Evidence of the Changing Face of Retail: LA’s Westside Pavilion

It was announced in March that the Westside Pavilion—a longtime landmark of Los Angeles shopping—will be converted into mostly office space after losing its anchor department stores and the migration of customers to online shopping. Put this transition into context.

Larry Kosmont: Even a decade ago, who could have thought that the Westside Pavilion—what many of us called “retail ground zero”—would have to be recast into a totally different set of uses in order to be an economically viable real-estate strategy? That is exactly what is happening—and it is emblematic of what is happening overall in the retail and consumer markets, where we have moved very quickly to a digitally connected society that gives people choices about where they go and what they buy.

When it was built, we all saw the Westside Pavilion as a cutting-edge approach to retail. Now, we are facing the truth that retail has changed so much that unless we recast the Pavilion, it will not have a long-term future. Market forces are driving this project toward what the economy views as the demand today.

What is the demand today? First, you have to create a sense of place and purpose for your uses. For workspaces, in order to attract millennial workers, this means becoming more collaborative and creative defined as open form workspace with a mix of social and entertainment aspects, Retail, likewise, has become a less competitive component of any real-estate strategy unless it too is part of an interactive destination.

Whether you’re an aging member of the population or a millennial, we all have choices in how to buy our goods and services. Stores like Macy’s have to rethink how they can best attract their audiences.

Look at other revitalized retail areas in the region, like Century City and the Santa Monica Place: they have recast themselves as entertainment-based destination spaces. Westside Pavilion had been left in the dust. Now, this new reinvestment program is an investment into the future—focusing on what I call a blend of uses. Success comes from getting the right blend of workspace, retail, and entertainment. 

Is the Westside Pavilion’s anticipated change of use an aberration? Or is it a reflection of the marketplace seeing a higher and better use for shopping malls in markets with high demand for housing and office space?

It’s a little bit of both. I think this is reflective of what is going on throughout the country—the tipping point of retail has occurred. The country is well over-retailed; there is a lot of retail space in the U.S. Moreover, the millennial population has quickly embraced buying goods online. This combination is recasting how retail has to respond to the marketplace.

If potential buyers are not making trips to shopping centers to make purchases, then retail per square foot declines rapidly. The problem we have to solve today is: How do we get people out from behind their computer screens and to the destination itself? That is what the Westside Pavilion has struggled with. Even though the Pavilion is located in the middle of great demographics for shopping, those users now have choices to shop online or elsewhere.

It is no longer simply an issue of mixed-use; it is about a blend of uses that creates the right balance to generate trips consistently. These uses could be workplace, educational, medical/fitness, cultural, or residential. But you have to put your property in a position where it is the first thought when people need to make a trip. Otherwise, it will not be as competitive, and the sales per square foot will suffer. 

There is speculation that the Westside Pavilion site will be attractive to technology companies seeking flexible working space and access to transit. How do such factors play into how the market evaluates highest and best use of like properties?

In Los Angeles, we are experiencing a redefinition of what is called the “100% corner.” If you were a real-estate developer back when the Westside Pavilion was built, you would view a location like Wilshire/Westwood as a “100% corner”, based on traffic. Traffic has been the defining element, but if you are a developer today, you’ll see the 100% corner is now shifting toward adjacency to transit—especially in dense areas. The Westside Pavilion picks up some of this benefit, as it has become a transit-adjacent site to the Expo Line. The entire Westside of LA’s preference in site selection for development is being reset by the county’s $100+ billion investment in transit.

We are seeing a market conversion to creative office space for technology and digital era companies, coupled with the desire to be as close to transit as possible. The average occupants in these projects are primarily millennial and creative workers who embrace ride sharing, shared workspace, and the broader applications of a "sharing" economy.

Is it an emerging trend in California to repurpose shopping malls as housing? By example, developer Sand Hill Property Company has unveiled a new vision for a 55-acre failing mall in Northern California that invokes the new state law SB 35 to revitalize that retail into 2,400 units of housing and 400,000 square feet of mixed-use retail and entertainment. Is SB 35 a contributing incentive to this apparent trend toward retail reuse?

In California, we are seeing the state and the economy recognize the significance of meeting the housing demand. Using SB 35, and the 14 other laws that were passed in 2017, the state has prioritized housing as a cornerstone to the next generation of economic development.

The 2017 housing bills are geared at tightening the regulations that prevented the construction of urban housing, or at trying to make it easier to develop housing by providing money or statutory clearances including relaxation of CEQA. By stick or by carrot, all the bills are focused on delivering housing projects.

The Sand Hill project is the first in California that is applying SB 35 to a mall context. It allows for a much more permissive planning process in the transformation of retail to housing, as long as the project provides the sufficient amount of workforce and affordable units.

For those of us in the local government sector (Kosmont Companies represents over 60 cities), the fear is that the state has now declared that housing is the primary economic issue. Because of the state’s proclamation, they are looking to erode local control on land-use approvals when it comes to housing. While we appreciate the State's recent exuberance on housing, a balanced approach is needed.

Representing those 60+ cities, you are well aware that converting retail space into housing means that sales-tax revenue necessary for local government services will decline. Moreover, housing itself is typically a net loss for city budgets. In light of those factors, how should cities consider developer proposals to convert housing to retail conversation?

