San Diego Retail Centers Blossom : Chains Seek New Outlets as County Population Booms

With the opening of two super regional shopping centers--North County Fair in Escondido and Horton Plaza in downtown San Diego--within six months of each other, a lot of hoopla has focused on malls.

But neighborhood-center leasing agents have quietly known for two years or so that retail has been about the hottest type of property in the San Diego commercial real estate market.

The reason is that the office and R&D; complexes are overbuilt, resulting in high vacancies (up to 40% in some areas of the county and about 27% overall) and low rents (about $4.80 to $11 per square foot on an annual basis).

But in the retail market, a shortage of zoned land, low interest rates, better economy, booming population and the need for chain stores to follow, all have contributed to very robust retail activity.

The Right Demographics

While offices are often built before most of their leasing begins, the opposite can be true for strip centers.

"There are national or regional chains that want to be in every regional mall, and others that choose strip centers where the demographics are right," according to Dick Bridy of the John Burnham & Co. real estate firm.

"When I have a center that meets the needs of one of the chains, I know they will want to be in, so the space is leased before the center opens."

Although no accurately documented retail vacancy statistics are available, some areas, such as Kearny Mesa and Mira Mesa in North County, are enjoying a 2% vacancy factor, according to Bridy. In a "high" retail vacancy area like Poway, 10% to 14% is more standard. That would be considered low in a new office building.

Limited Partnerships

May Centers of St. Louis, and Ernest W. Hahn Inc. of San Diego, own seven of the nine super regional malls in San Diego County, but the hundreds of strip centers (100,000 to 300,000 square feet) and neighborhood centers (generally under 100,000 square feet) are owned by limited partnerships, pension funds, individual investors or retained by the developer.

Today investment interest is shifting away from apartments (with the continuing risk of rent control) and poorly performing offices to shopping centers.

"Because of the bad economy in 1981-83, retail was doing poorly. Business was bad and rents couldn't be raised," Steve Avoyer of Flocke & Avoyer Commercial Real Estate, said. "But now, retail is the darling of the investment community.

"Rents are high ($1.25 to $1.50 per square foot per month in prime retail areas) and tenants pay triple net (all operational expenses such as real estate taxes, insurance and maintenance). Offices are just starting to go to that type of lease, where feasible."

People Didn't Move

Retail developers are watching demographics carefully. Formerly, a strip center was built right along with the residential area it would serve. The 1980-83 recession changed that. When home building stopped, the people never moved in to shop in the stores that were already under construction. Now the houses must be built and occupied before the center is started.

Partly because of these demographics, there is a shortage of prime locations. They are either six to eight years away from having sufficient population bases (outlying areas) or too fragmented and overpriced in mid-city areas of San Diego, according to developers.

Prices for zoned land in outlying areas are in the $10 to $15 per square foot range, but mid-city locations can be 50% to 100% higher.

"We're very aggressive on price for 100% locations," said Mark McLaren of Sickels McLaren & Associates, developers of 10,000-40,000-square-foot centers. He added that his firm recently paid $1.3 million for 1.45 acres in Hillcrest (mid-city).

"We can pay that for good retail space in an area that has not seen new space for a long time," he said. "We are expecting the rents to be $1.50 or better per square foot.

'Some Locations Overpriced'

"But we're very conservative on sites. Some locations, especially, in suburban areas, are becoming overpriced. We're seeing residential builders or office developers buying those sites, just to get into the retail market. We feel the sites just don't 'pencil out' at those prices."

Much of the retail development and leasing activity is due to increased demand from:

--Off-price strip centers that continue to flourish throughout Southern California where retailers can benefit from lower rents than in regional malls. Avoyer noted that now department stores are running sales every week, instead of several times a year to compete with successful off-price stores like Marshalls.

Opened Discount Outlet

Even Nordstrom opened a discount outlet, Nordstrom's Rack, last year in a Mission Valley strip center. He added that some smaller retailers, like video tape rental shops, even prefer an off-price center and add to the demand for space.

--The Home-improvement market which is undergoing considerable change with the addition of Home Club and Home Depot to San Diego. "These stores are being built at unheard of sizes (100,000 square feet) for home centers," said Jeff Bradley of Coldwell Banker.

"Right now the competition for home-improvement sites is great for brokers," added Avoyer, "but it will be interesting to see how many will survive in five years."

--Expansion of chains, which puts the "American Dream" of owning your own business out of the reach of most individuals if that dream includes leasing prime retail space in Southern California and other parts of the country as well. Chain stores rent most retail space today.

'Chains Run Good Business'

"The chains run a good business. They advertise more and have the financial backing to see them

through the slow start-up period," McLaren said.

"If someone is looking for space to start a business today, I'd have to say, 'Stand in line,' " added Bridy.

However, Bradley said, "Half of my leasing activity comes from the small businessman. I look at a combination of things when recommending a potential tenant--two of them being experience and financial statement.

"If someone has never owned a restaurant but managed one successfully for 15 years, he's a good candidate. Likewise, if another individual has sufficient savings, I know he won't have to go out of business right away."

--Increase in the number of manufacturer outlet stores, importer's retail stores and more segmentation or specialization of inventory. This last category comes from a spotty trend in which a retailer or chain is specializing inventory between two or more stores--such as Foot Locker and the new Lady Foot Locker (both owned by Kinney Shoes) thus renting more retail space.

Lower Interest Rates

Lower interest rates have benefited new retailers as much or more than the developers, who typically, have construction loans tied to the prime interest rate (one to two points over prime). The retailers have been able to finance their inventories at lower cost, so they may have more money left for rent. But most sources say they believe tenants are now showing resistance to further rent increases.

Zoning and land use ordinances--not to mention other forms of public protest--continue to be nuisances to most real estate developers in San Diego County.

Ernest Hahn first approached Escondido for the North County Fair location 20 years ago, but dropped the idea after much public opposition. When negotiations began on the site again in the late 1970s, two voter approvals were required before construction finally started in 1984.

Besides San Diego's topography with its many canyons and surrounding mountains that tend to segregate population areas, the passage of Proposition A has restricted development in future urbanizing zones for years.

Land Value Drop

A recent planned-district ordinance in San Diego set up restrictions in certain commercial areas that actually has caused land values to drop for prime retail space.

Despite this atmosphere, some smaller cities are seeking retail development because of the sales tax revenue it brings.

For example, Price Club and its neighbors, Levitz and Home Club helped boost sales in San Marcos (North County) by 33% from 1983 to 1984 when the $55 million Vallecitos Town Center opened, and 58.4% from 1984 to 1985. Since 1% of the 6% collected on retail sales is returned to the city by the state, cities like to keep shoppers in their hometowns.

Retail, along with the rest of the commercial real estate market runs in cycles. Most experts indicated that the current expansive cycle has been building for about two years and may be reaching maturity.

"I'm not a guru on these matters," claims Avoyer, "but for the next six months or so, I think things will continue to be hot. After that, it's anyone's guess."

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