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Re-Positioning Vacant Retail Boxes

"When you find out the answer, you will make more money than Bill Gates!"

The question is what can be done with the large volume of vacant retail big box space. In the Chicago market, there are 175 vacant retail big boxes which total 9.5 million square feet. This vacant retail big box problem is not unique to the Chicago market. Many developers are working on a variety of solutions. This paper will discuss issues concerning the re-development of retail big boxes (single-tenant store space over 20,000 SF).

Presented By:

Richard Knitter
Great Realty Advisors
3009 35th Street, Suite 300
Oak Brook, IL 60523

(630) 323-9000
FAX (630) 323-9026
email knitter@greatrealty.com

Which of the following is a re-use of a failed retail big box?

  • Funeral home
  • Flea market
  • Hospital clinic
  • Senior housing
  • Used-car dealership
  • Governmental offices
  • Rental storage space
  • Micro brewery
  • Roller blade rinks
  • Basketball courts rented by the hour
  • Off-campus university classrooms
  • Bingo parlor and a bowling alley
  • High-tech office space
  • Another retailer who thinks he is smarter than the guy that went bankrupt

"What can you do with some of Chicago’s 9.5 million SF of vacant retail big box space and still make a profit?" A well-known, retail developer replied "start a demolition company".

"There is a retail bookstore conspiracy going on out there. Putting a Starbucks coffee shop every 150 feet has led people to staying awake and reading at night which has led to the need to have Barnes & Noble, Super Crown, and Borders."

One in every 136 people works at either Wal-Mart or Kmart.

After the following overview of the Chicago retail big box market, big box trends and issues concerning re-development of vacant retail big boxes are presented.

Chicago Retail Big Box Market: Proof that big box retailers command the market is demonstrated by the fact that 20 retailers command 60% of all retail sales in the Chicago market.

In the Chicago metropolitan market, 85% of the total retail space developed from 1993-96 are centers with category-killer stores (big boxes or single tenant stores in excess of 20,000 SF).

As evidence of the decreasing percentage of in-line shop space, the four centers at the intersection of 75th Street and Lemont each have over 30% in-line small shop space. The 1993-developed Darien Town Center on 75th Street has slightly less than 10% in-line shop space while the newly-developed Centerpointe center on 75th Street has no in-line space within its 437,990 SF space leased by 5 big box users.

The Nike Town store in Chicago attracts more tourists than the Chicago Art Institute and the Museum of Science and Industry combined. The second most popular tourist attraction in Paris is the Virgin Records store and it is not that exciting.

Retail development of new construction and expansions in the Chicago area includes:

1994 - 6.8 million SF
1995 - 3.4 million SF
1996 - 4.8 million SF
1997 - 5.5 million SF
1998 - 6.3 million SF announced.
Proposed 1999-and-later expansions include an additional 10.7 million SF.

For the last 10 years, Chicago has averaged 5 million square feet of new retail space annually or 420,000 square feet each month for the last 120 months, which equates to almost 1 square foot for each person each year.

The new construction activity is driven by retailers new to the Chicago market and those with expansion plans. Chains expanding in the area include Barnes & Noble, Bed, Bath and Beyond, Best Buy, Borders, Builders Square, Circuit City, Cub Foods, Fresh Fields, Home Depot, Kohl’s, Linens ‘N Things, MC Sports, Menards, Office Max, Office Depot, Pep Boys, PetsMart, Sears Hardware, Service Merchandise, Sportmart, Sports Authority, Super Crown, Target, Value City, and Wal-Mart.

Newcomers include Baby Superstore, Designer Shoe Warehouse, Home Goods, MacFrugal, Med Mart, Men’s Warehouse, Michael’s, Noodle Kidoodle, Old Navy, Strouds, Quizno’s Subs, Youngworld, and Zany Brainy.

There are a number of new furniture stores expanding in the Chicago market including Marshall Field’s Furniture, Room & Board, JCPenny Home Stores, and Sears Home Life. An interesting retailer that is growing very rapidly, is Corner Bakery which does not locate in a typical corner bakery location, nor is it anywhere near the size of an old, small corner bakery.