It’s a big question, because there are a lot of conflicting interests. One conflict is that we need sales tax, and therefore retail, because that is what supports the level of services for our residents. When you replace retail with residential, you take tax value away from the city.

But the reality is that retail is going to shrink in most communities, and that sales are not going to take place nearly as often in physical stores. In other words, the entire equation of sales taxes as revenue generation for cities is at risk.

It’s a given that a city needs tax-generating uses, such as office and retail. It’s also true that housing is a place for a job to sleep at night, yet a fundamental conflict is that many localities in the state that do not support a range of workforce housing solutions. And when demand is suppressed by local land use bias against residential or just flat out exceeds supply, certain areas such as San Francisco will find themselves in the situation where companies are looking to locate in other places because workers cannot find adequate housing.

As a former city manager, I believe that the economic models that show residential as a deficient contributor to the city’s budget overlook the fact that if you don't have the proper balance between commercial and residential, you are in trouble. After all, workers need to sleep somewhere.

So, while some city managers still believe that residential is poisonous to their budget stability, the state has come to the conclusion—and I believe the state might be right—that if we can’t keep younger middle-class workers because they can’t find affordable housing, then we lose. Other economies—in Colorado, Texas, or the Pacific Northwest—will win.

At the end of the day, there is no simple answer. We cannot shove residential zoning down a city’s throat. Nor can a city just pursue sales tax anymore, because that equation no longer works.

We are looking at reforming a number of different paradigms—parking requirements, blend of uses, and value capture—as a way to find solutions for economic development. The economic development model can no longer be about getting a Costco. It is now much more about creating a strategy that meets the priorities of a millennial cohort that consumes, communicates, and mobilizes differently than past generations. Our land-use policies and tax structures do not yet reflect this changing economy.

Is it possible for the state to adopt “housing as an economic development strategy” without first addressing Prop 13 and its unintended effects? Is Prop 13 still off the table for reform some four decades after passage, or is there a constituency ready to address it? 

I think Prop 13 will be politically off the table for a long time. The problem is that residential prices are so high. It’s hard to patch a balloon when it is swollen, and it’s a hard time to fix property tax rates when property values are so high—and getting higher. The individual financial exposure to a property tax rate change at these pricing levels is too frightening, and as a result I believe it will be political dynamite for the foreseeable future.

I think a possible fix is on the sales tax side: We can support local government by reconfiguring the definition of the sales tax. The formula that impacts the distribution of sales tax cannot penalize the cities that have high-spending populations with low retail footprints—because then consumers will move online even more.

We also have to fix the connectivity between last-mile delivery sales and store sales in a way that improves distribution to all communities. As people’s consumption is becoming more delivery-oriented—that is, more service-oriented—we need to expand the definition of sales tax to reflect that. It will be easier to fix those taxes than to fix property tax by amending Prop 13. 

You’ve been a thought leader on how Enhanced Infrastructure Financing Districts (EIFDs) might herald the creation of more new tools for local economic development. How might EIFDs capture value from aging public spaces in need of repurposing?

The other half of the “housing as economic development equation” is that the state has announced that sustainability and climate action is economic development. To that end, they have handed cities and counties a number of new tax-increment financing districts that I refer to as “sustainability and housing districts.” They are EIFDs, CRIAs, and a whole host of others geared at inducing private investment for sustainable economic development in communities.

The output of that investment is to generate housing across all incomes, and clean economy jobs that are near transit. The goal is to reduce our footprint and increase economic productivity. Smart, zero-net-energy buildings are becoming more common everyday, and these buildings are taking advantage of tax-increment financing.

If redevelopment agencies come back, they will come back in the shape and form of an EIFD. EIFDs and similar infrastructure-oriented districts will proliferate and expand in their capacities over time. But overall, the state has written the prescription of sustainable growth to increasing housing supply, while utilizing private investment to enhance climate action strategies. The mantra is: achieve the green to get the green. 

Lastly, you spoke on the disruption of urban distribution systems and the need for reimagined delivery hubs on a VerdeXchange 2018 paneled titled “The Amazon Effect.” What should our readers expect to see in the evolution of urban retail in the coming year?

Retail is reinventing itself. We are seeing all different types of realignments and disruption models. CVS is buying an insurance company; Amazon, JP Morgan, and Berkshire Hathaway are looking to disrupt healthcare. The alignments in retail are changing, and the purpose and function of the store is changing.

We are seeing strategies like “click-and-collect” as a way to get people out the door. For example, Wal-Mart can use its 100,000 plus square feet retail stores located throughout California as last-mile delivery points. Essentially, they have built-in industrial last mile facilities where their own workers can deliver what we buy online to our homes when they get off their shifts. It’s a whole spectrum of realigning retail and industrial models, and it’s being driven by the goals of convenience and expedience. After all, our desire to immediately receive goods is not going to change.

The explosion we are seeing in industrial is really an expansion of the retail floor. The consumer is demanding the good faster and more conveniently. It’s too early to say how we will solve our land-use and tax challenges to adapt to a new retail paradigm, but it’s not too early to think about policies that will help governments adapt and survive this tectonic shift in how the economy is operating.