As part of a larger economic development strategy effort by Applied Development
Economics (ADE), Allan D. Kotin & Associates (ADK&A) has prepared this discussion of mechanisms for reducing the extensive vacancy that characterizes the retail, office and industrial space inventories in the City of Petaluma.
Vacancy reduction as considered here is for the most part a short term rather than a structural change in the economy. The development strategy is necessarily more concerned about the structural changes and the long term impact. At the same time, lowering vacancy is critical not merely as a manifestation of economic growth or health but perhaps even more important to halt the infectious aspect of vacancies on the value and viability of nearby occupied properties.
At the same time, however, this discussion of vacancy does incorporate several elements which bear directly on the long term economic development strategy for the city, for instance, reshaping the mission and activities of the redevelopment agency to address the issue of filling vacant space rather than creating new development.
BACKGROUND AND CONTEXT
High vacancy in each of the three relevant categories (retail, office and industrial), is not a recent phenomena. Much of the office and business park vacancy dates back more than five years to a major industrial shift where high tech industries, such as Telecom, initially locating in Petaluma moved away from the community. The information published by Cassidy Turley, suggests that vacancy rates in Sonoma County in the industrial category have been over 10 percent for almost five years and were over 10 percent at the peak of the economic boom in 2007 and early 2008. Current vacancy rates in industrial space as of the fourth quarter of 2009 were approximately 15.4 percent in Petaluma representing almost 800,000 square feet of vacant space out of an inventory of just over 5 million square feet.
With respect to office space, the situation is actually much worse. In Petaluma, the vacancy rate at the end of 2009 was almost 35 percent well above the county total of 29 percent. This pattern had persisted for several years since even in 2006, 2007 and 2008 the vacancy rate was at or above 25 percent. A different source, Keegan & Coppin, puts the third quarter vacancy in Petaluma at 35.2 percent without sublease vacancy and at over 41 percent with sublease vacancy. This represents 1.3 million square feet out of a total inventory of 3.1 million. The same source, again for the third quarter of 2009, puts the vacancy rate for industrial at 17.3 percent out of the inventory of 5.3 million.
Turning to retail, third quarter 2009 vacancy was 11.4 percent for the City of Petaluma versus 9.2 percent for the whole county. In this instance, there was a vacancy of
approximately 300,000 square feet out of 2.6 million. At the end of 2009, several retail projects were approved or proposed, potentially adding 773,000 square feet of retail space.
The three projects are East Washington Place, Deer Creek Village and miscellaneous mixed use projects totally 80,000 square feet. So far, most of the vacancy has occurred in older marginal space as discussed below in the discussion of flight to quality. This trend could continue into the future if owners of older strip-commercial centers do not continue to invest in the up-grading of their properties. According to the FEIA’s completed for the East Washington Place and Deer Creek Village proposals, these projects are positioned to capture regional sales and should not significantly affect existing local spending. However, as noted below, other changes in consumer demand are occurring that will affect the competitiveness of older retail centers.
The recent economic crisis has masked certain important longer term trends. Industrial vacancy rates were high and growing in Petaluma for some time. Furthermore, retail vacancy at one level will be very difficult to cure insofar as there is a long term structural contraction occurring in the amount of retail space needed to accommodate the same volume of sales.
There has been a long term reduction in the amount of retail area needed to accommodate demand that is being masked right now by the recent entry of retailers particularly at the Regency center which has just been approved.
The source material for this includes interviews with the business community. These interviews were particularly relevant in that they provided insight as to why the vacancy was occurring and what some of the obstacles were to filling the space.
RETAIL
Special Context and Structural Change in Local Mix
Petaluma retail exists in two very different configurations, one a restored downtown retail characterized generally by smaller local tenants and two, a major retail corridor of the more traditional chain store type east of the river along the McDowell and Lakeville corridors.
