The San Francisco Case: Why Mandating Ground-Floor Retail Fails

A growing problem is emerging in many thriving metro areas that have had significant mixed-use, office and residential development. While many projects are delivering offices or apartments fully or nearly leased, their ground-floor retail often remains vacant. And it is not exactly the fault of the troubled retail industry.

“There [have] been 10 years of approving mixed-use without understanding retail and forcing retail on the bottom of a project where it doesn’t really belong,” JLL Senior Vice President Christine Firstenberg said.

The empty storefronts are creating blight across San Francisco, Oakland and San Jose. Developers are delivering physically obsolete space that is too small, with ceiling heights that are too low or is in a bad location with not enough foot traffic, according to Firstenberg.

Cities are starting to reconsider how they approve mixed-use development and some are thinking of charging a fee to building owners with spaces that remain vacant too long. But there is no easy fix, Firstenberg said. 

The problem with ground-floor retail is most apparent on Market Street in San Francisco. Crescent Heights planned to bring in a restaurant in 2013 to its Nema luxury apartment project, but the restaurateur pulled out due to complications and ongoing delays. Since then, the 13,500 SF ground-floor retail space has remained vacant, according to the San Francisco Chronicle. Nema is not alone. The Chronicle reviewed 20 housing developments on or near Market Street and found 17 vacant storefronts as of late November. 

How Bay Area Cities Overbuilt The Wrong Kind Of Retail

Cities continue to pursue ground-floor retail development because it is a large tax generator, according to Christina Briggs, City of Fremont deputy director of economic development/assistant to the city manager.

Cities want to create as many opportunities as possible for revenue generators, especially with brick-and-mortar sales revenue declining with the expansion of online shopping, Briggs said. Retail also allows cities to activate neighbhorhoods.

Activating streets can be a long and arduous process. Bay Area projects can take two to five years to complete, and new retail space that was designed years ago no longer meets the needs of today's retailers, Regency Centers Senior Manager – Investments Alison Warner said. Regency Centers owns and operates grocery store-anchored shopping centers around the country. 

The shift to more omnichannel and e-commerce business has led to retailers no longer needing the 5K SF they needed several years ago, according to Warner. Instead many are using a small brick-and-mortar store as a showroom with fewer products in stock. Customers can purchase products in-store or online.

Grocery stores’ needs have shifted as well, but still require large blocks of space that sometimes are not part of a developer’s original mixed-use plan. Grocery stores, which have been among the more active retailers in the Bay Area, used to require 60K SF, but can work with 20K SF to 40K SF in urban areas, according to Warner.

Why Ground-Floor Retail Is Complicated

Fixing the problem starts with understanding that retail's needs are very different than office or residential, Firstenberg said. Retail depends on the type of sales and cannot be placed in just any location. 

The needs of retailers do not always blend with the developer's and city's plans for a project, Firstenberg said. Oftentimes developers build office or residential with column spaces that maximize rentable space or increase condo prices, but are not ideal for retail, Firstenberg said. 

Grocery stores and other large anchor tenants, which are important for drawing additional customers to smaller shops, cannot operate with columns every five to seven feet, she said. If property owners adjust building column spaces to accommodate a large anchor, they could lose up to 20% of efficiency in residential units, she said.

Parking also is a big deal for many retailers, especially in areas outside urban cores, such as in Potrero Hill in San Francisco or along the Peninsula and South Bay, Warner said. This can put the interests of cities, which are pushing for smaller parking ratios, at odds with what a retailer requires. 

Retailers like areas that are accessible, approachable, visible with good signage and in a location where customers feel safe, Warner said.

“You don’t want space to feel cramped,” Warner said. “You don’t need it to be too deep so there is no light or visibility in the back.”

Many of the physically obsolete sites have sat vacant for so long in Downtown San Jose and Oakland that the spaces are no longer compliant with the Americans with Disabilities Act and need earthquake upgrades, Firstenberg said. Building owners who cannot afford these upgrades have tried to pass on those improvement costs, roughly $200K per property, to retailers in exchange for free rent. But these retailers are very unlikely to spend that kind of money to rent as little as 1K SF, she said.

“The cost gets so high to bring spaces up to code, [the problem] will get worse and worse when codes become more and more onerous,” Firstenberg said. “Some buildings aren’t going to get leased unless cities come up with money or grants of some kind to help bring buildings up to code.”

