COVER STORY, MAY 2012

THE CHANGING FOOTPRINT OF THE LARGE-FORMAT RETAILER
Size and location of real estate matter more in the evolving retail sector.
By Jaime Lackey

Between the recession and the Internet, some large-format retailers and shopping center owners are feeling a little squeezed in today’s retail environment. Closures by retailers like Circuit City and Linens ’n Things left many boxes dark during the downturn. And Best Buy’s recent announcement to close 50 stores and move toward a smaller prototype indicates there are still some issues for the industry to sort through.

Northeast Real Estate Business talked with property owners and developers as well as brokers and retailers to see how retail developments are evolving to meet the needs of large-format retailers and to see what opportunities the future holds for retailers that have traditionally occupied big boxes and mid-size boxes.

Big Boxes Grow Under Urban Conditions

“The big box industry is bifurcated,” says Jeff Olson, CEO of Equity One. “Across the U.S., commodity-oriented retail that occupies big boxes will continue to come under pressure resulting in less demand for space in suburban markets where big boxes have traditionally thrived. However, urban markets are so under-retailed that demand will continue to increase.”

And national big box retailers are more interested in urban opportunities than ever before, says Kathryn Welch, senior vice president and director of retail with Forest City. “In 1996, when we opened Atlantic Center in downtown Brooklyn, it took some cajoling to get tenants to consider the opportunity. They didn’t understand vertical spaces and we had to work through everything that is different in two-story locations: loading issues, staffing issues, cart escalators.”

In 1996, Forest City opened the doors of New York City with Atlantic Center in downtown Brooklyn. More recently, the company developed the four-level, 485,000-square-foot East River Plaza, which opened in 2010, bringing several large-format retailers to Manhattan, including Costco, Target, Best Buy, Marshalls and Old Navy.

Since opening the 394,000-square-foot Atlantic Center project, Forest City has been involved in a number of developments that have opened the doors for big boxes to enter urban markets. Most notably, the four-level, 485,000-square-foot East River Plaza, which opened in 2010, brought several large-format retailers to Manhattan, including Costco, Target, Best Buy, Marshalls and Old Navy.

In the last 15 years, retailers have seen that working through the challenges of urban big boxes has its rewards. “Retailers recognize the dense populations served by our centers. They are able to see beyond their prototypes, becoming more flexible and creative to take advantage of spaces available in urban areas,” Welch says.

Steven Restivo, senior director of community affairs with Walmart, agrees that flexibility is key to expansion in urban areas. “We now have formats that range from 15,000 square feet to more than 150,000 square feet. We customize the footprint of our stores to fit the real estate available and we customize the merchandise mix to ensure that we are still serving local customer needs.”

However, it isn’t always easy to plug your model into any site, says Dave Messner, vice president of Real Estate with Costco Wholesale. In addition to ensuring truck access and creating pedestrian access to taxis, often there are other big boxes in the same center. This isn’t standard operating procedure for many large retailers.

Costco has opened stores in Manhattan and Queens in the last few years. “These stores have great sales momentum,” Messner notes. “We are interested in opening additional urban sites. But, like all retailers, we are being very selective. We want the right markets, the right sites, the right physical layout — and the right deal.”

Messner points out that urban areas may provide the most opportunity for many big boxes because those retailers are already in so many markets. Companies that have not yet saturated suburban markets may still see growth potential outside the urban opportunities. Retailers do look at competitors in the market when selecting sites but they really focus on their own penetration of markets with target demographics. (Witness the phenomenon of competing home improvement stores within miles of each other.)

As Messner of Costco explains, “We only have 433 locations in the U.S. — far fewer than Target, Walmart, Home Depot or Lowe’s. We are very bullish. Yes, there are great opportunities in urban markets, but there are also a lot of suburban and midsize markets that we are not yet in. We want to be proximate to high income households, with our typical store serving a trade area of 200,000 or more.”

Owners & Developers

Suburban markets with strong demographics are great for companies that want to sell to owner-occupiers like Costco. But for owners and developers, more potential tenants are interested in urban opportunities these days. Now that big box retailers are willing to compromise on prototypes, developers and owners scour densely populated areas for space.

“Everything we’ve been doing at Equity One recently is focused on big box retail. We’ve been buying land or large buildings anticipating strong demand in urban markets,” Olson says.

For example, the company recently purchased a 55,000-square-foot building at 17th and Seventh in the Chelsea area of New York City. The building is leased to Loehmann’s until 2016. “This is an opportunity you can’t replicate,” Olson says. “There are no buildings like this available. We see potential for many users to be interested in this space.”

Equity One has also been selected by the New York City Economic Development Corporation to develop a site for big boxes in the Bronx. “We expect a dozen large-format retailers to be interested, but we will only have space for four big boxes,” Olson says.

On Long Island, Equity One is developing The Gallery at Westbury Plaza, a two-level, 330,000-square-foot project that will include Trader Joe’s, The Container Store, S.A. Elite, Nordstrom Rack, Saks Off Fifth, Bloomingdale’s Outlet and Old Navy.

