By Matthew M. May, President, May Realty Advisors
A bird’s-eye look at the Los Angeles metro prior to the coronavirus outbreak reveals that the area was already beginning to soften as it worked its way through more than 1.26 million square feet of new retail space that was delivered to neighborhood and community shopping centers over the past five years. According to REIS, about 35 percent of that, or 443,000 square feet, came online in 2018.
Vacancy rates increased every year for the past five years, while averaging about 7.3 percent for the metro area in 2019. Despite the increasing vacancy, we also had quarter-over-quarter and year-over-year growth in asking rents, primarily led by increases in the higher-end neighborhoods.
Matthew M. May, President, May Real Estate Advisors
At the street level, quarterly asking rents for neighborhood and community centers averaged about $33.03 for 2019, while increasing about $0.5 per square foot from 2018 to 2019. However, pre-leasing has been weakening over the past few quarters.
Discussions in development circles were indicating fewer mixed-use projects in the planning stages with more builders favoring dedicated multifamily builds. Nevertheless, new retail inventory was in the pipeline for this year, with optimism surrounding the evolving retail landscape.
All of this was, of course, pre-coronavirus, which changed everything. No one really knows what the long-term impact of the pandemic will be. However, I believe we’ll see three market trends begin to take shape as retailers, developers and investors in metro LA reassess and pivot with strategies to address the new market conditions and emerging landscape.
The Los Angeles market will experience an accelerated conversion of closed restaurants into ghost kitchens as the takeout and delivery trend hastens its grip on consumers. Closed boxes will continue to convert into distribution centers, essential retail services, or be slated for redevelopment. We’ll also see development projects shift to new ownership or new purposes as the market adjusts.
Pre-coronavirus, developers were already leaning away from LA mixed-use projects that had traditional ground-floor retailers. This trend will continue with the exception of spaces for regional or national credit tenants, such as grocery and drug stores, and health and wellness centers.
We’ll see a wave of vacancies in the short-term as retailers and restaurants that were unable to survive the shutdown permanently close their doors. The brunt of this will be taken by independent operators.
Many of the big box retailers that were on shaky ground prior to the pandemic had already closed. Those on life support will now have to pull the plug. To create liquidity, some retailers will execute sale-leasebacks while others will be forced to sell at reduced prices. Meanwhile, billions of dollars of dry powder wait on the sidelines ready to pounce.
LA neighborhoods with stronger demographics will likely bounce back quicker as demand, combined with discretionary income, will help restore sales.
Asking rents that were already too high will now dip between 10 percent and 30 percent as landlords will have to make more concessions to bring in new tenants and keep existing ones. Going forward, risk mitigation will be an even stronger consideration as underwriters tread more cautiously, landlords look for protections, and tenants attempt to secure a way out or through the next pandemic or force majeure scenario.
Two of LA’s core industries, entertainment and hospitality, were hit hard by the pandemic. While we don’t know for sure how things will evolve over the coming months, we do know that Los Angeles had an expanding economy going into the crisis. This strong foundation, along with our ability to quickly adapt, should aid in our recovery.
Does that mean we’ll get our Hollywood ending? While the plot may develop slower or differently than some would like, I think we’re going to be surprised at the better-than-expected reviews.