Gimme an 'A'
Competition eases for California real estate
The landlord's market that has existed in California for more than a dozen years has now shifted in favor of the tenant. Real estate prices have declined, there is less competition for space and landlords are more willing to make deals with franchisees.
Landing top retail and restaurant locations in California has been a challenge in recent years due to the frenzy for good sites. In fact, the intense competition has kept some brands from expanding into the market all together. But the softening of the economy, and the retail market, is opening up new real estate opportunities.
"Some of the brands abdicated California, because they couldn't compete for locations, or (real estate) pricing was so outrageous," says Scott Kaplan, senior managing director, western region retail services at CB Richard Ellis in Chino, California. It was easier for a new Subway franchisee to get started in Milwaukee where there were more real estate options - at a much lower rate - than in California, he adds. But now is the ideal time to expand into California if you have a successful franchise, because you can acquire real estate at "sale" prices, he adds.
Top-notch locations in California that were once off limits are now within reach for many franchises.
"If you have a great concept, and if you have your financing or money in place, then it is a pretty good time to be looking for space," agrees Randy Carucci, chief development officer for The Counter, a gourmet burger franchise based in Culver City, California. The Counter has 20 locations, half of which are located in California. The chain expects to open an additional 15 to 20 stores in 2009, and is looking for locations in the San Fernando Valley, San Diego, Los Angeles and the greater San Francisco Bay area.
Given its sheer size, California possesses its own substantial micro economy. The state is home to about 36.5 million people: roughly 12 percent of the nation's population. Yet the housing bust and economic downturn have hit California hard. Much of the state rode the meteoric rise of the housing market with home values that doubled and tripled over the past decade, and then fell just as hard when properties became devalued and the residential expansion ground to a halt. In addition to slumping home values, the California job market has weakened significantly. The state unemployment rate rose to 8.2 percent in October - well above the U.S. average of 6.5 percent.
That being said, there are certainly parts of California that are faring better than others. Urban markets such as Los Angeles, San Diego and San Francisco have weathered the economic downturn because of their large, dense populations and diversified business base. In comparison, emerging markets that were in the path of new growth, such as the Inland Empire, have struggled due to the halt in residential expansion.
The Inland Empire encompasses the western-most portions of Riverside and San Bernardino counties in Southern California. Over the past decade, the area has experienced a dramatic rise in both its population and job base. The speculative housing boom generated median home prices that soared 260 percent between 1997 and 2007. In the aftermath of the housing crisis, Riverside and San Bernardino Counties now have the third-highest foreclosure rate in the county, behind Las Vegas and Detroit, according to a real estate market report by NAI Global.
The Santa Monica, San Diego and San Francisco areas have been fairly recession resistant. Historically, retail vacancies in those areas have hovered around 7 percent, and vacancies now have bumped up about 100 basis points to 8 percent. In comparison, the Riverside-San Bernardino area has seen its incredibly low vacancies of 4 percent soar to 15 percent, Kaplan notes. Those markets that have been hardest hit by the housing decline have seen a corresponding jump in commercial vacancies. Areas such as Sacramento, Bakersfield and Riverside-San Bernardino have been "hot spots of pain" for the housing correction, Kaplan adds.
Chains such as Buffalo Wild Wings are eyeing expansion opportunities in the California market, thanks in large part to less competition for real estate, while other brands are discovering that it is an ideal time to upgrade locations.
The softer market is making California real estate more affordable for local and regional retail and restaurant operators, as well as up-and-coming franchise brands that are still in expansion mode. Brands are taking advantage of the opportunity to upgrade their locations because they are able to move from perhaps a "D" to a "B" location for "C" pricing, Kaplan says. "If you have a franchise that is doing well, or have a franchise that is resistant to the downturn in the economy, you have an opportunity to land good locations right now," he adds.
Two years ago, Javier's Cantina, a popular Orange County restaurant concept, was competing for the same sites as P.F. Chang's. Shopping center owners preferred the credit and name recognition of the national tenant. Now those same landlords are more open to working with local players such as Javier's, Kaplan says. Landlords also are willing to negotiate favorable terms, such as higher tenant improvement allowances.
In addition, franchise groups can nab top locations that return to the market after deals have fallen through. For example, The Counter landed a great space in The Fountains at Roseville, a new lifestyle center near Sacramento that opened its first phase of shops in summer 2008. "We had another site in the same project that was scheduled to be built later, but we got this phenomenal space at center court because someone else bailed out on it for whatever reason," Carucci says.
The Counter prefers end-cap locations within well-tenanted, specialty-retail centers. Competition for end-cap locations has been red hot in recent years. Starbucks alone could step in and pay top-dollar rent for a high-profile end-cap location. But that picture has shifted as both restaurant and retail chains have slowed expansion plans amid the economic downturn. Tenants certainly hold more power in the current market, and that climate is expected to continue into 2009.