Different Solutions Needed For Each City

Each of the Bay Area’s metros have city-specific problems. A San Francisco city ordinance prohibits the placement of formula retailers, which is defined as a retailer with 11 or more global locations, in certain neighborhoods, according to Firstenberg. 

The definition also includes large store brands even if the locations are owned by local franchisees, Firstenberg said. To open a location in a restricted area, these owners would have to apply for a conditional-use permit, which can take up to two years to get and cost $40K to $80K. 

The ordinance also allows formula retail on one block but not the next, making it confusing for retailers to figure out where they can rent. Areas like Union Square, where formula retail is allowed, have the highest rents in the city, making it even more difficult to find affordable space, Firstenberg said.  

In Oakland, much of the problem has to do with obsolete spaces that do not have high enough ceilings.

“Offices above [retail space] can’t just go and raise the ceiling,” Firstenberg said.

In addition to physically obsolete spaces, many of San Jose’s storefronts sit along city bus lines and light rail that create too much activity to attract customers, who may not feel safe.

“Cities need … to think about zoning properly … in a way that is not changing people’s habits but accommodating how people behave,” Firstenberg said.

That means providing retail where people are already going without making them drive farther out, she said. 

What Cities, Developers Are Doing

Better planning, zoning and careful consideration of retailers’ needs can help solve this problem. Firstenberg, Warner and Briggs co-chair the International Council of Shopping Centers' P3 Committee in Northern California and are working to educate community leaders and private companies on how to create the best retail sites in the best locations.

“We’re trying to get cities to understand retail is not like other categories,” Firstenberg said. “It’s not if you build it they will come.”  

Fremont has been reviewing its retail priorities and pruning back some of its retail space, Briggs said.

“I don’t have a lack of demand [for retail],” Briggs said. “I have a lack of the right type of space.”

Some of Fremont's real estate needs to be modernized, transitioned or converted to other uses, she said.

The city also is focusing on density near both of its BART stations. At the Warm Springs BART station, Fremont did not create minimums for retail developments, allowing for retail to go where the market dictates, according to Briggs.

“We think that’s going to yield the right amount of retail,” Briggs said.

That could mean retail, such as food and services, for a daytime office population that will eventually number in the thousands, she said. 

Warner said Regency Centers’ approach is to be a part of the development conversation as early as possible.  

“It’s a lot easier to design and build successful retail if we’re involved in the beginning,” Warner said. 

Equity Residential approaches retail differently as well. The developer has a retail team devoted to filling ground-floor space and views retail as an amenity for tenants, Equity Residential Vice President of Development Drew Sullins said.

In the last 10 months, the developer has opened or signed 10 retailers leasing a total of about 21K SF at its three new developments in San Francisco's Design District.

Many of the retailers it chooses are oriented toward food and services attractive to both residents and the local community. It recently signed a lease for an artisanal taco bar, El Pipila, and Peet’s at 855 Brannan.

It also looks for retailers that can bring something different to a neighborhood, such as The Grove at One Henry Adams, which offers a whimsical storefront as well as outdoor eating space. A high-end Japanese steakhouse also will be opening up in One Henry Adams in 2018.

Equity Residential lucked out with Airbnb and Dropbox signing large leases nearby that will bring additional foot traffic to the area.  

“I’ve lived here long enough to see foot traffic at all three of those properties is off the charts compared to what it was five or 10 years ago,” Sullins said.

Nontraditional Retailers Part Of Solution

While restaurants have been filling in a lot of the ground-floor retail, fixing the problem also may come down to redefining retail.

Retailers that are actively expanding include fitness centers and urgent care centers. Fitness, which used to be its own retail category and had high parking requirements, now requires less space. Boutiques like Orangetheory Fitness or SoulCycle require less parking and have members who spend less time at the locations than a traditional gym, Warner said. Zoning does not often allow for these uses in some areas and would need to be changed.

Maker spaces or production, distribution and repair also is increasingly popular as a potential alternative to help activate the street. Regency Centers has been tracking PDR in San Francisco and is figuring out the right uses for PDR. It would love to include users that produce products on-site and use a small retail space in front, Warner said.

“We don’t need every street to be Chestnut or Fillmore or Market Street,” Warner said. “There are other ways to activate street frontages.”