2023 SoCal Inland Empire Retail Real Estate Observations
Aerial view of the downtown area of Ranacho Cucamonga, California.

Last year was a record year for the Progressive Real Estate Partners team having completed more retail investment sales and leasing transactions (134) than any other brokerage in SoCal’s Inland Empire. Although our relationships, skills, and marketing were key to our success we also recognize that the thriving Inland Empire economy and having the wind at our back as a result of post-pandemic demand certainly helped.

As the team’s leader, one of my roles is to look across the bow to see how the winds are changing and what adjustments we might need to make. In this blog I share our observations as we seek to navigate the Inland Empire retail real estate market throughout 2023.

Low Vacancy Leasing Environment and Little New Development: The current Inland Empire vacancy rate is below 6% for the first time since 2008. BUT there is a dramatic difference between then and now. From 2006 to 2008, there was over 20M square feet of retail built in the marketplace. In the past 3 years there was less than 3M square feet constructed and the pipeline remains near record lows. As such not only is the vacancy rate low, but there is very little new inventory coming online and this new inventory is mostly pre-leased. This is great for owners, but more challenging for brokers and tenants. As such this is causing us to have to be more strategic as I outline in this next section.

Causes for New Vacancies:  New vacancies are occurring mostly for the following reasons:

  1. Tenants Quitting: Many of our newest availabilities are the result of long-time businesses coming to the end of their lease and deciding not to renew. These tenants are either retiring or eliminating marginally profitable locations.
  1. Landlords Want to Upgrade: Many of our clients are evaluating their properties with an eye toward replacing existing tenants with higher quality brands with stronger credit. Often these new tenants are willing to pay higher rents. Unlike multi-family, office, or the industrial sectors where it is much easier to assess the “market rate”, it requires a broker who really understands the retail sector to guide their client to the true potential of a space. Even I have been amazed at some of the rents our team has been able to achieve.
  1. Tenants Failing: Traditionally this was the number one reason for new vacancies, but it is much less prominent today. Both corporate and independent tenants are having challenges either because their concept is outdated, the business is poorly operated, they are under-capitalized, or a combination of ALL these issues. We regularly work with our clients to get ahead of these situations, but sometimes you only find out when a tenant doesn’t open their doors one day.

Despite Rising Interest Rates Investment Sales Activity Still Vibrant: While the Investment Sales market has declined somewhat from the booming activity of 2021 and early 2022, there is still plenty of activity as the sector has returned to the more “normal” levels experienced in prior years. There continues to be a substantial pool of private investors that require little to no debt to complete their acquisition. They recognize that the current environment is likely to result in rising rents over the short and long term, the opportunity to achieve a higher yield than cash (even though the yield on cash has grown substantially) and they appreciate the benefits of depreciation and appreciation that commercial real estate provides.

Many Sellers Seek to Simplify Their Life: Although we have clients selling for the typical reasons like taking a profit, partnership dissolution, heirs wanting to convert real estate to liquid assets following a family member’s death, we also have more and more clients that want to sell so they can simplify their life. Many have managed their retail properties themselves but they are now looking to make their lives easier and prepare their portfolios for their eventual heirs. This frequently involves the sale of a multi-tenant property and the reinvestment of the proceeds into single tenant assets with long term leases. Some of our clients are even just paying the taxes. We are also seeing clients willing to sell for a 6%+ cap rate and reinvest the proceeds at a 4 or 5% cap rate. They are not bothered by doing so because often they have created substantial wealth and they prefer the peace of mind of stable cash flow with less work compared to the potential for additional cash flow and appreciation.

Businesses Outside of California are Wary of the State:  I could avoid pointing out any negativity but if we only highlight the good then we are doing a disservice to our clients. For those already doing business in California they are familiar with the challenges.  But when we talk to tenants outside of California about locating here we notice a significant aversion at this time. One primary concern is AB257 aka The FAST ACT which was supposed to go into effect January 1, 2023 and would have created a Fast Food Council with wide ranging authority over the fast food industry including the possibility of raising the minimum wage to as high as $22/hour. Fortunately, because opposition to this bill gathered enough signatures, it will go to a ballot proposition which will likely not occur until 2024. Due to the potential widespread effects if this bill were to pass, I believe that any retailer not already doing business in California is likely to stay on the sidelines for the next couple of years.

Home Prices Decreasing Likely to Soften Consumer Confidence:  Due to the lack of building and the fact that so many people locked in record low mortgage rates, I am not concerned about a home price implosion. BUT I believe that softening home prices and higher interest rates, which also make home equity loans more expensive, will have a negative effect on homeowner’s psychology. It is just easier to make big purchases when your house went up in value by $50,000 or more in the past year. The trickle down effect from home purchases and large investments in people’s homes is also likely to have a negative effect on the retail marketplace.

Service Station & Car Wash Business Remains Strong: As I have written previously, the number one type of retail business that was built in 2022 were gas stations and car washes. This has resulted in a lot of land sale activity for our team as well as the sale of existing gas station and car wash properties. Despite all the news geared towards electric vehicles, many in the gas station business believe there is at least a 20-year window before they encounter true challenges. Furthermore, a substantial amount of profits come from the convenience stores which are getting bigger and bigger. Also, the stations are generally located on high quality land that, if necessary, can likely be utilized in a different manner. Our outlook for this sector remains quite strong, although operators who do not reinvest in their properties to keep them at current standards will likely not prosper in the future.

Overall Outlook:  The overall market dynamics in terms of job, wage and population growth remain positive and the Inland Empire is outperforming California’s other major metros on most key measures which is helping drive continued demand for retail real estate opportunities. This combined with the conditions described above makes us moderately optimistic as we enter 2023. And if we do encounter headwinds we are confident we can work with our clients to achieve the best possible outcomes.

In closing the Progressive Real Estate Partners team wishes all those reading this blog a very successful 2023 and we look forward to doing business with as many of you as possible.