Bay Area Retail Fractures Along New Economic Lines

Union Square San Francisco retail real estate

By Sharon Simonson

Strong merchant demand for premium Bay Area retail locations is escalating rents for newly built shop space from San Jose to San Francisco to housing-boom levels and above, even as lesser-quality properties in inferior locations languish.

The disparity is opening a widening rent chasm between the best new properties and the rest. A 50 percent rent disparity exists even between existing class-A properties and new class-A construction. The poorest quality centers are no longer able to compete even offering rock-bottom rents, according to new research from Terranomics Retail Services.

Developers are rushing in with 11 new Bay Area centers expected to be under construction in 2013 and seven more proposed in the following two years, Terranomics says. The region leads new retail construction in the western U.S., with an aggregate of at least 3.2 million square feet approved or likely to be approved and built through 2015.

“We have reached a point where [new tenant] growth has been stunted in most of the Peninsula [from San Francisco to San Jose] because there is just not enough new space to move into,” said Garrick Brown, Terranomics’ national retail research director. National credit tenants, confronted with no space that means their standards, simply won’t move.

At the same time, the traditional distribution patterns of U.S. goods are evolving as consumers gravitate online. Already, shopping center owners are leaning more heavily on restaurant and entertainment tenants because they offer authentic experiences that can’t be replicated virtually. Also expanding are fitness centers, health and spa concepts as well as pet-supply sellers and off-price apparel and thrift stores, according to Terranomics.

Merchant demand for retail bricks and mortar within population centers also is being displaced by demand for industrial space outside those population areas but near them. Nowhere is that pattern more apparent than the Bay Area, where just announced that it intends to build a one million square-foot fulfillment center in Tracy.

The redevelopment of an antiquated shopping center at a key retail corner in Mountain View well illustrates the trends. Merlone Geier Partners, the force behind The Village at San Antonio Center on El Camino Real and San Antonio Road, is garnering shop-space rents of $60 a square foot a year to $65 a square foot in the Safeway anchored mixed-use property on the Palo Alto city line.

“The rents are pretty impressive,” Matt Kircher, Terranomics’ managing partner, said Feb. 14 at an annual retail forecast in San Francisco. “Just a couple of years ago across the street, we did a deal with MetroPCS at $28 a foot.”

San Antonio Center’s first phase, to be completed later this year, includes 330 apartments and 318,000 square feet of retail space. “This is what we expect to see more of in the Bay Area. The Safeway has parking on the roof. You have residential over retail,” Kircher said.

The center’s rents are at least 50 percent higher than projected, said Michael T. Grehl, a Merlone Geier vice president who is spearheading the San Antonio Road redevelopment. “When we underwrote the development, it was 2009, and I can assure you that we weren’t predicting $60 rents. Our expectation was that we would be in the $40s for most of the shop space,” he said.

The have-have not dichotomy is visible everywhere in the valley, where a grocery-anchored center might garner rents of $42 a foot a year, while a center only blocks away without that is asking only $12, said Todd Oliver, a Terranomics partner also speaking at the company’s annual event. “It is pretty much a different language,” he said.

The same cautious sentiments are being expressed in the investment sales market, said Dan Wald, who specializes in institutional and private client buyers. Investors were willing to accept yields as low as 5.25 percent last year for low-risk grocery- and drug-anchored shopping centers but commanded 9 percent yields for C-quality assets. “B properties are B properties because investors are wary about the sanctity of the income stream and will mom and pop be there,” Wald said.

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