The super-laundromat is officially here with the arrival of five Spin Cycles and plans for 30 more.

Two used-car dealerships have recently come to Chicago, J. D. Byrider with a half dozen sites planned and Driver’s Mart Worldwide, that join the 2 existing newcomers, Car Max, a division of Circuit City, and Auto Nation, a company controlled by Wayne Huizenga.

The big box retail space has evolved from "the dirtier the floor is, the better" to having a hot cup of cappuccino, carpeted floors, and "as large as an aircraft hanger but as intimate as your Grandma’s living room". The two other trends are the affiliations of complementary retailers such as McDonald’s locating in the Wal-Mart stores, and banks in grocery stores and the trend of the manufacturer opening up more stores such as Mikasa, Ralph Lauren, Sony, and Levi’s.

The under-construction Wilderness Mall will offer innovative entertainment, theaters and other entertainment along side big box space that has replaced staid department stores and in-line shop space. The newly-opened Shops at Oak Brook Place include 7 adjacent big boxes. This is an example of complementary stores as well as including an example of a manufacturer expanding into the big box retail field.

"The Best Real Estate Investment is a Retail Big Box!" As the investment sales pitch goes; You get a long-term lease to a strong credit tenant, the percentage rent clauses cover inflation risk, the tenant won’t likely move due to the large size, no other large retail spaces will likely be available so the landlord can double the rent at the end of the lease, no common area charges, good access and visibility for the retailer, lower occupancy costs, and the tenant’s low prices and great selection will keep their sales growing."

What happened? The list of retailers that have gone out of business, consolidated stores, merged with other firms, and changed the size of their store, includes Phar-Mor, Child World, Zayre, Today’s Man, F & M, Polk Brothers, Krochs and Brentanos book stores, Silo, and on and on. The component that the losers have in common is that new competition came to town.

Big box stores had been eating small stores and now they are devouring other big box stores.

Per Mid-America’s Big Box Vacancy Study of the Chicago market, there are 175 retail big box spaces available encompassing 9,489,000 square feet!

In 1992, there was almost 3 million square feet of vacant big box space and people thought that this large vacancy would impact new construction, rents, financing, retail expansions, etceteras.

In 1996, there were 51 big boxes that became available encompassing 2,548,000 square feet.

To add insult to injury, there have been recent announcements of additional Kmart store closings, the consolidation and closing of Whole Foods/Fresh Field stores in Evanston and Northbrook, the consolidation of Marshall’s and TJ Maxx resulted in the closing of 7 stores that overlapped, and Handy Andy went bankrupt bringing down 25 stores. Byerly’s, which entered the Chicago market in 1995 with two stores, is now leaving town and selling the stores to Dominicks.

The following are additional big box trends that impact re-development plans.

Is It A Business Loan Or A Mortgage: While the tenant’s credit has always been considered in making a loan especially for retail big box centers, this is now more important due to the number of failing retailers. Whether the rent is above market or below market, or whether the construction costs are high or low, is not nearly as important as the financial condition of the retailer and the projected sales for that location.

Adding Convenience/Customer Service to Low Prices: The traditional split of retail into categories such as strip centers, community centers, and regional malls, has been blurred. The split of retail evolved into convenience-, style-, or value-oriented. If the retailer does not excel in one or more of these areas, then the retailer will soon be categorized as bankrupt.

While the initial thrust of the big boxes was great selection at the lowest prices, the desire to beat the competition has resulted in big box retailers including a strong emphasis on convenience and customer service. Based on two sets of independent focus groups, the sole reason that Menards and Home Depot dominated Builders Square and Handy Andy is not price, is not selection, but is due to service with informed employees interacting with customers.

Cross-Shopping: The Fall 1996 ICSC Research Quarterly reported on power center cross-shopping. The old thinking has been that power centers with their big-box retailers had little cross-shopping due to their large sizes and open air designs. When shoppers went to the big box retailers, the thinking was that the shoppers were more single-minded and the acquisitions were bulky. Power center tenants were classified as a destination shopping experience and not a comparative one. The thought was that if someone shops at Wal-Mart that they will not go to a shoe store to check out its shoes. The recent ICSC survey corrects these misconceptions with significant figures.

