anywhere. Evolutionary brands like Dunkin now have a container prototype.
- MEGA CHURCHES: God forbid!
Scores of today’s REITs are struggling, in part because they have siloed themselves into a single class of assets, while the ground beneath them continues to move, and the ongoing disruption of retail continues to play out before our eyes. Perhaps they can learn a thing or two from their very own retailer tenants, which have embraced the reality of constant reinvention and evolution.
Optimistically, the list above reminds us that the real estate investor has an ever-growing menu of places to capture retail rent dollars, and that proven retail and dining brands are leading the way. Perhaps a bold and evolutionary REIT will be the first to cobble together a portfolio of these “other” places. Doing so would represent a fundamental change in the premise behind how properties are aggregated. Whereas today’s investor builds his portfolio based on product type, perhaps tomorrow’s investor will embrace a user-driven model that goes wherever the credit tenants wish to spend their rent dollars. Perhaps aligning a portfolio with the varied places that expanding credit tenants seek to find customers would insulate the investor from the jarring jolts that have occurred as assets such as malls and power centers have fallen out of favor. Perhaps.
No one ever said this business wasn’t interesting.
Riki Dalal – Main Street Plaza
Prior to World War II, Oakland was one of the major retailing markets in the West. In an era when the department store was the king of retail, serving as the ultimate validation of a retail marketplace, downtown Oakland was home to R.H. Macy’s, H.C. Capwell’s, Sears & Roebuck, I. Magnin & Co, Joseph Magnin, Kahn Brothers and others. Like San Francisco’s Union Square or the Miracle Mile of Wilshire Boulevard in Los Angeles, Oakland’s Broadway became an essential location for every major west coast retailer. This dynamic drove property values higher and attracted scores of small to mid-sized retail brands, as well as theatres, restaurants, banks and office buildings.
The dramatic changes in the post-war era, including the rise of the automobile, the growth of suburbs and the advent of the regional mall, wrought havoc on downtowns across the land, and markets reacted or evolved with varied levels of success. Perhaps no market was as unsuccessful as Oakland in adapting to these changes. The market experienced both the exodus of every one of the department store anchors that formed its’ retail backbone, and a paucity of any lasting or successful new retail to take its place. Absent a menu of competitive retail centers, Oakland became a city of pocketed retail streets and districts, each with a unique offering and vibe.
The bad news for Oakland wasn’t just in retail. Schools, wages and employment all sank, and crime levels soared, while the city’s identity went through radical changes in ethnicity, income levels, educational attainment and other demographic metrics. This was the Oakland that I first encountered professionally some thirty years ago.
Despite its hard luck, Oakland had and still has some unmistakable advantages. First, its in the geographic center of the Bay Area, the 6th largest metro area in the country. The weather and the cost of living are both far superior to San Francisco. Oakland is the western terminus of the transcontinental railroad and home to the busiest shipping port in the northwest. The affluent Oakland hills communities of Piedmont, Montclair and Rockridge are home to millionaires and billionaires alike, and one of the world’s leading research institutions, the University of California at Berkeley, is right next door.
Yet as retail became vastly more formulaic and homogenized in the 60’s, 70’s and 80’s, expanding retail and restaurant brands built their growth on the surging wave of mall expansion and suburban shopping centers anchored by high-copy anchors like K Mart, Wal Mart and Target. But with no major new retail centers offering that proven vehicle for a retailer to access its’ market, wave after wave of expanding retailers skipped over Oakland, instead dotting the map with surrounding stores in nearby markets. A generation of Oaklanders were thus trained to leave town when a new suit, a washer & dryer or a bedroom set was on the shopping list.
It’s no exaggeration to say that the failure of Oakland to reinvent its retail-self in the post-war years was a critical reason that leafy Walnut Creek, a town of only 60,000 at the time and some 15 miles east, became the alternate destination for brands like Macy’s & Nordstrom, and later Neiman Marcus and Tiffany & Co, when they determined how best to capture the 2,000,000 + population of the East Bay marketplace.
For me, Oakland’s rock-bottom moment came as I was preparing an East Bay site tour for a national retailer in the late 90’s. In a pre-tour call with the firm’s VP to discuss the proposed itinerary, I rattled off suggested sites in Walnut Creek, Pleasanton, San Leandro, Oakland and Berkeley.
“Take Oakland off the list” my client advised.
“Oakland is a no-fly-zone.”
