California NNN Retail Market
California has long been known for its vibrant economies, breathtaking landscapes, and thriving real estate markets. Among its many sectors, the triple-net (NNN) retail market stands out as an area of particular interest and resilience. After navigating the obstacles of 2020, the retail real estate industry has demonstrated remarkable adaptability and strength in the last few years. In Q2 2023, demand for retail space grew by almost 12 million square feet, according to CoStar Group, continuing the trend of growth in retail space markets for the ninth consecutive quarter.
Market Outlook
The California retail market is poised for continued growth and resilience. As the economy rebounds and evolves, several factors are likely to influence its performance:
- Technological Integration: Technology will enhance the tenant and customer experience. Retailers may leverage data analytics, augmented reality, and smart systems to optimize operations and engage consumers effectively.
- Consumer Experience Focus: As more businesses focus on the consumer experience and opt for more convenient business plans, the retail market will continue to evolve. Convenience-driven features such as seamless online shopping, efficient delivery options, click-and-collect services, and streamlined in-store experiences can enhance customer satisfaction and engagement.
- Economic Resilience: The West Coast’s robust economic foundation will continue supporting the NNN retail market. As industries diversify and grow, consumer spending and demand for retail spaces will likely follow suit.
Major Trends Across the Coast
Rising Cap Rates
Cap rates for retail spaces across the nation are on the rise. The RCA Hedonic Series, which accounts for variations in cap rates influenced by the quality of assets, indicated that retail cap rates reached an unprecedented low of 6.1% in 2022. However, by Q2 2023, they had climbed to 6.5%. Currently, the 6.5% mark aligns with the levels observed before the pandemic. In the period spanning from 2015 to 2019, this metric maintained an average of 6.6%, with values fluctuating between 6.5% and 6.7%. Nevertheless, cap rates have recently displayed an upward trend.
Top Retail Markets and Deals
Los Angeles was the #1 market for retail investment in H1 2023. This top-ranking status has been consistently upheld every year since 2016 when the market displaced Manhattan from the top spot. The surge in sales primarily stemmed from the exchange of individual properties, as portfolio transactions made up a mere 2% of the total deal volume. According to MSCI, with 125 deals closed, Los Angeles stood out as one of only two retail markets to achieve sales exceeding $1 billion during the year’s first half. Out of these, merely four deals
surpassed the $50 million mark.
The Suburb Migration and Lifestyle Changes
More than a quarter of Americans wish to move to California, according to a recent study conducted by Homebay. Additionally, due to the high cost of living, the state had a net loss of 343,230 residents in 2022. Other residents who cannot afford to stay in cities have moved to more affordable suburbs within the state. This was highly evident in San Francisco. The city was a prominent urban center that saw unforeseen population declines from 2020 to 2021. However, the most common choice for San Franciscans looking to relocate was mainly to other suburban counties within California. Among the top 10 preferences for individuals leaving San Francisco, nine were within California, and six of those were situated within the Bay Area. The most recent IRS data reveals that a significant number of individuals migrated to neighboring suburbs. However, less typical locations experienced a surge in inbound migration during the initial year of the pandemic, with certain counties witnessing over double the usual number of people relocating compared to previous years.
According to Home Bay, 25% of Americans relocated from cities to suburbs in the last year, while 31% of rural residents relocated to suburbs.
Other lifestyle changes, including evolving work-from-home policies, have also played a major role in the ongoing suburb migration. A recent statewide survey conducted by the Public Policy Institute of California found that approximately 16% of residents in California engage solely in remote work. An additional 19% have embraced a flexible work arrangement, which entails part-time remote work. This significant shift in work dynamics has initiated a noteworthy transformation across various regions of California. The prevalence of remote work has empowered specific individuals to relocate from areas characterized by high living costs, primarily urban centers, to more budget-friendly
neighborhoods.
As a result of this migration, there has been a noticeable decrease in foot traffic in once-bustling office hubs. Several California companies have begun dismantling their urban operations and shifting their focus to suburban areas, aligning themselves with the residences and workplaces of their customers. This trend will most likely persist across the West Coast as the surge in remote work continues to skyrocket.
The impact of more people moving to the suburbs on retailers can be substantial, affecting areas such as customer base, demand, competition, infrastructure, and overall business strategies. Retailers may see a shift in the types of items and services in demand. Suburban residents may have different interests and demands than city dwellers. To appeal to the interests of the suburban population, retailers may need to change their inventory and products. Adapting to the changing dynamics of suburban markets is crucial for retailers to succeed in these evolving environments.
California Grocers Market Performance
Despite inflation slowing, prices remain high, and consumers face higher costs for eating out; therefore, value grocer formats benefit. Visits to discounted grocery stores have notably increased in response to the uptick in food prices. For example, budget-friendly grocery chains, such as Aldi, are surpassing the broader grocery sector. These stores tend to prioritize their in-house brands and offer a more limited range of products, enabling them to minimize operational expenses and pass on these savings directly to customers by offering lower prices.
The Golden State has long been known for its robust visitation, making it a high-value grocery market. According to Placer.ai, since January 2023, year-over-year (YoY) grocery visits in the state have consistently outperformed the nationwide average.
The most dominant grocer in the state, Safeway, has about 11% of grocery visit share and is thriving. Sprouts Farmers Market and Aldi are also outshining other retailers in California, including Whole Foods, Trader Joe’s, and the California-based Grocery Outlet Bargain Market. However, Grocery Outlet Bargain Market is making strides and is set to open two more stores before the end of Q3 2023.
Grocers that understand what their customers want in 2023 can alter their offerings and shop layouts to accommodate shifting consumer patterns. Grocers can maintain their competitiveness even during grocery downturns by expanding beyond their core business to deliver more experiences alongside grocery products and to establish new revenue opportunities through retail media networks.
Increase in Restaurant Expansion
Major restaurant chains’ executives are looking to expand their locations, capitalizing on demand. Resilient consumer spending, coupled with the rise of digital sales, has propelled sales for many chains, fueling restaurant development and design plans. According to Costar Group, KFC, Taco Bell, Applebee’s, IHOP, Denny’s, Cheesecake Factory, and Outback Steakhouse discussed these trends during analyst calls. Yum Brands, overseeing KFC, Taco Bell, and Pizza Hut, reported opening over 1,800 new restaurants in the first half of the year, emphasizing international expansion. Operating Applebee’s and IHOP, Dine Brands Global focuses on remodeling, expanding its “ghost kitchen” network, and testing dual-branded concepts. Bloomin’ Brands, including Outback Steakhouse, plans significant restaurant development driven by robust sales growth. U.S. restaurant sales in June 2023 rose 8.4% year-over-year due to increased menu prices.
California, the origin of McDonald’s and Taco Bell, may be changing the fast-food industry. As a labor powerhouse, the state may be best positioned to be
the first state in the country to achieve the long awaited goal of unionized fast-food employees.
In 2022, California narrowly approved significant legislation proposed by the Service Employees International Union. This bill established a fast food labor council with the authority to enhance wages and establish work-related regulations.
However, the fast food industry promptly initiated a voter referendum against this law, causing its implementation to be postponed. In 2023, SEIU took action by reintroducing a bill aimed at controlling franchisors – a concept omitted from the 2022 bill. Additionally, SEIU increased its political influence by obtaining funding for a state wage regulatory body that was previously inactive. This bill fell short as a result of heavy opposition in July, however, it has the potential to return in the last few weeks of the legislative session.
