WESTERN SNAPSHOT, NOVEMBER 2008

Los Angeles County and San Fernando Valley Retail Market

A weakened national economy is affecting retail sales, but there are pockets in the country, such as Los Angeles and the San Fernando Valley, where prospects for sustainable, long-term retail growth support a positive market outlook. The housing downturn, combined with elevated fuel and food costs, has modified consumer spending patterns, resulting in retail sales gains of just 1.5 percent, down from 3.8 percent 1 year ago.

The metro’s housing-related employers continue to feel the effects of a slowing residential market, with many reducing headcounts. As such, metro-wide retail vacancy has pushed up in the last year, with the exception of the San Fernando Valley, where housing demand remains strong and vacancy is expected to improve by year-end 2008. Builders in the Valley have taken note of current trends and forecasts, and although approaches tend to be conservative, there is a new development platform focused on urban infill projects emerging in the Los Angeles metro area. This trend is also increasing in popularity throughout the San Fernando Valley. Developers and builders are focusing on mixed-use and redevelopment projects, such as the L.A. Live complex downtown, Pacoima Plaza and the newly constructed mixed-use Avalon Center in Encino offering high-end apartment living with ground-floor retail. Also, across from the nationally renowned Sherman Oaks Galleria, there’s the Sherman Oaks condo mixed-use project, which is scheduled for construction and completion by 2010.

In the San Fernando Valley, approximately 690,000 square feet of retail space have been completed during the last 12-month period. The largest project delivered during that timeframe was the 475,000-square-foot lifestyle center called the Americana at Brand. Tenant improvements continue at this high-end, European-style Caruso development. As a result, this open-air retail and residential property should normalize in the next 18 months, making it even more of a destination location. Developers currently have 330,000 square feet under way, much of which is anticipated to come online in 2009. The area’s planning pipeline consists of 1.7 million square feet. The 750,000-square foot Laurel Plaza is the biggest development planned for the area. Presently, no groundbreaking date has been scheduled, though the project is tentatively due for completion in 2010. After just 160,000 square feet of retail space came to market in 2007, construction activity is forecast to accelerate; builders are expected to deliver 730,000 square feet of retail space this year.

Valley vacancy will have declined 30 basis points since 2007 to end this year at 6.4 percent. Asking rents are forecast to increase 3.3 percent to $33.83 per square foot, while effective rents increased 2.3 percent to $30.76 per square foot. Sales velocity has slowed by 28 percent, due in part to the current financing climate and lenders’ strict underwriting terms, which has resulted in a decline in the number of qualified buyers. Deal flow has been limited in the San Fernando Valley’s multi-tenant sector. During the last year, sales activity for this property type has declined 74 percent, with only a handful of assets trading. Valuations, meanwhile, have risen to $372 per square foot because investors are targeting newer properties. During the past 12 months, single-tenant cap rates have averaged in the low- to mid-6 percent range, depending on tenant credit-worthiness and demographics. Multi-tenant assets have traded with initial yields in the low- to mid-6 percent range, but as the economy normalizes these yields are beginning to increase. Burbank’s city council recently approved the expansion of Hotel Amarano, which will add another 132 rooms which should increase foot traffic in the area and generate increased retail sales for surrounding retailers.

Los Angeles County’s favorable extended outlook will help to sustain investor interest in 2008, although sales activity will remain more measured than in recent years due to more stringent underwriting standards. Multi-tenant cap rates are averaging in the low- to mid-6 percent range, while single-tenant properties are trading with initial yields in the high-5 percent to low-6 percent range. Rates vary depending on property quality and location, with stabilized assets occupied by national-credit tenants commanding a premium.

Pending approval, a proposed 1-year moratorium on new fast-food restaurants in a 32-square mile area may increase a driving demand for existing properties, particularly in South Los Angeles. Cash-heavy buyers may want to explore opportunities in the west side cities, where luxury hotel renovations and new construction are under way, including that of the Beverly Hilton expansion and the Montage Resort construction in the heart of the golden triangle in Beverly Hills, which are expected to bolster retail sales for some high-end retailers in the immediately surrounding areas.

Even in a weakened economy, development and investment activity remains strong in Los Angeles, particularly on the west side and in the San Fernando Valley. There are many new ground-up development projects under way, mixed-use redevelopment projects are springing up across the metro area and well-located properties continue to trade even in the midst of shifts in the capital markets. Although the current volume of sales has slowed since the frothy times of 2005 and 2006, the prospect for sustainable, long-term growth and appreciation of property values make this market appealing to investors and supports a positive outlook for the retail market in 2009 and beyond.

Mitchell LaBar is the managing director and regional manager of Marcus & Millichap Real Estate Investment Services’s Encino, California, office, and Lior Regenstreif is the senior director of the firm’s National Retail Group and an associate vice president there.

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