On Long Island, Equity One is developing The Gallery at Westbury Plaza, a 330,000-square-foot retail project that will open in September. Tenants will include Trader Joe’s, The Container Store, S.A. Elite, Nordstrom Rack, Saks Off Fifth, Bloomingdale’s Outlet, and Old Navy. The L-shaped, two-level center allows shoppers easy access to all stores without driving from one store to another.

“Prior to our project, there has been no large collection of big boxes in this area,” Olson says. “We are looking to serve a lot of people and we wanted to create an aggregate of big boxes next to our 500,000-square-foot project containing Walmart and Costco. We amassed a large diversified mix of retailers that will cater to many needs.”

Forest City opened the first stores at its two-story 1.1 million-square-foot Westchester’s Ridge Hill in Yonkers, New York, in 2011. Approximately 25 new stores will open in the next few months, including TJ Maxx and LA Fitness. (L.L. Bean, REI, Lord & Taylor, Dick’s Sporting Goods, and Whole Foods have already opened.) “We started the center in 2007. We have had to stagger the grand opening due to the recession, but we are thrilled with the momentum we see today,” Welch says.

Across the region — in urban and suburban markets — the recession pushed some prime large tracts of real estate to market. “The crash opened up a number of non-traditional sites to us, including car dealerships that went out of business, government-owned parcels and former schools. In certain cases, cities were trying to plug holes in their budgets and they were selling land,” says Messner of Costco. “We have also back-filled anchor spaces in malls.”

Municipalities Open Their Arms

Not only are retailers becoming more flexible and creative to make urban spaces work for their stores, but cities are becoming more accepting of big boxes. “The anti-box mentality is easing,” Olson says. “Residents need value places to shop and cities need the tax revenue.”

Restivo and Messner agree.

Restivo says, “In this economy, communities and public officials have gained a greater appreciation for what Walmart stores can offer: jobs, low prices, and taxable revenue. In cases where we take over vacant boxes and revitalize dormant spaces, there is an economic development benefit as well.”

Messner notes, “Costco units average more than $140 million in annual sales. Municipalities recognize us as big revenue generators — but we're also a great employer with our average wage exceeding $20 per hour plus benefits.”

Pressure: Recession & The Internet

At the beginning of the recession, national retailers worked on their balance sheets and supply lines — improving comparable sales and then focusing on internal strategies, according to Tom Simmons, president of the Mid-Atlantic and Northeast regions with Kimco Realty. He says, “As a result, these retailers have much better bottom lines today. They are leaner and much more effective at delivering higher margin products.”

For example, electronics retailers and office supply companies realized they can be more profitable in smaller format stores. “Electronics retailers were spending too much money on store space for CDs and DVDs, which are outmoded. These companies realized they can sell their highest profit items — such as smartphones — in much smaller format stores,” Simmons explains.

The Internet is also changing retail — and the changes affect retail real estate. “Showrooming” is one of the most prominent trends at the intersection of cyber shopping and physical stores. Shoppers visit stores to scout products but then head home to purchase the items via websites that offer lower prices. Shoppers can even use apps to scan barcodes in the stores and curate a list of websites to compare prices on the same item.

The success in big box retail may lie in companies harnessing the power of showrooming to direct buyers to their own websites and other means of creating sales strategies that allow e-commerce to complement in-store sales strategies rather than develop competitive strategies, according to Ken Bernstein, president and CEO of Acadia Realty Trust.

“Over the next few years, most large-format retailers will learn to embrace multi-channel initiatives. Our best retailers will need to provide great in-store experiences and use stores for effective showroom branding,” he adds. This includes allowing customers to pick up and return items at local stores.

These trends dictate that convenient locations will become evermore important to retailers’ success, Bernstein predicts.

In the meantime, Internet sales are not going to eclipse in-store sales any time soon. Some categories of retail — including electronics, books and music — are significantly affected by Internet sales, but many others — such as clothing — are not. “And Internet sales are still a very small percentage of overall retail sales,” notes Welch.

In fact, the U.S. Department of Commerce reported in February that 2011 e-commerce sales, an estimated $194.3 billion, accounted for just 4.6 percent of total retail sales.

While the change in Best Buy’s strategy has created a focus on how e-commerce has negatively impacted the company’s brick-and-mortar stores, online sales do create some benefit for retail real estate teams. Retailers can use data collected from Internet sales to make better site selection decisions for physical stores. “Retailers collect zip code data in stores and via Internet sales. Zip code analysis helps us to target store locations within metro areas,” says Barry Fishbach, executive vice president with RKF.

Tenant Potential

Demand for larger retail spaces has been steady for the last 18 months, says Simmons. “We’ve seen sales growth in high-end retailers and value-oriented retailers — a dumbbell approach if you would. Value retailers like TJX, Ross Dress For Less and Bed, Bath and Beyond have been interested in doing a lot of deals. Further, higher end retailers like Nordstrom and Saks have been increasing their offerings with expansions of their Nordstrom Rack and Sacks Off Fifth concepts.”