His words have been etched into my memory ever since. He continued, “…we’ll never get a site in Oakland, California approved through our real estate committee.” The sentiment of this firm was not unique.
Perception had become reality for this and countless other users – brands that had the opportunity to tap into a densely populated and dramatically underserved trade area – brands that had the potential give as much to the community in jobs, legitimacy in the world of retail, and pride, as they would take in sales success.
But then, finally, something happened. Things got so bad, that they actually got good. The historic Great Recession simultaneously destroyed the myth of the regional mall’s invincibility, and exposed the sprawling suburbs’ penury of density, daytime population, transit and resilience.
Resilience? Did someone say resilience? Well if Oakland developed one virtue over the past 60 years, it was resilience. This happens when your NFL franchise leaves…twice. The Great Recession’s validation of the virtues of core-market fundamentals made Oakland a poster-child for what employers, lenders, investors, office & retail developers, and best of all retailers and restaurants, were looking for.
A canny plan to densify the Downtown and Uptown sub-markets, linked together via Broadway, with 10,000 urban residential units, aspired to spark a renaissance through more foot traffic, more neighborhoods, more strollers, more dog-walkers, more shoppers and more diners. Preparation met opportunity when the Great Recession re-set national real estate priorities around resilient, durable core markets. Alert to this population surge, best in class brands like Whole Foods and Sprouts opened stores, cool breweries and tap rooms like Drake’s and The Trappist appeared, and an epicurean’s dream food-scene exploded.
And unlike many of its peer communities, Oakland doesn’t have the costly, thorny and politically charged question of how best to re-purpose its’ dead regional mall – since it doesn’t have one. Its retail infrastructure, built on heavily trafficked retail streets and self-sustaining retail districts today looks prescient, knitting together retailing and dining brands with transit, daytime and residential populations. Today, occupancy levels on Oakland’s historic retail streets and districts averages 98.61% (read report) – numbers that beat virtually every market in North America – or anywhere else on the planet.
As I write this, Oakland is a city of cranes. Over a dozen giant construction cranes now mark the cityscape, from Jack London Square on the bay all the way Uptown, along and around the historic Broadway spine. Office towers, residential towers, mixed-use projects, state of the art medical centers and transit-oriented developments are simultaneously creating a new Oakland in real time.
And what about those beautiful old department store buildings? The Capwell’s building (later Sears) was sold to UBER, and is now being beautifully reimagined as a stunning first-class office space, close to transit, shopping, dining and the swelling Uptown neighborhood. Its tenants won’t feel too pioneering as other new economy tech-firms like Pandora and Ask have already joined Blue Bottle Coffee, Cost Plus World Market and Clorox in making Oakland their headquarters.
Just like its pre-WWII self, Oakland is once again a short-list destination for investors, lenders, REITs, retailers, restaurants and residents. Once labelled a no-fly-zone, Oakland today is a target rich trade area with a growing inventory of new, high quality retail assets that both retailers and dining brands are prioritizing. Oakland’s long winter is finally over.
The San Francisco Bay Area is now home to not one but two of the most evolutionary new projects in the world of commercial real estate. The first, Apple’s 2.8 M square foot circular headquarters building in Cupertino, elevated the low-rise suburban office campus to an art form, much like the firm did in designing desktop computers and mobile phones.
The second is the newly completed regional retail project by Sunset Development in San Ramon called City Center (Visit Site). As iconic in form as Apple’s circle, City Center is a cube shaped, two-level retail, dining, fitness and entertainment anchored project located adjacent to Sunset’s 10 M square foot Bishop Ranch office park, home to Chevron’s world headquarters, AT&T, GE and other blue-chip employers.
Strolling through City Center, I was struck by multiple innovations: in design, in anchor tenant choices and in a calculated leasing strategy in relation to competition from e-commerce, all of which define the project and redefine regional retail. Another East Bay icon, muckraking journalist Lincoln Steffens said famously after visiting post-revolutionary Russia, “I have seen the future, and it works!” Steffens’ words came to mind as I contemplated Sunset’s project.
Having spent much of the past 3+ decades working on, walking through and studying retail centers of all shapes and sizes, indoor & outdoor, luxury and discount, very little in our industry anymore strikes me as new. Yet City Center was chock full of innovation. Here are three examples:
- Given both the hasty demise of Department Stores and the ceaseless disruption in Big Box retail, City Center has boldly positioned itself as an anchorless mall. Proximity to both a massive Class-A office campus and a high-end demographic residential population, provide the project with a stable daytime population, as well as evening and weekend patrons. Sunset wisely positioned a regional retail project where its target customers already work and live, thus reducing project dependence on the drawing power of one or more anchor tenants. The Shopping Center industry has repeatedly proven throughout the post-recession era the merits of core-market fundamentals, of building where the customer works and lives, rather than trying to drag them out to some retail destination. City Center is a prime example of this dynamic at work, thus enabling the anchorless design to succeed.