The average number of stores in power centers that were shopped per trip was a healthy 1.7 stores (malls have an average of 2.5 stores and often have over 100 stores). This is a high number considering that one of the stores is likely a grocery store or a large discounter. The centers with the higher degree of complementarity and merchandise overlap had the highest cross-shopping. Hence, the old thinking of "category killers" as being the only source for its goods is not founded. Whether the goods are furniture, appliances, or computers, having alternative store choices available is helping pull in a greater number of customers and increasing total sales.

Overstoring: The excess development of retail space is well documented. While well located vacant big boxes can be re-developed, there are many poorly-located stores that have been built and are now empty for good reason. In the retail war, these stores lost due to inferior locations.

When a vacant big box is being considered for another retailer, the retailer and the landlord both need to understand why the first tenant failed and why the replacement tenant will succeed. Retailers and landlords can not afford to make mistakes with big boxes due to their high front-end costs.

"With a stable population, the growth of the new big box is at the expense of their competition. People are not simply doubling their spending." Instead of thinking that the big box market is overbuilt, some state that "it is just under-demolished."

The reason that a retailer wants to put a store in a specific neighborhood on a specific street has nothing to do with there being a vacant store available; the rational is based on the location of other stores and market demographics.

Re-development examples of converting poorly-located big boxes include funeral homes, health care facilities, back-office space, senior housing, and used car dealerships.

An potentially profitable point of the overstoring of the Chicago metropolitan area is that in aggregate there is too much retail space but there are specific market niches that Chicago is understored compared to Los Angeles and New York. Examples include children’s apparel, computers/electronics, home furnishings, and of course, restaurants.

Regional Malls and Strip Centers Verses Power Centers: While they seem to be at war with each other, an entertaining note is that each side is becoming more like the other.

The north shore’s premier regional mall, Old Orchard has its 5 department stores but now also has Strouds, Barnes & Noble, and other large big box users with their own signage and street-facing entrances. Alternatively, a new power center has a Starbucks, nice landscaping, a small playground, benches, fast food franchises in the stores, and brick-paved sidewalks.

Just as some regional malls now have the unthinkable, a grocery store, power centers with a grocery store are now offering cash station machines, mail and shipping service, copying, restaurants, and dry cleaners.

Evolving Big Box Market: While locating and sizing neighborhood shopping centers is rather standardized by simply plotting households verses supply of space, the location and sizing parameters of big box retailers continues to evolve.

The following are issues that impact the re-development of retail big box space.

Re-development: The research of what to do with "the glut of vacated second-generation big box stores" came up with a large, diverse set of solutions.

There were 39 existing big boxes that were re-developed with new retail tenants in 1996. Encompassing 2,476,000 square feet, the list of replacement tenants includes Mega TJ Maxx, Old Navy, Sears Hardware, Baby Superstore, Michael’s and Borders. None of these replacement stores existed in Chicago several years ago.

Re-development depends on market demand and the ability to gut retrofit for new users. When the space can be retrofit for another retail user, the rent/sales price is the highest and hence retail is the first option to explore.

It is obvious that well-located big boxes with available capital can be re-leased quickly. There are many examples including Kmart vacating a store on Ogden Avenue in Westmont and Dominicks striking a re-development deal with Tri-Land in 3 weeks time.

The "push" stores developed by the overly-eager developer who bought the land and then secured a tenant are less likely to continue their retail use compared to "pull" stores that were based on consumer demands in the market.

"The larger sites are most viable but the biggest sites aren’t always the best." As an example, Walgreens is one of the nation’s fastest growing retailers and they demand a 13,500 SF free-standing store. When Walgreens re-leases a big-box, some of the old space is demolished.

An example of a large space being re-developed is an 89,000 SF single-tenant store being split up to three users, Linen ‘N Things, Filene’s Basement, and Cole Taylor Bank.

