After taking a massive economic hit during the pandemic, Palo Alto is once again open for business, with parklets packed with diners, shoppers returning to stores and hotels bouncing back after a deep COVID-19 slump.

A new study from city consulting firm Streetsense showed that downtown Palo Alto generated $3.2 million in sales tax revenues in fiscal year 2021-22, more than any other downtown in the region. Palo Alto's food and beverages sector was particularly strong when it comes to sales dollars per capita, second only to Burlingame's.

These positive signs, however, belie deeper problems in the local economy, according to the Streetsense study. The city's recovery, while steady, has been grossly uneven, with much of the growth driven by the success of Stanford Shopping Center, a regional draw that dwarfs most other commercial districts in the region.

By contrast, the commercial areas of University and California avenues continue to struggle with storefront vacancies, with 10% of the retail spaces on University and 15% on California vacant at the end of 2022. Both districts are facing stiff competition both from Stanford and from downtowns in neighboring cities such as Menlo Park, Mountain View and Redwood City.

And both have seen increased tension between restaurant owners, who generally love parklets, and retailers, who often resent the on-street structures for obstructing their storefronts.

But it is the city's shrinking customer base that is a major problem for local businesses, according to Streetsense. With more companies shifting to either "hybrid" or fully remote work, there are now fewer workers patronizing local businesses. If this trend persists, as Streetsense expects, these high vacancy rates on University and California avenues will be a regular feature rather than a pandemic-induced aberration.

The new analysis concluded that the switch to hybrid work has reduced demand for retail in Palo Alto by more than 100,000 square feet, about the equivalent of Charleston and Midtown neighborhood shopping centers combined.

While residential and commercial growth in the region is expected to spur more retail activities, the study concluded that it will take more than 10 years for the demand to match the existing retail supply. The report notes that the city currently has about 3 million square feet of retail, even though there was only demand for about 2.57 million square feet in 2022. Retail demand is expected to increase to 2.68 million square feet by 2032, according to Streetsense, though that would still be well below the existing supply level.

Some possible solutions

So what is a City Council to do? The report offers a few ideas.

One is to ease existing restrictions on what types of businesses can go where. Larisa Ortiz, managing director at Streetsense, noted that some retail locations on California Avenue are subject to as many as five zoning "overlay" districts, each with its own permitting process and use requirements that a prospective business owner has to navigate. In addition, certain types of businesses, including beauty salons, barbershops, fitness studios, medical offices and dry cleaners, can only go in if the city approves a conditional use permit for it.

"These are the kind of things you can't do online," Ortiz said. "These are the kinds of uses that help sustain many communities and neighborhood-serving business districts. We really need to look at these rules and step back and allow some degree of permissiveness."

Another idea is to reconsider the city's ban on chain and big-box stores, a prohibition that has led to a proliferation of such stores just beyond Palo Alto's borders. The Streetsense report noted that there are nine Target and seven Costco Wholesale stores in close proximity to Palo Alto. These stores, according to the report, are "cannibalizing the retail offering within the city."

"They are concentrated along the periphery of the city and that really does result in a leakage of resident dollars leaving the city and going there," Anya Chan, a consultant at Streetsense, told the council Monday, March 13.

The report suggests that the city can consider a more limited prohibition such as a cap on the number of big-box stores or restaurant chains or a restriction by size.

These ideas are among the suite of policies that the city will further explore in the coming months as it moves to adopt a new strategic plan for economic recovery. In a broad discussion about the topic, council members generally supported the approaches proposed by the consultants, particularly their recommendation to improve pedestrian and bicycle connections to University and California avenues, improve signage and come up with a cohesive strategy to champion local businesses.

Unlike the privately run Stanford Shopping Center and Town and Country Village, two successful retail destinations that enjoy tight control over their respective tenants and built environments, the city's two downtown districts don't have a manager who assists and promotes their businesses.

"If you can imagine a mall without a manager that's managing the common area — that would never happen. It's something that our downtown districts in Palo Alto need," Ortiz said.

For the council, some of the strategies proposed by Streetsense would represent a sharp break from the recent past. Council members have been generally united over the past two decades in preferring boutiques over big-box stores and when it comes to zoning changes, they have been far more prone to tighten regulations than to loosen them.

Even so, council members generally supported the strategies that Streetsense presented to them Monday. The list includes focusing improvements on downtown, which is facing heated competition for shoppers around the region; expanding opportunities for new neighborhood businesses to open on California Avenue, possibly by easing the regulatory burden; and fixing broken links in the city's bike and pedestrian network to make downtown and California Avenue more accessible.

Council member Ed Lauing suggested that one way to deal with the recent workplace trends and the decreasing retail demand is by building more housing in commercial areas.

"There probably needs to be a transition to housing in downtown so there's basically permanent residents who are going out all the time to their favorite restaurant, their favorite shoe repair store and so on," Lauing said. "I think this is a trend we should be looking at even in the context of our current housing planning."

Both he and council member Julie Lythcott-Haims also advocated for finding new activities that would draw shoppers to the city's commercial areas. Lauing pointed to California Avenue's popular farmers market as an example, while Lythcott-Haims suggested looking for new opportunities to establish places that could function as a "third space" — a gathering space where residents can socialize and have fun. She lamented the loss of local businesses that have served that function, including Palo Alto Bowl, which closed in 2011.

"We all need a third place which is neither work nor school nor home but a third place we can go to where everyone knows your name, like the bar Cheers," Lythcott-Haims said. "As Palo Alto has become more chichi, more tech-oriented, more famous, we have lost many of our third places."

Not everyone was convinced that the new normal will necessarily be the permanent normal. Council member Pat Burt suggested that even as employers adopt the hybrid model, they will still require office space — just not as much as they did before the pandemic because only a portion of the workforce would be at the office. Eventually, he said, the city will hit "a new equilibrium" in which the number of workers in commercial districts will be higher than it is today, even if it remains below pre-pandemic levels.

Burt also observed that the high vacancy rates in downtown and California Avenue are, to a large degree, a product of the high rents that property owners charge in these areas. He said he'd heard from various retailers who wanted to move to University Avenue but couldn't afford it.

Even when vacancy rates shoot up, many property owners have faith that the demand will rebound and are wary about getting locked into longer-term leases at discounted rates. That gamble seemed to have paid off during the dot-com crash of the late 1990s and, more recently, during the Great Recession, Burt said.

"We may be in a different period right now where we really finally do have structural change," Burt said. "In each of those prior eras, there were broad assertions that this was the new normal and we'd never return to a high-demand period again, and that was really disproven."

The Streetsense analysis is an early component in the council's effort to spur economic recovery, a key council priority. According to a report from the office of City Manager Ed Shikada, the consultant will now work on creating a "comprehensive economic development strategy," which will be brought to the council for adoption.

The third and final phase will be recommendations based on the strategy, which will also be brought to the council for consideration and adoption. Vice Mayor Greer Stone said Monday that the council will have to strike a balance between supporting economic development and making sure that residents continue to get the types of businesses that they need and want.

"There's a reason why these regulations are in place, and, at least in the past, they reflected community values and desires," Stone said. "How do we balance that?"