In the City of Petaluma as well as elsewhere, there is a pattern that may be characterized as a
‘flight to quality’. In a healthy and growing market, retail tenancy typically is distributed among at least three classes of shopping centers. Sometimes referred to as A class, B class and C class and at other times designated as regional, community and neighborhood at different levels. This distinction tends to preserve the most desirable A class centers for large chain tenants and only local tenants with significant ability to pay high rents. What happens, however, in a downturn, be it a cyclical or structural one, is that as the volume of available tenants shrinks, the A class centers are much more willing to accept local and smaller tenants that they would not have otherwise taken. This tends to create a situation in which B and C class centers are de-populated disproportionately not merely due to the contraction in the economic cycle but to the upward migration of their tenants. One of the important implications of this distinction is that a broad undifferentiated effort to preserve retail
occupancy is doomed to failure and there should be some inherent element of prioritization to focus on those B and A class centers which have a reasonable prospect of survival.
In this regard, it is particularly important to remember that the City will be much better served by one abandoned shopping center and two relatively full centers, than three shopping centers all of whom have very high discernable vacancies. One possible basis for setting priorities is to favor those centers which have the least deferred maintenance and design obsolescence in the absence of any major renovation commitment by the center owner. For the city to aid merchants in centers where the owner is unable or unwilling to commit to renovation may only be postponing the inevitable.
Applicability of Alternative Solution Scenarios
Generally speaking there are three categories of alternative solutions: technical and financial assistance; marketing to non-traditional tenants of retail space, and adaptive re-use.
Assistance
Retail is an area where technical assistance and modest amounts of financial assistance can preserve tenancies that would otherwise terminate, and can motivate tenancies that would not otherwise occur. Tenant assistance can come in several forms: technical assistance in how to reduce costs for inventory, energy, marketing and telecommunications: low cost loans for either inventory expansion or refurbishment of the stores; or limited subsidies to landlords to make up rent differences.
The form of tenant assistance that would be most useful would be a combination of a loan program and a resource center. Resource centers in which the services are made available either at public expense or at significantly reduced cost could be useful. In parallel, a loan program at subsidized interest rates possibly with deferred payoffs would also assist stores that could otherwise not refurbish their stores or perhaps even fund required inventory.
Non-traditional Tenants
Another class of solutions is finding non-traditional tenants. In general, the two classes of non-traditional tenants that are eager to occupy retail space and who will not harm adjoining retailers and may in fact enhance them are non-profit corporations and artists and artisans.
At selected locations, the city could actually sponsor art or artisan centers. Using an empty store as a gallery is a very useful thing to create certain amount of visual interest that can be done at low cost and gets away from the appearance of decay and decline.
Non-profit service providers of social services, advice, legal services etc. are natural occupants of street front retail space although they often cannot pay full retail rents. In implementing the strategy of this type, the city or redevelopment agency may consider a loan program or a limited subsidy program to the landlords or to the non-profits to allow them to occupy space they could not otherwise afford.
Adaptive Reuse
The third major category of the solution scenarios is adaptive reuse. There are three modestly well-established adaptive reuses for vacant retail space that have some precedent.
One emerging replacement use is health services. Key features of a good retail site such as accessibility and adequate parking are precisely the same features that define a good health services site. Clinics, physical therapy facilities, and other services that represent relatively easily relocated medical services that do not require elaborate in place infrastructure are good candidates for retail.
Another use is education. Training, as distinguished from regulated school education, is something easily done in many retail spaces. This can be physical education, occupational training and other similar elements. Under certain circumstances, retail spaces can actually become schools although the standards imposed by the California Education Code make that difficult.
A third possible use would be conversion to public agency uses. Examples include the Petaluma City School District which occupies a former neighborhood center as their administrative offices.
OFFICE AND INDUSTRIAL
As background, it is important to establish some level of context and structural change. The proliferation of high-end business parks and office campus type facilities that occurred in the 1990s, created an oversupply that seems to be fairly permanent in nature. Many of these buildings along McDowell Boulevard or in the Redwood Business Park are clearly designed to accommodate large employers with extensive highly paid technical staff. These employers no longer are locating in the Sonoma County or Petaluma area and, as a consequence, much of the space remains unoccupied.
