By Meghan Hall
The previous two years have been interesting ones for traditional retail centers as several waves of bankruptcies and anchor store closures have continued to check the growth and stability of the retail real estate market. While the market remains healthy by historic standards, a third quarter report released by Walnut Creek, Calif.-based commercial real estate firm John Cumbelich & Associates indicates that the real estate market for tenants, landlords and developers in the retail space is changing, and that core power centers are most capable of weathering the market’s changing dynamics.
“I would say that there are a couple areas of caution,” explained John Cumbelich, the chief executive officer at John Cumbelich & Associates. “One is that we have not seen the end of bankruptcies of the big box, large format retailers. I think the real question going forward for the next four to eight quarters is what ability does this market have to continue to absorb large vacancies when we aren’t seeing a corresponding emergence of new brands seeking entry into the market?”
So far, the market has generally been able to absorb new vacancies that have hit the market. According to the report, flagship power centers across the Bay Area registered an overall increase in occupancy, with the occupancy rate up to 95.89 percent from 93.55 percent in the second quarter of 2018. The most significant increase occurred in the South Bay, where the occupancy rate rose to 93.57 percent from 87.35 percent, bouncing back after the closure of several Toys “R” Us stores. The East Bay and San Francisco Peninsula saw occupancy rates of 95.69 percent and 96.52 percent, respectively. Only the North Bay saw a small dip in its occupancy rate, which decreased slightly to 96.60 percent.
“By historic standards, these are great numbers,” said Cumbelich. “The market never really gets above 97 or 98 percent occupancy.”
However, more store closures are on the way. Lowes recently announced the closure of all Orchard Supply Hardware stores, an exclusively Northern California chain. Sears, another major big box retailer, just secured a $350 million in bankruptcy financing to allow it to keep stores operational through the holidays. Combined with e-commerce’s growing impact on the retail industry, Cumbelich believes more change is on the horizon, which will continue to alter the way experts approach real estate in the retail market.
“I’d say if you look at what e-commerce’s share of the overall pie is, there is a very steeply ascending line,” said Cumbelich. “As retail sales migrate, we’re also seeing a reduction in the number of peers within the retail category. We’ve seen a consolidation within the office product industry, the electronics industry, the apparel industry. Only the best brands continue to have a presence in the brick and mortar space.”
As the market changes, tenants, landlords and developers are altering their strategies to ensure the success of retail centers not just in the Bay Area but also around the country. Pulling from lessons learned during the Great Recession, those involved in the retail real estate market are careful about how they move forward in this industry.
Part of that solution has been to diversify the offerings available at retail centers and work toward creating mixed-use development.
“These lenders, owners and developers, what they learned was that pre-recession there was this constant wave of shopping centers being built on the edges, and they were chasing the housing, which was going further and further afield,” explained Cumbelich. “But these markets were in fact really fragile, and they didn’t have the fundamentals to withstand a huge downturn in the market.”
According to Cumbelich, the changing market fundamentals will affect flagship centers everywhere, although retailers in core urban centers typically have the stronger fundamentals needed to maintain stability. Those core markets are typically surrounded by areas with higher densification, higher education and higher income levels, giving consumers more leeway on where and how to spend. Proximity to additional factors like major employment, transit centers and high levels of traffic also increase the viability and stability of flagship shopping centers.
Those fundamentals, however, have not stopped major densification projects surrounding Bay Area malls from moving forward. Richmond’s The Shops at Hilltop is undergoing major changes, as is Newark’s NewPark Mall and the Westlake Shopping Center in Daly City. The projects are all looking to add significant amounts of residential and commercial space to support the retail components of the centers.
“I think the world of retail is learning that it can’t be an island, and that it’s going to be more successful if it is tied together with other uses,” added Cumbelich. “For the investor and developer, they are going to want to have a hedge against a pure investment in retail.”
Cumbelich says that some Bay Area centers will see more success than others as the market continues to evolve. According to Cumbelich, Santa Clara County has some of the strongest fundamentals for retailers, and the East San Francisco Bay Area, with its rapid development and educated population, will continue to see success, as well.
The U.S. 101 Corridor, however, might have more trouble in the future. “I think they’ll have a more difficult time of weathering the next round — or two — of big box vacancies,” said Cumbelich. Cumbelich sited the vacancy left behind by Mervyns at Santa Rosa Plaza seven years ago, which still has not been entirely filled and highlights the center’s trouble with absorbing new space.
For Cumbelich, the transition from retail-only centers to mixed-use developments is just starting, and there will be more to come in the future as centers become ripe for redevelopment.
“We have had great advances in the market over the last ten years, but I don’t think anybody expects that the continue rise in rental rates or new inventory will be as robust as it was over the last ten,” said Cumbelich. “These regional malls are going through a huge, cathartic transition right now.”