By Meghan Hall
Since the pandemic began nearly nine months ago, all eyes have been on the retail sector and the industry’s real estate fundamentals. Experts have quickly learned that the latest market correction is impacting the industry in ways different from economic cycles past, and the factors that once made the strength core markets seem nearly indisputable have proven to be a shortcoming in the face of the coronavirus. Retail in markets such as the San Francisco Bay Area and Puget Sound will likely face challenges into 2021, as retail continues to adjust to new realities, according to a recent report released by Colliers International.
“I have been through a number of market cycles before…and the retail that holds on best, usually, in a downturn and the markets that are the most resilient are those with sound fundamentals: affluence, education, density, markets that are not over-built,” explained Colliers’ Executive Vice President of Retail, Julie Taylor. “What is different about this cycle is that many of the markets that have been most hurt [now] are those that have been more resilient in the past. The things that have made that market resilient are completely absent in a COVID-19 environment.”
In both Northern California and the Puget Sound, real estate assets in the suburbs fared better than their urban counterparts. In Northern California, overall retail leasing volume has picked up since early September, but Colliers cautions that the market will remain challenging well into 2021. The Northern California market saw its availability rate grow to 8.1 percent, translating into nearly 183,000 square feet of negative net absorption across the region. The Peninsula alone accounted for 62 percent of negative net absorption, with 113,000 square feet of space added back to the market. Rents softened only modestly—a more positive sign—decreasing about one percent to $24.35 per square foot.
Markets such as downtown San Francisco have faced the largest challenges. By the second half of the year, the city still faced an unemployment rate of 7.8 percent, and its retail availability rate increased to 16.5 percent. Foot traffic in the hardest hit markets of the city, like Union Square and the Westfield Mall, are down as much as 90 percent. Rental rates, although fluctuating, are up from the first quarter of the year from about $42.50 per square foot to just over $44 per square foot. Transactions such as Ingka Group’s purchase of 6×6 on Market Street from Alexandria and TMP Partners also provide hope for the future of retail in San Francisco.
“That is a property that has been a tremendously exciting idea and project, but remained uncommitted,” said Taylor. “Now we have somebody who is incredibly committed to realizing a vision to occupy the property and make it vibrant…It’s an incredibly important piece of the greater puzzle.”
The Peninsula submarket has also been relatively quiet in the face of coronavirus, with increases in vacancy and softening rental rates. By the end of the third quarter, retail availability grew to six percent. Redwood City, San Carlos and Belmont saw the largest jumps, increasing from 2.5 percent to 6.8 percent quarter-over-quarter. Rents continued to dip to about $37 per square foot triple net, down slightly from the beginning of the year.
Silicon Valley has produced a similar narrative. The submarket saw its availability rate rise to 6.7 percent, likely due to an influx of new product. Markets like Mountain View, Palo Alto and Los Altos remained strong, with 3.7 percent availability. Rents dipped just 0.3 percent to $34.74 per square foot. Palo Alto, Mountain View and Los Altos saw its rates increase 4.9 percent to more than $60 per square foot.
In the East Bay, vacancy only increased modestly from 8.44 percent to 8.54 percent, while rents decreased from $31.98 to $28.18 per square foot per between the first and third quarters.
Colliers notes that while many expected a “retail apocalypse,” fundamentals have not fluctuated as much as first predicted. While headwinds do certainly remain, a rebound is expected once the pandemic has passed, as rents and vacancy rates have held relatively stable and in line with historic levels.
“Activity is so much more limited than it was just because a lot of retailers are very much still on pause, or they’re slow playing their negotiations,” said Taylor. “We have seen the momentum start to pick up with announcements of vaccines, and we are anticipating a significant shift because there are a lot of opportunities out there with the softness of rents. People want to expand when things are more affordable.”
The Puget Sound—considered by many to be another dynamic market with strong fundamentals—has seen similar trends to the Bay Area but has managed to remain stable. The total availability rate across the Puget Sound’s 132 million square feet of inventory came in at just 3.6 percent. In suburbs like Bellevue, the total availability rate was even lower, at 2.8 percent.
The relative strength of the Puget Sound retail market compared to national averages and historic numbers was relatively surprising, according to Colliers’ Puget Sound and Portland Research Manager, Jacob Pavlik.
“I think it makes sense when you are looking at the full picture, you would assume that retail is doing poorly,” said Pavlik. “Nationally, retail is actually performing much better than anticipated and the story is not too different in the Pacific Northwest. I think Seattle and Portland are uniquely positioned to weather the storm given our historically low availability rates and the rents that we’re able to get.”
The Pacific Northwest in particular, noted Colliers has been bolstered by a saturation of tech workers who have been able to maintain employment despite work from home. This, coupled with relatively high median incomes—just under $79,000 per year region-wide—has meant residents have discretionary spending money.
And, as retail follows rooftops, suburban markets are continuing to fare better than core assets in the Puget Sound.
“Suburban lifestyle centers are the ones faring the best, by far,” said Pavlik. “If you are a retail property and you’re located in an area where people can drive to you and where there are drive-through opportunities, or you live in one of those areas that hasn’t been hit hard by unemployment, then those factors go together.”
The strength of suburban retail will continue to be a trend through the medium-term, believes Colliers, and core assets will see once foot traffic resumes in urban centers. Colliers notes that consumers—79.4 percent—miss visiting shops and malls for social interaction. 62.8 percent of consumers miss retail and malls as a destination within their communities. Once vaccines are widely distributed and retailers can operate without strict occupancy requirements, there will be demand for brick-and-mortar retail footprints.
“I think we all miss running an errand more than we want to admit,” said Pavlik. “I think we’ll be surprised by how many people start going into stores versus what they have been doing for the previous year.”