Everyone has heard the “rule” that 90 percent of restaurants fail within their first year. In fact, the first year takes a heavy toll on small businesses of all types; if you don’t believe that, try opening up a bookstore in San Francisco. But added to the usual challenges of small businesses is the same economic boom that is making housing prices spike in the city. Retail space, too, is getting hard to find and harder to pay for.
It might appear to be a paradox. When the local population booms, that should be great news for local businesses. It means more customers and more foot traffic outside their stores. But San Francisco doesn’t have a large inventory of available retail space any more than it has a large inventory of residential space, so landlords looking to fill new, refurbished, or even existing space that’s facing a lease renewal are able to command top dollar for their square footage.
There are always businesses going out of business. When you have many thousands of shops, restaurants, bike repair sites, and more in a city, there is a regular turnover, and it’s not always for nice mom-and-apple-pie reasons such as the elderly owners retiring after 50 years of success. They also go out of business because one of the partners running the thing drank the profits, the food wasn’t very good, they were swindled by an unscrupulous financial advisor, or maybe they just couldn’t sell enough of whatever they were selling to make their payments to the bank. It’s sad, but it’s normal.
What is beyond normal right now is the very low vacancy rates and very high increases in lease rates that retailers are experiencing. Over the past couple years, there have been reports of numerous small businesses forced out of their space because of rental costs that doubled or more when their leases came up for renewal. As a result, they closed up shop, either moving to a less expensive location and hoping their customers follow them or giving up and retiring to Phoenix.
The challenge is not only felt by small businesses in town. As a 2013 report from Terranomics Retail Services (www.terranomics.com) notes, “rising rents and declining vacancy figures underscore the intense demand for downtown retail opportunities, and Class A landlords typically take the pick of the litter. … [I]n this atmosphere, entrepreneurial startup tenants often end up getting treated like the runt. These small boutique retail hopefuls, often unique and creative, regularly get overshadowed and squeezed out by their institutional competitors due to their lack of longstanding credit. In some instances, Class A landlords will require a letter of credit guaranteeing six months to a year’s worth of rent.”
In the commercial real estate world, “Class A” refers to the newest buildings with the most modern amenities. Younger and shinier is always rated more highly than older and experienced.
Commercial real estate services firm Cassidy Turley (www.cassidyturley.com) recently released its 2014 retail forecast, and much of the news in it is not likely to make local retailers warm and fuzzy, unless it’s from drinking heavily. For community/neighborhood retail space (the second largest category after “all shopping centers” in San Francisco), Cassidy Turley predicts a low vacancy rate of 4.3 percent, with just under 10,000 square feet of space newly leased, and an average quoted rental rate of $27.68 per square foot. That’s the lowest per-square-foot leasing rate of the various categories; specialty centers are highest at $60, strip shopping centers are the closest at $28.27, and the others — power/regional centers and malls — are somewhere in between. A possible indication of relief is that 270,000 square feet of community/neighborhood space should be under construction, and when that comes to market, it should help puncture the pricing balloon.
San Francisco’s quixotic formula retail laws — Terranomics notes that the city’s “[n]eighborhood commercial districts are controlled by stringent zoning codes that adamantly oppose any formula retail tenants opening store locations within their jurisdictions” — will continue to protect some of the neighborhood business owners from competition from large chains, and therefore it will limit the number of institutional renters getting long-term sweetheart deals from landlords. But that pressure will remain. As Cassidy Turley notes, “Luxury retailers are back and are looking for space in the nation’s high street shopping districts and trophy shopping malls. We also continue to see new concepts from abroad in this category looking for new flagship locations on top shopping streets in markets like Manhattan, San Francisco, Beverly Hills and Chicago’s Michigan Avenue.”
And once you’ve planted your luxury brand on Union Square, what better place to put your second local location than on Chestnut? Or, if there is no space in Union Square to begin with, why not start out on Chestnut and be right down the street from where your customers actually live? Again, as Cassidy Turley writes, “The shortage of Class A space is now starting to discourage growth in some trade areas. For example, we know of a number of retailers who have slowed or postponed planned expansion in the San Francisco Bay Area as they patiently wait for quality space to become available.”
To play with Las Vegas’ marketing line, what happens downtown does not stay downtown. The lack of Class A space in and around the Financial District will keep up the pressure on retail space in the neighborhoods, including the Marina. And that means good and bad things for you. Your favorite business might find itself forced to vacate its location. Or your least favorite business might find itself forced to vacate its location and a business you like better might grab the spot.
Either way, San Francisco’s transformation from the economic boom is only beginning.