Despite concerns before and during the pandemic, the retail space market in California continues to rebound and shows remarkable signs of resiliency. El Warner, Vice Chair of Retail Capital Markets at Colliers, and Amanda Donson, partner at Allen Matkins, share their thoughts in the Winter 2023 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey, specifically regarding the current and future state of the retail space market.

An Impressive Rebound Shows Stability in the Retail Space

Even before the pandemic, there were concerns about the future of retail space due to a continued upward trend in online sales. However, once COVID hit and consumers increasingly made their purchases online, it seemed like retail might not recover from that blow.

However, Warner points out that “even during the height of the pandemic, only 16% of all sales were online. That was up from 12% in 2019. And now, in the third quarter of 2022, it’s down back to 14%.” These numbers show that despite the perception that online sales would hurt in-store purchases, retail has the resilience to flourish in the current environment.

Retail Is Feeding Off the Surge in Online Sales

Rather than seeing online sales as a threat to the retail market, Warner views it as a positive. As online sales increase, so does the need for retail, as evidenced by the uptick in the fulfillment of online purchases at physical locations. “In 2015, less than 10% of all online transactions were fulfilled in physical locations ... In 2020, 22%, and in 2025, we’re expecting it to be a third.”

Bringing this point closer to home, Warner remarks, "from a personal perspective, I have two kids. Their favorite restaurants are Jersey Mike’s and Chipotle. Respectively, 40% to 60% of all their orders are through online channels.” So while online sales are still above 2019 levels, the retail sector is also gaining from those sales by completing an increasing number of those transactions.

Fundamentals and Opportunity in the Retail Market Are Strong

Warner notes that the fundamentals of retail keep improving for developers and owners. In the U.S., year-to-date sales of retail space through November of 2022 were $77 billion — a 14% increase over the $69 billion sold in the same period in 2021.

Consumer spending is also up — total sales volume in 2022 saw a 9% increase compared to 2021. In the fourth quarter of 2022, the vacancy rate dropped from above 5% to approximately 4.2%, lowering the amount of available space. Challenges in developing new space are limiting supply — in 2016, there were 90 million square feet of retail space under construction, and in 2022, there were only 30 million.

All of these numbers indicate continued growth for the foreseeable future. With interest rates predicted to potentially decrease to the high 3% or low 4% range by mid-2024 and current pricing at a slight discount, Warner sees ample opportunity in the current retail market.

The Overall Sentiment for Retail Is Positive in California

There is some skepticism in California. Donson mentions Silicon Valley and San Francisco as two areas where there is a lack of confidence in the retail space. In Silicon Valley, “some struggling retail centers are proposing to subdivide and convert plazas to multifamily communities with a smaller retail component.” In the case of San Francisco, remote work, tech sector layoffs, and a decrease in tourism are casting doubt, though some of these concerns may have dissipated in recent months.

But in most of the state, the sentiment is that retail has already bottomed out and is on its way up. Even in the areas of doubt, “there is an overall expectation that retail will continue to rebound and recover with a new cycle by 2025.”

Future Expectations

Both Donson and Warner believe there will be an uptick in demand for retail in the near future. Donson mentions that as the residential market improves and people look to buy homes, they will want to see nearby shopping for household needs, dining experiences, and coffee shops where they can take a quick release from their remote work. There is also newfound demand for retail near workplaces, “with office plazas being redeveloped to make sure there are coffee, snacks, and lunch to make going back to the office a little more inviting.”

Warner expects retailers to get creative with better products, services, and entertainment to keep consumers interested and boost profit margins as retail space costs continue to increase. There might be closures since not all retailers will be able to adapt, but ultimately, that would present a natural evolution of the retail space as spending behaviors and patterns change.