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June 29, 2017

On the Block: Despite the turmoil, Seattle retail is doing fine

Seattle Daily Journal of Commerce

Brian Miller

It was a head scratcher for some people when Amazon announced its $13.7 billion purchase of troubled Whole Foods.

Yet the acquisition makes sense on some level, as analysts have observed, since it allows the Great Disruptor to continue experimenting with brick-and-mortar retail. Those baby steps began with its bookstore in University Village, and have continued with Amazon Go grocery stores - now in beta in South Lake Union and Ballard.

The irony, of course, is that even while Amazon and other online players are destroying malls and traditional retail (see: Macy's, which just sold two more floors of its downtown flagship store), Seattle's retail climate is doing just fine.

Marcus & Millichap's latest market report shows the regional vacancy rate fell to 4 percent at the end of the first quarter. In downtown Seattle, we're at 2.5 percent.

The firm's John Chang writes, "Retail vacancy has reached a cycle low, as retailers and service providers expand to meet the growing needs across the region." Chang says the Seattle-Tacoma market holds the top spot on the National Retail Index (we're up from number three in last year's rankings).

M&M also says that average asking rents for the region are up 5.7 percent year over year, rising to just over $20 per square foot. In downtown Seattle, the average asking rent rose 7.9 percent to $27.50 per square foot.

Kidder Mathews basically agrees. Using a different regional yardstick for the first quarter, it puts the vacancy rate at 3.7 percent for King County. KM's trends and numbers generally align with M&M's more granular figures. And KM's Andy Robinson concurs that, "The retail market is strong in the core markets of Seattle and the Eastside. There is positive absorption, new construction and a strong investment climate for stabilized centers and single-tenant net-leased properties."

All of which sounds rosy. Still, there's an eye-level paradox to our robust retail market. Each new office building created for Amazon to lease, or each new apartment building created to house tech workers, brings with it the requirement to activate the street with storefronts. And those stores - whether destined to become restaurants, retail or commercial space - often remain vacant for a very long time.

It's the affluent opposite of the broken teeth on Main Street effect, where crumbling downtowns gradually lose their retailers one by one. Instead, in the shiny new Seattle buildings we tend to notice the most, for-lease signs can hang in the windows for months and months.

Why is that?

KM's Susan Zimmerman says those spaces mostly are in mixed-use buildings with a residential component. The empty spaces are being marketed to commercial tenants who'll provide amenities for the renters upstairs. Zimmerman cites the "We really want a restaurant!" syndrome among developers. "They want it to be a lifestyle component." But there are only so many bars and restaurants to go around, and the food and beverage biz is notoriously fickle - and very labor-intensive in a town where labor supply is constrained.

In SLU's big new commercial buildings, says Zimmerman, some owners are fine with a safe, reliable tenant like CVS or Starbucks. "They pay the highest rent." However, the building owners "are all drawing from the same pool of retailers," meaning there are only so many CVS stores and Starbucks you can have on a block. (Right, right...?) So owners wait and wait for the perfect retail fit, as hungry office workers file past the vacant space during lunch hour.

Owners afford can to be choosy, Zimmerman says, since those new retail bays are a small part of the bottom line.

"If they have the ability to wait, they'll wait," she says. "Some landlords want the uniqueness." Again, tenant supply is constrained. There's a limit to how many new restaurant concepts Tom Douglas can generate. He's only one man.

If, for instance, Amazon has leased all the office space in your building, and there's a 2,500-square-foot corner retail space sitting vacant, perfect for a bar or restaurant, that's absolutely no deterrent to an institutional investor who wants to purchase the building. And the same holds true for mixed-use: So long as the apartments are full, buyers are happy.

What's the micro-trend in our tight market? First, micro itself is trend. Zimmerman joins other retail experts in citing the movement toward smaller, showroom-style boutiques.

"There's definitely some downsizing. You don't need to carry every single product. It's more of a showroom."

After that, "Food and beverage is the most active category," says Zimmerman. "Grocery stores are the new restaurants," particularly for tired techies who work long hours and favor grab-and-go dining over sit-down fare.

And urban grocery stores are shrinking, down from 50,000 square feet to 40,000 or even smaller, says Zimmerman. Such hybrid urban delis can more easily fit in the ground floor of an office building - like Uwajimaya's 5,500-square-foot Kai Market in Skanska USA's 400 Fairview building.

Which brings us full circle back to Whole Foods, whose store at Westlake and Denny is - even before the sale - a de facto Amazon cafe.

Both M&M and KM paint an optimistic view of the retail horizon. Vacancy rates will dip to 3.7 percent by the end of the year, says M&M, hitting a 10-year, pre-recession low.

Long-term, says M&M's Chang, "The recently passed Sound Transit 3 measure extends the transit system and will likely instigate development near train stations, generating demand for retail nearby."

That's beyond the downtown Class A retail area. But even at Northgate or future light-rail stations with mixed-use development planned, big boxes are on their way out. Zimmerman says large existing mall spaces will increasingly be backfilled and divided. In CenterCal Properties' current redevelopment of Totem Lake Mall, notably, excess retail space was demolished to make way for housing.

But here's a caveat from KM's Robinson: "Pressure continues to grow from e-commerce entities, and retailers who cannot differentiate themselves from this form of competition are under stress." Examples, please? "In 2017, we expect to see closures of Macy's, Sears and Kmart stores across the region."

They are the victims of changing retail habits. Millennials and young Amazon workers especially seem disinclined to waste time browsing racks for sizes and colors that may be out of stock. They want everything in the right size and right color, delivered to their door, tomorrow. (Or today, if Jeff Bezos' drones become reality.)

Finally and most fundamentally, our retail is healthy because our population is surging. The U.S. Census recently reported that Seattle is the fastest growing city in the country, adding 3.1 percent to its population between 2015-2016.

Now we're over 704,000 strong. More bodies equals more shoppers.

And there's a limit to how many UPS delivery trucks can clog our streets. At a certain point it's faster and more convenient to walk down the block and buy the cat food yourself.

Got a tip? Contact DJC real estate reporter Brian Miller at brian.miller@djc.com or call him at (206) 219-6517.

© 2017 Seattle Daily Journal of Commerce. All rights reserved.

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