The Applicability of Alternative Solution Scenarios
In this instance, perhaps even more directly than in retail, there is a nexus between economic development and increased occupancy. It should be possible to provide both grants and low cost loan programs to tenants willing to relocate to currently vacant space in these business and industrial parks.
Creating such a program and providing it to the owners and landlords for use in recruiting tenants could bear some useful benefits.
Once again, a resource center that dealt with such issues as tenant build-out, recruiting, employee training (perhaps through local community colleges) could be a resource for enhanced occupancy.
In this instance perhaps even more than retail, finding non-traditional tenants becomes quite attractive. Among the classes of non-traditional tenants that are available are education
facilities which often work fairly well in office buildings, government facilities, and temporary offices for large projects.
The opportunities for adaptive reuse of office space that is truly office space are pretty limited. At the same time, however, freestanding buildings which could be converted to recreation uses or even clean industrial uses might be somewhat appealing. Even warehouse uses for low-rise facilities with large interior spaces represent an alternative.
Another use which could be considered is to convert well situated space to hospitality or, more likely, hospitality enhancing uses. Office or industrial buildings of good quality which include relatively large clear span spaces can be converted fairly easily to conference centers which in turn enhance hotel use.
As is the case in retail, there is a risk in the diffusion of efforts to try and make all industrial spaces more occupied. As uncomfortable as it seems, there should be some effort and prioritization so that programs designed to aid tenants and provide additional inducements are concentrated in places where they can materially change the appearance and character of the space. Once again the likely criteria for prioritization would include the level of differed maintenance, considerations of design obsolescence and the willingness of the property owner to commit to parallel efforts of project wide renovation
SUMMARY OBSERVATIONS AND RECOMMENDATIONS
Review of the finances of the Petaluma Redevelopment Agency suggests that there is a financial reserve adequate to launch and fund loan and assistance programs. Such programs, or analogues to them, were a part of agency budgeting but have not been used and could be restored without creating a major new precedent.
Clearly, a set of financial programs need to be developed for re-tenanting vacant space. They include loans to new tenants to finance their tenant improvements at low cost rates. Such loans might be forgiven on a pro rata basis as a function of additional employment generation. This has been done in other redevelopment areas. The city could also help eligible potential users by identifying alternative non-city financing which could help to finance projects that would be owned by non profit and other public entities – e.g. 501(c) 3 and 63-20 revenue bonds)
There exists also some opportunity for direct assistance to either landlords or tenants to attract new tenants who are particularly beneficial from a physical point of view or alternatively job generating.
Finally and perhaps most important is the creation of resource centers for both office industrial tenants at one level and retail tenants at another, where they can get assistance in both identifying where space is, what programs are available to assist them and resource assistance for those aspects of their business which will make them more efficient and better able to pay rent.
One of the great truisms of economic growth is that the vast majority of new jobs are created in very small firms. At the same time, neither Petaluma nor most jurisdictions are set up to assist small firms. This is why resource centers which become the funnel for both technical support and financial assistance may be particularly desirable.
Depending on the resources available and interest of other entities, these resource centers could take two forms. They could be small offices and web sites with a good publicity program but where the primary contact was initiated by merchants, employers or property owners in need of support. Alternatively—or perhaps at a later stage—the resource center and its services could be combined with a business outreach program undertaken jointly with the community college district as a potential source of specialized required training. This outreach or visitation program would target various business clusters that the city is most interested in expanding and/or assisting. (Please see discussion regarding Business Retention and Expansion and Technical Assistance in the Action Plan, Parts B and C.)
A systematic search for non-standard tenants of both retail and office industrial space would also be helpful. Identification of non-profits capable of paying some rent but not full rent would be useful. Identifying artists, artisans and sources of gallery exhibitions which would add to the appeal of retail space and, under certain circumstances industrial space as well, could also reduce some of the pernicious effects of visible vacancy even though they would not necessarily generate revenue.
In this environment of economic constraint and high vacancy, it is particularly important that regulatory staff be perceived as helpful and assisting. In the past, contrary observations have been made but the City has taken steps to create a more customer friendly approach in the development entitlement process. This is an encouraging transition as such flexibility can be a critical tool in assisting desirable business expansion.