The Price Is Not Right : Escalating rents have retailers in the Southland playing musical chairs.
Scenes from the lease struggle in Southern California:
* After 33 years on the swankiest part of Little Santa Monica Boulevard in Beverly Hills, veteran restaurateur Jean Leon this month moved his five-star La Scala restaurant to nearby Canon Drive. He had been paying rent of $3,500 a month plus $3,100 a year for property tax on a 10-year lease. When the lease expired, the landlord wanted a whopping $36,000 a month, plus $57,000 a year for property tax, plus 6% of his gross sales, plus a cost-of-living increase after the first year. “It’s insane and it’s greedy,” Leon says. “No restaurant can afford that type of lease.”
* Manuel’s Custom Upholstery used to be on Sepulveda Boulevard in Westchester. But owner Manuel Madrid’s lease ran out, and his rent almost doubled--to $2,800 a month. So, even though most of his customers are in West Los Angeles, Madrid moved to a seedy stretch of Adams Boulevard near Crenshaw, where he rented a small storefront for a much more affordable $1,000 a month. “My shop was three times bigger (on Sepulveda), and the neighborhood was better,” Madrid says. “We didn’t want to move, but we had to move.”
* Sara Schifrin has operated her women’s clothing and gift shop on Montana Avenue in Santa Monica for eight years. She’s watched the avenue change from a neighborhood shopping area to a trendy “walking street” that draws people from throughout Southern California. She calls herself lucky because her landlady has not raised the rent much, even though business is growing. “Actually, I’d prefer to do less business and maintain that neighborhood feel,” she says. “I believe in quality of life.”
There is trouble in retail paradise. The region’s well-established stores and service businesses--dry cleaners to nursery schools, hardware stores to shoe repair parlors--have been served with sizable rent increases in recent years, and not just those in the trendiest neighborhoods and malls.
Although the most dramatic increases have been felt in areas such as Westwood Village, Rodeo Drive and Montana Avenue, retail locations across the Southland have experienced a significant increase in rents. Some merchants that moved from Westside stores to other sites from Orange County to the San Gabriel Valley to get away from high rents are now faced with huge increases at their new sites.
Many stores have relocated, but more have simply disappeared in the cross-fire of skyrocketing land values and upstarts eager to pay high rents to reach Southern California’s free-spending consumers.
In the parlance of leasing and real estate experts, what’s happening is a “conversion to higher-end” businesses, which roughly translates as a death knell for those merchants who cannot or will not raise prices high enough or cut overhead deeply enough to pay much higher rent.
“I think rents going up are a way of driving out (merchants) who aren’t financially prepared for an upswing,” said Sandy Allen, a property owner on Montana Avenue. “Maybe it’s unfortunate because it would be nice to have that diversity, but it’s the American way. If you can, you can. If you can’t, you move.”
To be sure, not all of the thousands of retail businesses in Southern California have faced stiff rent increases. Bigger stores and shops, particularly those that “anchor” malls or neighborhood shopping strips, have had the leverage to hold down their rents by threatening to leave. In some parts of the region, even smaller retailers and shop owners have been able to forestall rent increases because of higher vacancy rates in a few areas.
And the run-up in rents has hardly caused a flood of business failures. In fact, statistics indicate that Southern California remains one of the few places in the country where chains are still clamoring to get in and retail businesses are still being bought or started at a healthy clip.
No sooner does one business owner decide to sell out because of high rents or competition than someone comes along to take his or her place--usually buying the business and the lease at a price that gives a healthy profit to the person who is “going out of business.”
Observers trace the soaring lease phenomenon to the seemingly insatiable appetite of area shoppers, coupled with the rise in the 1980s of “walking streets” such as Melrose Avenue that have revived quiet, older retail space where longtime merchants had enjoyed cheap, stable rents. Space in the region’s malls has also increased significantly in price, but the biggest hikes appear to have come for storefronts and free-standing sites.
Also, nearly a decade of relative prosperity and low interest rates has created a frenzy of commercial and retail real estate deals in Southern California. Some prime parcels have changed hands two or three times, each time at a much higher price. This has given birth to a generation of landlords waiting impatiently for long-term leases to expire so that they can impose sharply higher rents to cover their own huge mortgages.
Neighborhood Retailers Out
“What it does is take away the neighborhood retailers who knew you and bring in the chains,” says David C. Lachoff, senior marketing consultant for Grubb & Ellis, a large commercial real estate firm.
On a larger scale, the phenomenon is what accounts for the loss of many supermarkets and gas stations in parts of Southern California during the past 10 years. The rising value of land--and the resulting higher price of a lease--makes it too difficult for some low-profit businesses to hang on, or else the price offered to sell out is too tempting.
How severe is the problem? No one is certain, because no detailed statistics on leases or business turnovers are maintained. But experts say a tripling or quadrupling of Southern California business lease costs has occurred during the 1980s.
There is plenty of anecdotal evidence to support that. Walter Bass, chairman of the Service Corp. of Retired Executives, a volunteer group that counsels business owners through the Small Business Administration, says SCORE has noticed an increase in the number of businesses seeking assistance when their leases expire and they are faced with sharply higher rent.
To some, the situation is not new and nothing to be worried about.
