As printed in the San Diego Business Journal and in the San Diego Daily Transcript
ANALYSIS : SAN DIEGO
COUNTY RETAIL INDUSTRY 1997-98
By K. James Flocke
Principal
FLOCKE & AVOYER Commercial Real Estate
In San Diego County like everywhere in the nation, the retail industry has always been, and will continue to be, like a Darwinian struggle of survival of the fittest. But for many retailers, the recent recession dramatically accelerated the life-or-death struggle. Many regional malls were threatened with extinction; many mom-and-pop shop tenants -- and a number of the typical, free-standing pad users like some of our local financial institutions -- did in fact become extinct.
To understand the condition of San Diego's retail industry today, not to mention projected conditions for 1998, it's necessary to look back to the recessionary years of the 1990s, which witnessed dramatic changes in retail patterns.
The first half of the decade was characterized by considerable expansion by virtually all of the price-value type of anchor retailers until the level of competition became incredibly brutal and resulted in many casualties. Competition placed increased pressure on these retailers to grow sales, increase market share and drive down their cost structure -- all while delivering value to the customer and making a profit at the same time. The "category killers" of the world -- the Wal-Marts, Targets, etc. -- generated such massive competition in their respective categories that by the time the dust had settled, we were down to two or three dominant survivors in each category, and sometimes really down to only one, such as Toys 'R Us. The resulting shake-out/consolidation process greatly reduced the pool of anchor tenants to fill a center, which understandably made developers, lenders and investors alike increasingly nervous.
While price value category killers were vanquishing the once-mighty, they also a virtually obliterated the small shop tenants in many projects. The problems of small retailers were further exacerbated by an evolution in the supermarket industry. As supermarkets, in their quest for increased profits, expanded their merchandise lines and began introducing competing such concessions within their stores as dry cleaners, videos, florists, restaurants, banking services and such, the benefit to the small shop tenant of locating next to the supermarket was greatly diminished. The surviving shop tenants were predominantly service users and food establishments and far fewer retailers.
As San Diego began to recover from the recession, so did the retail sector in general. San Diego's retail market in bottomed out in mid 1994, and has improved slowly and steadily since then. We finished 1996 with a nice increase in retail sales and a solid level of retail construction activity in the county, although not as much construction as during 1992 though 1995. The overall improvement of San Diego's economy, with its attendant job and residential growth, made the market strong for supermarkets, drug stores and home improvement retailers -- all of which remain very active. Although not as pervasive as in the past, there are a number of power center-type projects in various stages of pre-development around the County.
In 1997, we may have finally returned to a healthy balance wherein all the parties in the retail sector -- tenants, landlords, lenders and investors -- have more realistic expectations and are more careful in their approaches to the business. Specific characteristics -- some not without incumbent challenges -- of the 1997 marketplace include the following:
In addition, there is something interesting occurring. We are seeing an increasing number of institutional investors now getting directly into development themselves. As it has become increasingly more difficult to win the race for existing product, particularly competing for anchored projects in good grade areas, institutional investors are finding they can manufacture the product cheaper and at higher starting yields than they would typically see through acquisition. Although development can certainly have its share of risk, to me this seems like a very smart way to go.
And now for the big question: Where do we go from here?
FLOCKE & AVOYER Commercial Real Estate is very bullish on the long-term prospects for the retail sector in San Diego County. San Diego is projected to be one of the top 10 metropolitan areas in terms of job growth between now and the year 2005, and it is this continued job growth that will fuel the economic engine of the region. We feel the local economy should see a good run for at least another two to three years and we feel there is a bright future for well managed retailers and well located/well thought-out retail projects.
There are, however, some cautionary notes that should be registered. Although consumer confidence and job security have improved significantly, there remains a high level of consumer debt which will continue to be an undercurrent affecting shopping patterns, as is evidenced by the continued weak sales among a considerable number of soft goods retailers and restaurant chains.
Also, we don't feel we have seen the end of the shake-out and consolidation among price value/big box retailers as they continue to fight for dominance in their respective categories. Does anyone actually know how many months Incredible Universe was open for business at its Interstate 15 location? I'm guessing 18 to 24 months, tops -- a classic case of a 185,000-square-foot Brontosaurus becoming extinct in record time.
One thing for certain is the rate of change in retailing will accelerate. To distinguish themselves from their competitors, retailers will be reinventing themselves at increasing rates, and to accommodate this rate of change, the retailers will be asking landlords for shorter primary terms, more options, options on adjoining space. We also expect more retailers will seek to reserve expansion areas as does Wal-Mart. An example of a leading retailer that is changing its format at an incredible rate is Walgreen Drug Stores: in the last several years Walgreen's has changed its prototype size roughly a half-dozen times, going from 18,000 to 13,000 square feet (and various sizes in between), and then introducing a 2,500-square-foot store with a drive-through.
