Dining Evolves in Hermosa Beach

The dining scene in Hermosa Beach continues to evolve and, perhaps surprisingly, the pace of change appears to be accelerating. A record number of restaurants closed this past year and they are being replaced by new concepts that embrace chef-driven menus, professional management and provocative design. As a result, Hermosa may see the reversal of a long term trend of declining total eating and drinking revenues and, at the same time, the continued improvement in the quality of dining options.

There may not be a completely objective way to measure the quality of restaurants, but one positive sign of this comes from Yelp. An impressive 55 of the 89 restaurants in Hermosa now have a rating of four stars or higher, up from only 40 just five years ago.

While eating and drinking revenues in Hermosa are tracked by the city, they are not split out so it is hard to tell what is happening within each category. Nonetheless, a number of owners have confirmed that alcohol revenues have been dropping for years while dining revenues in general have actually been climbing. Last year the combined total revenues dropped by 2 percent from the prior year and remain below their peak back in 2000 just a few years after the opening of Pier Plaza.

In short, food revenues are increasing as the perceived quality of food improves and overall alcohol sales continue their descent.

Four relatively recent forces appear to be triggering the sudden ramp up in restaurant turnover: i) the upper Pier redevelopment project, which manifested in the repurposing of dozens of businesses and buildings; ii) six consecutive years of 9 percent annual home appreciation, which put Hermosa home values in the top 2 percent of the country and continues shifting the demographics of the city; iii) the doubling of commercial lease rates in the past four years, which has significantly impacted cash flow for restaurants negotiating new or extended leases; and iv) the maturing of a secondary market for the challenged restaurants, which has given operators a chance to recoup losses while moving on and, at the same time, limiting the newcomers to those prepared to take on the substantial investment required for success.

Over 30 of Hermosa’s 89 restaurant locations have changed hands and concepts in the past five years. Of these transitions, 10 occurred in the past year alone. Though increasing expenses and declining revenues prompted the vast majority of the recent closings, they were all precipitated in some way by one or all of the forces described in this article.

Upper Pier redevelopment project – The ribbon cutting ceremony for the redevelopment of upper Pier Avenue occurred many years ago in late 2010, but the impact has been far-reaching. First and foremost, the project triggered significant investment in both businesses and properties. A remarkable 60 to 70 businesses in downtown Hermosa had changed hands or rebranded in just the first 18 months that followed the ribbon cutting. This increased the demand for space there resulting in commercial lease rates on upper Pier now being commensurate with Hermosa Avenue after several years of significant gaps.

Strong annual home appreciation rates – Home appreciation rates in all of the beach cities are sizzling, which has helped make the area an even more attractive place to live. Since the beginning of 2011, there have been just under 1,500 homes sold in Hermosa alone, which is a significant percentage of the approximately 4,300 owner-occupied homes in the city. Rental rates typically rise when house prices rise and so there has likely been a similar turnover rate in rentals as well. The net of this is that the demographics of the city have been shifting quite a bit over the last several years with the growth in the city’s median income being just one example. It is not much of a stretch to conceive how dining preferences would have shifted as well.

Restaurants provide more than just food and drink and have, historically, helped shaped social relations. In essence, they fulfill a need for human connection. They also play an important role in helping shape local economies and the nature and makeup of cities. As home prices continue to rise at blistering rates in Hermosa and the city’s demographics change, the success of restaurants increasingly depends on the ability of operators to track shifts in what brings people out to eat in the first place. The inability of some owners to do this in a rapidly changing environment may be the primary reason why there has been such a significant jump in the number of restaurant closings over the past 12 months.

Higher commercial lease rates – The cost of restaurant space has doubled in the past four or so years and, if residential housing prices are a leading indicator of changes to come in the commercial real estate market, long term lease rates will continue to rise. As leases expire, landlords generally have the opportunity to adjust rent upward to fair market value and often do so.

One extreme example of this was a byproduct of the sale of the Mermaid property in 2013. The lease rates at the site were substantially below market value prior to the sale. All of the restaurants on the property had month-to-month leases so after the close of escrow, some restaurant groups on the property saw their rents triple almost overnight. For one of the groups, this resulted in an increase of over $100,000 in annual rent making it far more problematic to remain open at that location.

A maturing secondary market for restaurants – Demand for restaurant space in the beach cities is astounding. Listings for available locations garner dozens of calls. This manifests in interesting ways for both restaurant operators and landlords. New tenants are often more willing to pay higher rents to secure a location in the beach cities, an obvious benefit to landlords. At the same time, this high demand for space has afforded restaurant owners the chance to not only move on from their leases, but also to sell their assets for amounts well above the market value of the those assets. This helps take the sting out of the decision to transition out and move on. It also creates somewhat of a barrier to entry for underfinanced or inexperienced operators.

All but a couple of the restaurant transitions this year involved a buy-in by the new restaurant operator. The transitions that didn’t include money for the owners moving on had unusual circumstances such as highly unfavorable short lease terms of three years or less.
All of these changes have a plus side. As restaurants close, they make way for new concepts with big potential. We are seeing a number of unqualified success stories with many of the new restaurants that have been opened in the past few years.

Relative newcomers like Tower 12, Rabano, and Radici are joining the ranks of successful concepts like Baran’s 2239, Laurel Tavern, Greenbelt and Hook & Plow that are helping pave the way. Look for the opening of Slater’s 50/50, Decadence and Serve on 2nd this year to continue this favorable trend.

The convergence of changing social demographics with rising expenses has put an increasing number of Hermosa Beach restaurants at risk. On the other hand, this has created huge opportunities for well financed and experienced restaurant operators with a knack for addressing the elements of great food and social relevance. Change can be good and Hermosa will continue to see a positive transformation in dining in the months and years to come.