The greatest leasing activity among large-format retailers comes from value retailers that have thrived during the downturn and are taking the opportunity to expand into new stores. TJX and Bed Bath & Beyond are opportunistically looking for quality locations, according to Matthew Harding, president of Levin Management.

New categories of tenants are also backfilling empty boxes. Fishbach points to health clubs as a source of activity in the large-format retail sector. Planet Fitness, LA Fitness and Blink Fitness are looking at large spaces with good demographics. Harding and Fishbach note that supermarkets, including ShopRite and Fairway Markets, also are looking closely at opportunities to expand while rents are still under some pressure.

In general, many grocery stores are looking for larger spaces than they did a few years ago, Fishbach says. They are adding a greater variety of food items and fresh produce, as well as prepared items, lunch, coffee and breakfast, and full bakeries and sometimes a bank, he explains.

Smaller Configurations

On the other hand, many categories of retailers — including electronics and office supply stores — are moving to smaller spaces.

“Where appropriate, we are working with retailers to right-size their stores,” says Simmons of Kimco. “When we can take back a piece of a store and re-let it, we create a win-win situation for our tenants and ourselves. For example, a Staples in our Shrewsbury Shopping Center in Shrewsbury, Massachusetts, recently downsized from 25,000 square feet to 18,000 square feet. We’ve kept Staples at the center and we have an opportunity to add another retailer to the tenant mix.”

Simmons expects to see large retailers “rightsizing” their stores for years to come as leases expire.

Harding notes that landlords with vacant mid-size boxes also have an opportunity to sign large tenants looking to “rightsize” in markets where their current landlords are not able to take back space, whether due to logistical challenges or capital limitations.

Walmart's small-format Neighborhood Market concept allows the retailer to enter urban markets more easily.

While Restivo says that large format stores remain the primary growth engine for Walmart, the company is opening a significant number of smaller format stores as well. The company developed its Walmart Neighborhood Market format in 1998. There are 170 of these stores, which average 42,000 square feet, across the nation. The company recently has opened 10 Walmart Express formats to test a smaller concept of approximately 15,000 square feet. Both formats offer mostly grocery items. “In this fiscal year, which began February 1, we will add 210 to 235 units, including new stores, expansions and relocations. Eighty to 100 of these will be the smaller format stores, mostly Walmart Neighborhood Markets,” Restivo notes.

Investor Potential

According to Mark Taylor, first vice president of investments with Marcus & Millichap’s Philadelphia office, the underlying real estate is becoming more important to investors that are interested in mid-size and big box retail. He says, “The strongest retail properties are those in strong locations, especially in urban areas with high barriers to entry, occupied by investment-grade tenants selling products that are recession proof and not likely to be curtailed by online retailing,” Taylor says.

The electronics and bookstore sectors are changing forever, he says. “A freestanding Barnes & Noble doesn’t create much interest because no one knows what will happen to that sector in the future. Staples, OfficeMax and Office Depot are contracting. Some electronics and appliance stores, like hhgregg, are taking over empty Circuit City spaces, but investors are skeptical of these companies as stand-alone single-tenants. There is concern about the survivability of these concepts in the world of the Internet.”

On the other hand, quality drugstores like CVS and Walgreens will continue to see strong demand, as will well-located big boxes. “Nobody believes this kind of retailing is going away,” Taylor says. “In general Walmart, Home Depot, Lowe's and Target own their own real estate. It isn’t often one of these properties is marketed for sale but those developers that do own the space have valuable properties.”

According to Taylor, the most active investors today fit three profiles: institutional buyers that specialize in

single-tenant properties; investors looking to complete 1031 exchanges who do not want any management responsibilities; and investors that historically have invested in stocks, bonds, and CDs but prefer the 6 to 8 percent return on single-tenant NNN deals today over the below-4-percent returns they find elsewhere.

Where is the greatest opportunity for investors? According to Taylor, necessity retail, especially free-standing grocery stores and discount department stores. He also predicts strong investor appetite for properties in the Washington-Boston corridor for the foreseeable future.

The Evolution of Large-Format Retail

“Box sizes have expanded and shrunk for years. It is just the reality of the industry,” Bernstein says.

He also notes that many other large-format stores — including Caldor, Ames, and Grand Union — have faded away without destroying the entire sector. “The formats we’ve been so fond of in the past decade may not be significant contributors in the future, but we shouldn’t be too concerned as long as the economy is strong,” Bernstein says.

“Retailers need locations where they can perform successfully,” he says. “While secondary markets where supply outstrips demand are tough, many Northeastern markets have high barriers to entry and there does not appear to be oversupply of large-format retail.”

As for the retailers, Bernstein says, “We can expect a continued evolution of boxes. Many retailers are considering different concepts and different square footage. Some will expand to add more categories of products. Others will shrink and pursue complementary e-commerce strategies. Underlying all the changes, the potential for growth in urban markets will remain very strong.”

©2012 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.