We believe we are seeing the end of an era where the box retailers made deals to gain market share in order to satisfy Wall Street rather than making deals based upon strong demand for their product in the given trade area, and this is good news. As the Wall Street era slows down, we hopefully will enter a phase where the expansion plans of retailers will be based upon profit growth and not purely upon sales growth. We believe the dominant players will have operations that will be profit-and-cost focused.
Another issue on the horizon is the aging of the baby boomer generation and what will happen as this population segment gets ready for retirement -- saving more, spending less and, accordingly, becoming a diminishing factor in consumer spending. Many economists that track the retail industry are concerned that spending cannot sustain strength in an economy whose biggest population bubble is moving out of the most dynamic spending bracket. It will be very interesting to see how this plays out and what the real impact on consumer habits will ultimately prove to be.
Statistics show an ever increasing number of dual-income families, a trend that we feel will continue for the foreseeable future. This trend leads many industry experts to characterize today's customer as very time-constrained, yet virtually every sizable project is looking to add an entertainment component, which might seem a contradiction. Our reading of the phenomenon is that time has become a very precious commodity for consumers: if they are shopping for "necessities" they better also be receiving value, convenience and service, or if they are going to a shopping center for entertainment, they better have a truly "fun" experience or otherwise they would rather be home spending time the family.
A marriage of retailing and entertainment certainly has taken place and it is a trend that we definitely feel will continue, although we do expect a shake-out among the mega-plex cinema chains, as well as the inevitable recycling of the existing, smaller theater facilities. Lending credence to the adage that "one man's lemon is another's lemonade," we are beginning to see several new, relatively small theater chains come on the scene and specifically target the older theater facilities.
The "Entertainment Center" is a new and evolving concept and the shake-out of the megaplex operators aside, it will be very interesting to see where the concept ultimately goes as such powerhouses as Disney, Stephen Spielberg's DreamWorks and Sony become more involved in this new area of retailing. We also are seeing an increasing number of Interactive or Presentation stores like Oshman's Superstore, which is a trend that we believe will continue. The entertainment aspect of this format increases store traffic and average ticket sales size.
While the cornerstones upon which most retailers will continue to build their success and growth will remain their ability to deliver value, convenience and service, there are segments of the retail market that will have to also deliver a new fourth ingredient -- the "fun" component. Obviously, if you are selling auto parts like Pep Boys, it's value, convenience and service that count. But the introduction of entertainment and "fun" into the shopping experience is valid, and successful retailers will always come up with fresh merchandising plans and new formats to separate themselves from the pack.
Looking at San Diego County retail in the near term, we anticipate the following activity:
We do have reservations about a retail concept that is doing well in the Midwest and has been considered for Southern California. This concept is the "super center," which is a discount store such as Wal-Mart, Target or Kmart combined with a supermarket of 50,000 to 60,000 square feet, for total box size of approximately 190,000 to 200,000 square feet. We think this concept will be difficult in Southern California, with its population density and land prices. Competitive and survive in Southern California's already brutally competitive supermarket industry. We don't see Southern California consumers wanting to battle through a 17-acre parking lot and a 200,000-square-foot box to do their grocery shopping three and a half times a week.
Finally, it would be remiss to not mention the Internet, which we feel will have a huge impact on retailing in the future. We expect use of the Internet to increase explosively over the next five to 10 years, and we predict that retailers who embrace it and learn how to use the Internet will find it a tremendous source of revenue. Although presently there is concern among consumers about the security of making purchases over the Internet, with billions in sales potential at stake you can be sure the retailers will solve the problems.
When home videos exploded on the scene some years ago, many people predicted the end of the theater business as we knew it. It didn't work out that way -- the cinema and home videos ended up complementing each other very nicely, and that is what we think will occur with the Internet and shopping centers. We believe the Internet will become another avenue of convenience provided by retailers, and that customers will avail themselves of the Internet as well as continue the shopping experience. We expect to see many chain retailers evolve to multifaceted marketing wherein they have their regular retail stores, perhaps outlet stores, a catalog forum and then Internet sales operations. As sales over the Internet increase in the coming years, it will certainly apply pressure to shopping centers and to the retailers themselves to stay on the cutting edge in terms of the presentation of their stores and the way they merchandise. While the experience of shopping can never truly be replicated on the computer, it will be incumbent upon shopping center owners to make the shopping experience one of excitement and energy.
K. James Flocke and Stephen E. Avoyer are the founders and principals of FLOCKE & AVOYER Commercial Real Estate, San Diego's largest-volume, locally domiciled commercial real estate brokerage concentrating solely on the marketing of retail properties. Since its establishment in 1985, FLOCKE & AVOYER has been involved in $1 billion in total lease and sales transactions. In addition to representing retail tenants and offering comprehensive shopping center development consultant services, FLOCKE & AVOYER is the exclusive marketing agency for nearly 100 shopping centers (more than 9 mllion square feet of retail space) throughout San Diego County.