- Similar to Apple’s HQ, City Center has a vast open-air plaza in the center of its footprint. I confess that the cube-shaped design initially struck me as an artistic statement, and an attempt to fit in naturally with the straight lines of the adjacent office buildings. I was wrong. The Renzo Piano designed project’s shape is revolutionary in that it creates a retail space that is open-air yet enclosed all at the same time. Once a guest enters the central plaza, he is immersed in a self-contained, four-sided retail space that soars overhead, yet which remains refreshingly open air. Strange as this may sound, I was mentally transported to some of Europe’s ancient and timeless open-air retail districts built inside former fortress enclosures in places like Canterbury and Dubrovnik. Great retail places create a sort of alternate reality for the visitor. In the US, the fullest expression of this kind of metamorphosis has traditionally occurred in enclosed settings (think Forum Shops in Las Vegas, or the Mall of America). City Center has brilliantly managed to transport its guests to a galaxy far, far away while still beneath the familiar warmth of the sun.
- What Conrad said of the sea, applies equally to how today’s retailer (and their landlord) must view the internet. “It’s not for you or against you, it’s just very unforgiving of errors.” Indeed, all new retail development must be conceived with a deliberate plan in relation to e-commerce. Doing so requires creating a tenant-mix built to stand the test of time in the e-commerce era, with internet-proof and internet-resistant users. City Center is the best new example of what the post-department store, regional retail project will look like in the internet era. A super-cool second floor dine-in theatre called The Lot offers first-run movies that aren’t available online. The second major anchor, Equinox Fitness, is equally internet proof, while making a lifestyle statement for the project and providing a powerful drawing card to the tens of thousands of office park workers next door. While the latest movies and a workout can’t be found online, neither can lunch or a cold beer. City Center has cleverly built a robust food offering spanning multiple genres and price points. But perhaps most noticeable to me was the diversity of beverage-first establishments, including coffee shop, a brewery, a Boba tea shop and a wine bar. Over half of the project is leased to food, beverage, entertainment or fitness uses, all of which add to the project’s lively feel, while keeping concerns over the erosion of their businesses via internet competition at bay.
Rick Caruso, the developer of a number of smashing open air retail projects including The Grove in West LA, has commented, “Bricks and mortar retail is alive and well…good bricks and mortar retail”. Sunset’s team has emphatically re-proven Caruso’s thesis, demonstrating how smart real estate developers can successfully navigate the internet era and reinvent the regional retail center for 2019 and beyond.
La Fiesta Square – Phase II
The Shade Store
Way back in the 1980’s, I developed my first really important and impactful client relationship. My client Larry worked for a fast-growing Fortune 500 video store retailer. He was in the fourth quarter of a career in corporate real estate that had begun in the 1960’s, while I was a kid in my early/mid 20’s, just getting started.
I was stationed in a brokerage office in middle of California’s central valley, and I worked in every market along the Highway 99 corridor between Sacramento and Fresno. Virtually all of these communities, including cities like Stockton, Modesto, Manteca, Tracy, Turlock, Madera, Merced, etc. were, and still remain, growth markets that have absorbed a significant amount of California’s population growth over the past quarter century. Consequently, these markets were a natural target for a growth company seeking to penetrate the California market.
Larry and I would drive up and down the Highway 99 corridor and visit each of its many cities, evaluating sites and scrutinizing competition. Methodically we worked together to build a store network for Larry’s employer, positioning the brand to capture a wide audience of customers. My experiences with Larry taught me all the fundamentals: the importance of proximity to dominant grocery anchors; beating the competition into new markets to build up clientele and discourage competition; visibility; signage; access; convenient parking and free-standing locations. Once learned, I would employ these skills over and over again with countless other clients over the ensuing years. On a micro level I was learning how to identify sites, negotiate deals and open stores. But on a macro level I was learning how to build a successful store network that positioned the brand for sustained long term success. I learned about making both offensive and defensive real estate decisions in relation to competition, and how to build a store plan in a given trade area that maximized the number of units that could eventually be opened.