“We’ve always seen a rise in rents and we’ve always had a rise in demand (for store space),” said Brent F. Howell, first vice president and national director of commercial properties for the Coldwell Banker Commercial real estate firm in Los Angeles. “This (Southern California) is where major trends are begun in merchandising, and this is where merchants still want to come.”
In the past, however, leases were much simpler. A tenant typically agreed to pay a given rent for a fixed period. In the 1970s, that began to change when landlords demanded inflation adjustments, and rents usually rose every year to match the cost of living.
But in recent years, as the underlying value of the land has soared, landlords have added other terms to the leases--most notably “triple net”--as a means to increase their income from properties that have risen sharply in value. In a triple-net lease, the tenant pays not only rent but also insurance and property taxes, and makes all repairs.
So far, the spiraling cost of retail leases has not occurred in Southern California’s booming office space market. Observers say office space prices are still “competitive” because vacancy rates are relatively high--18% regionally at present. New space is being added rapidly enough to hold down lease costs, they say.
Although new retail space--particularly in malls--has continued to be built in Southern California, the vacancy rate is much lower than in the commercial and office market, they add.
The rise in residential real estate prices in Southern California during the past decade produced a spate of municipal rent-control laws designed to prevent landlords from driving out tenants by substantially increasing rents. But there are no rent-control laws governing the price of commercial or retail rents, so landlords are free to charge whatever the market will bear.
In some other regions, local governments have stepped in to control retail developments in certain neighborhoods. In San Francisco, for example, the size of stores in some areas was limited; this was done to keep out retail chains, which typically require larger stores. The thinking was that if chains are barred from coming in, rents will not rise as much and smaller neighborhood businesses will not be forced out.
Chopping Up Space
“The rent a business can pay is all determined by the volume it can do,” said Daniel Blatteis, a partner in Blatteis Realty, which does commercial and retail leasing in Los Angeles and San Francisco. “The chains can do higher volume, so they’re willing to pay more for space. The mom-and-pop businesses can’t keep up.”
Ironically, although chains clearly have forced out some smaller businesses in the Los Angeles area, the current run-up in rents has also driven out some big, chain-owned stores and brought in smaller businesses. Posh Larchmont Village near Hancock Park, for instance, has lost both its supermarkets in recent years. The former sites of Safeway and Jurgensen’s are now subdivided into several upscale stores that are able to pay more rent per square foot.
“Chopping up the space and getting several tenants makes good sense to a landlord,” Lachoff says. The smaller tenants pay proportionately higher rent per square foot, “and if one goes bad you still have the others,” he says.
At the same time, the lease situation is dramatically changing the types of retail businesses coming to Southern California, experts say.
“The businesses coming in today are the chains and the trendier, higher-profit outlets that can afford high rent,” said Howard Sadowsky of the commercial real estate firm of Julien J. Studley Inc. in Los Angeles. “The plumber and the hardware and the bakery and the coffee shop are leaving when their leases expire, or else they’re getting phenomenal numbers to sell out.”
Businesses most likely to suffer in the current environment are those with little ability to increase their volume quickly. “A preschool is a good example,” said Melodee Cole of Westwood Financial Corp., a Los Angeles real estate investment firm. “The school can only take so many children, and the parents will only pay so much before they take their kids elsewhere. So a sharply higher lease cost will force the school out.”
Today, even small businesses need advertising, good inventory control and a strong financial plan to generate the sales that they must have to survive Southern California’s expensive rents, according to Blatteis. What’s more, the new breed of retail business--by simply being able to afford the higher rents demanded by landlords--in effect “set the market” for other businesses.
“An example was, 10 years ago, the chocolate chip cookie stores came into Southern California,” Blatteis said. “They had the advertising, sophisticated cost control and sales volume to pay high rents, but the businesses on either side of them usually didn’t, so they left.”
That pattern has since been repeated by other high-end specialty shops selling everything from yogurt to croissants.
Is the phenomenon bad for Southern California? Not necessarily, many agree. The situation forces merchants to be much more efficient, said Howell of Coldwell Banker Commercial, “to look at the profit margins of products and not just fill your space.”
Grubb & Ellis’ Lachoff added: “It was easier to be a bad businessman in the olden days. With rents what they are now, you can’t do that any more.”
Lost Individuality
For Southern California consumers, the positive result has been a dizzying diversity of retail outlets, a flood of new, trend-setting products and enough competition to hold down prices.
On the other hand, what has been lost is the local focus and individuality of shopping areas. As rents force out the neighborhood stores, only the established, regional businesses and chains will remain, Sadowsky said. “Once the Gap goes on Melrose, (the street) is no longer charming,” he said.
Similarly, Rodeo Drive in Beverly Hills has become a street not for local residents but mostly for tourists and foreign travelers, he added.
Leasing experts estimate that rents on Rodeo Drive have risen in the past decade from as little as $2 a square foot a month to a whopping $40 or more. That has created frequent turnover by businesses who find that they cannot afford to stay, a booming market in resale of Rodeo Drive leases and a loss of local businesses, they say.
Others are worried that if lease prices continue to rise sharply, the ultimate result will be a rash of vacancies and boarded-up storefronts as businesses flee to cheaper outlying areas. This could be particularly true in strip- or mini-malls, which have been overbuilt in recent years and already have high vacancy rates.
“I can’t afford the next rent increase,” said the manager of a food market in a Sherman Oaks strip mall. “I’m going to sell while I still have two years left on the lease and this is still a profitable business.”
