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The Troubling Math on Retail Real Estate During COVID-9 Disruption

Brick-and-mortar retail is beginning to bounce back after COVID-19 related closures, but financial pressures remain for apparel boutiques.

Retailers have spent years turning their stores into experiential centers as a counterpart to the e-commerce experience. However, now even showrooming is limited by occupancy restrictions due to safety measures.

“Before the pandemic all the conversation around retail, death of retail, growth of e-commerce, the saving grace was really experiential,” said Ryan Patap, L.A. retail market analyst at CoStar, a commercial property analytics and marketing firm. “And so that obviously has to take a backseat right now given people are scared of leaving their homes…[and] not wanting to be in more social settings. I think that’s a long-term human want, I think that will come back, but depending on how long the pandemic really impacts the economy and consumer behavior, that’s the big question mark.”

Using Los Angeles as a case study, what is the survival prognosis for brick-and-mortar boutiques?

According to data from Foursquare, foot traffic in California apparel retailers has recovered slightly. As of June 23, visits were up 5.5 percent over the previous week. However, foot traffic was down 4.7 percent compared to the daily average pre-COVID in February. At the end of last month, California was in phase three of four total reopening steps.

Even if consumers feel comfortable heading out to shop for non-essentials, the state government has stipulated that retailers reduce their maximum occupancy to no more than 50 percent of pre-coronavirus numbers.

The typical independent fashion store in Los Angeles is around 1,500 to 1,800 square feet. While real estate prices vary from street to street, in desirable areas such as West Hollywood and Beverly Hills, pre-COVID prices could average between $120 and $170 per square foot. At the top end of these figures, tenants could be paying upwards of about $25,500 per month for their storefronts.

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Carter Magnin, director at real estate services company Cushman & Wakefield in Los Angeles, noted that retailers typically want to keep their occupancy costs between 10 and 20 percent of sales to maintain profitability. Beyond the cost of rent, retailers also have to account for salaries, employee benefits and insurance, among other expenses.

Retailers are also facing investments to make their stores safer. “Costs to comply with safety guidelines for cleaning, sanitization and modifications to stores for social distancing, curbside pickup, and contactless payment add up,” said Meghann Martindale, global head of retail research at commercial real estate firm CBRE. “These increased operational costs are necessary, but will affect retailers’ bottom lines, especially as many non-essential retailers have seen drastic sales erosion during the shutdown and phased reopening.”

Patap noted that reduced occupancy might be less painful for a luxury brand as the average purchase value is greater, allowing a few high spenders to make up sales. However, the bad news for high-end retail in particular is that the wealthy are cutting back. Research from Harvard University’s Opportunity Insights organization finds that consumers in high-income zip codes decreased their spending by 13.3 percent from January to June 17, compared to a 7.8 percent decline for middle income zips and a 2.8 percent dip among lower income areas.

As an example of the sales impact of the pandemic, a Cushman & Wakefield client with a 3,000-square-foot boutique in L.A., priced at around $200 per square foot, has previously generated annual sales of about $4.5 million. It was estimating before COVID-19 that it would surpass $5 million in sales this year, but now the projections are closer to $100,000 a month or $1.2 million for the year. With an annual rent of approximately $600,000, the pandemic has pushed the store’s rent from a comfortable 13 percent of sales to a less sustainable 50 percent.

A Cushman & Wakefield boutique client’s rental outlook.

“With a reduced staff and online sales, you can probably survive for a little while doing $100,000 a month,” Magnin noted. “But I think in the long term, it’s not sustainable for two, three, four years.”

How long a company could survive on reduced sales will depend on a number of factors, including their cash availability and margins. But generally, a store can’t stay open for the long-term if sales don’t pick up.

Data from CBRE shows that in the year to date, 6 million square feet, or 5.1 percent of the total 116 million square feet of retail real estate in Los Angeles, is vacant. While this is roughly the same rate as 2019, it is still early into the pandemic.

Moody’s projects that by the end of 2021, retail rental vacancies in the U.S. could rise to 14.6 percent, based on a worst-case scenario of a 30 percent annualized decrease in GDP during the second quarter.

Patap also expects vacancy rates to rise. “If you’re looking at the larger [retail] market, vacancies were already going up for years…And so my view is that now we’re going to see that accelerate,” he said. “The gross leasing activity has been down considerably in the last two months, and so we’re seeing in the overall retail market that there definitely is a pause, as people wait.”