A senior real estate manager who covers dozens of markets in multiple states is someone akin to the General Manager of a pro baseball team. He selects a team of players (brokers) who can maximize the organization’s chances for success. Players are scouted, recruited, interviewed, signed and cut. Over time, the GM forms a team that understands the unique organizational priorities, and can help him to execute them consistently over a long period of time. In building his Oakland A’s teams, their GM Billy Beane finds players who can draw walks more consistently than their peers and hit with power. Unlike other GM’s he doesn’t particularly care about base stealing or sacrifices, choosing not to give up his finite supply of offensive outs in a game. While on a superficial level his needs are very similar to all GM’s (finding high quality baseball players), at the much lower level his priorities are shaded and nuanced in various unique ways. Likewise, Larry taught the virtues of hard corner locations and trade area demographics that tilted towards families (more likely to stay home and rent a movie). He rarely fixated on rents (unlike many value-oriented brands), but rather focused on locations with the best long-term fundamentals for capturing his target customer. He would then negotiate the best deal possible with landlords, leveraging cheaper competing sites, the lack of peer retailers with good credit in his size range, and the opportunity to bring the landlord multiple deals in other locations for the favor of a good deal. Through Larry, I learned these organizational priorities, and soon became the ambassador of the brand to landlords and everyone else in the real estate community, over the large section of California real estate that I covered.
Larry had his quirks, and I had to learn them all. He preferred to travel by train, thus causing me to familiarize myself with train stations in places like Sacramento, Stockton and Fresno. He was an amateur bird watcher and could identify a host of California’s bird life. He was a rabid Cal Bears fan, and held season tickets for a number of their major sports programs. My own Cal undergraduate pedigree made this an easy place to bond, both in celebration and commiseration.
I later learned that corporate real estate guys generally fall into two camps: Day Trippers and Over Nighters. Day Trippers frequently have a young family at home and press to get a long day of touring real estate jammed between a very early and a very late flight. The brutal pace of their rapid-fire visits frequently left sites hastily glazed over, or missed altogether, and important questions left unasked. As an empty nester, Larry was not beholden to such demands and fell in comfortably among the Over Nighters. I emphasize the word comfort.
The typical real estate tour went something like this: Larry would alight his train at the Stockton Station mid-morning of a mid-week day. We would tour sites in the targeted central valley cities until about 1 pm, at which time we would seek out and uncover a local restaurant and enjoy a pleasant lunch, discussing the sites of interest that we had seen, how we would frame the offers, which sites remained on the afternoon itinerary, and finally, what was for dinner. We never ate in the car. Following the afternoon half of the tour, we would repair to a better local establishment for dinner and a beverage or two. The following morning, I would meet Larry for an 8 am breakfast and recap, followed by a half day in my office going over proposals, site approval packages and strategy. I dropped Larry at the train station by mid-day, and he dined en route back to the Bay Area, making calls and catching up on paper work.
Larry had both the pace and the wisdom of an experienced veteran, allowing himself to thoughtfully evaluate his real estate choices, spending both am and pm time in the market to take its pulse, all the while teaching and evaluating his young charge (me). In retrospect, I thank God that I was young and single, not worried about rushing home to my family. Instead, I was pleased to have the chance to spend 12-15 hours per day with my client, and presumably he was pleased to have someone that could give him both quality and quantity of effort.
My work ethic was met with loyalty and a frequently expanded territory to cover. Also, my appetite to consummate real estate transactions was matched by Larry’s desire to exceed his store-opening goals. Over the next decade we would complete over 100 transactions together, opening stores over a territory that covered nearly half of California. By my estimate, those 100+ store openings probably represent 500 to 700 sites that were visited, evaluated and/or pursued. It was a lot of work. But with it went a great deal of success, and many prized relationships across our industry built on mutual success.
Thirty years later, I am now the one who is beginning the fourth quarter. That sounds strange to me, because I still really do have the mindset of the young broker who has to hustle for every break. I realize that a few very important clients who became great friends, like Larry, loom large in my mind and have helped make my career and our firm into what it is. No doubt I’ve incorporated their lessons and adopted their philosophies about succeeding in commercial real estate. And my guess is that some of the young people who work with me will borrow a few of these lessons that I have paid forward, while chuckling at my quirks.
Thank you, Larry. I don’t know if I ever properly said thank you. It just took a while for me put the time we shared into its proper context. But with age comes wisdom, and gratitude for what we have been given. That’s why in my book, you’re the real Larry Legend.