Some of the Handy Andy stores have been re-leased to a single tenant such as Office Depot, while others got split up between several tenants (auto dealership, MicroCenter Computers, and PetsMart), and others are still vacant. One Handy Andy property was completely leveled and replaced with a newly-constructed Walgreens and a residential condominium building. Another 80,000 SF Handy Andy has a health club, medical offices and 20,000 SF of small shop space.

A large Kmart space vacated in Riverside has been re-let to Kohl’s and Burlington Coat Factory with tenant improvements and leasing commissions totaling $5 million.

Location, Location, Location: Location is still the key. As one retailer put it, "If the site can deliver more people, then we will get more customers, more sales, and the higher sales spell success for the landlord and for us."

Second-generation Space/Why Is There So Much New Construction With All This Vacant Space: Despite having 9.5 million SF of vacant big box space in the Chicago market, there is 5.5 million SF of retail space under construction with the majority being leased to big box tenants.

While apartment, industrial, and office tenants often have no problem leasing second-generation space, retailers often want new space built to their tight specifications. After taking into consideration the cost of retrofitting the old space, the retailer is less concerned with a minimal rent reduction and is more concerned with creating a profitable operation. The minimal rent reduction will not make a difference in the store’s financial success especially if there is a small decrease in sales due to less than optimal building design.

The occupancy costs to a successful retailer are minor and hence the key to a profitable store is not a rent reduction but is a function of sales, labor, and competition.

Specialty Center: Over the next 20 years, 80% of the nation’s population growth will come from foreign immigration and from births from Hispanics, Asians, and African-Americans. A board-based store could lose out to a group of big box retailers that specialize to their market. Retail development in the inner-city has to continually evolve to meet its market.

Entertainment Component: Dave and Busters is a national retail tenant that occupies 50,000 to 80,000 SF of space with restaurant and arcade games. Sega plans to open four dozen high-tech entertainment arcades. Sony is combining electronics, music, games, and food in a high-tech version of the big box bookstores that serve coffee and desserts while browsing through Barnes & Noble, Super Crown, and Borders.

Grocery Store Is Still The Major Draw: Two Harvard Business School graduates created a national chain of inner-city supermarkets called Delray Farms. Delray Farms bought three Goldblatt’s discount department stores, a firm started in 1914, which is consolidating their operations.

Grocery-anchored centers are one of the leading retail development and re-development sources. Chicago has two dominant players, Jewel and Dominicks, with the balance of the development coming from smaller-sized store formats of Fresh Fields, Delray Farms, Sunset, and Aldi’s. Dominicks will open 20 stores totaling 1.4 million square feet and Jewel is projecting to open 12 to 15 stores of 65,000 to 75,000 SF each.

Public Assistance: While local governments are upset about the closure and abandonment of large retail spaces in their neighborhoods, there is currently little public assistance being given to induce re-development but the trend has started and it may blossom. The City of Chicago has offered property tax breaks, TIF money, and infrastructure improvements to get larger vacant retail properties re-developed in less desirable neighborhoods. A few suburbs have offered economic incentives for retail development and more will likely follow being afraid of losing deals and additional tax revenues.

Lower Base Rent With Higher Percentage on Overage Rent: This helps the tenant during the start-up and if the location can deliver the results that the developer promised, that the tenant is more willing and able to pay the higher percentage rent. This allows a marginal location to be acceptable to a retailer and the base rent and risk are lower. This "win-win" lease scenario benefits the retailer as well as the landlord over the long-term. If the tenant’s sales are weak, then they would not have been able to pay the higher base rent in the case of the typical lease terms.

Institutional Re-use: If the property became vacant due to out-dated design, poor or decreasing demand and increased supply of competition with superior locations and tenants, the property could be considered for institutional re-use. Examples include a multi-story property now utilized as a Polish-American Museum and Theater, or a property with no on-site parking being utilized in the Pilsen neighborhood as a gym and playrooms for the local children. In Lombard, a large vacant big box was leased to the Department of Motor Vehicles and the Post Office which allowed the government to save money by not building a new facility, supplied ample parking, and there is adjacent retail that continues to thrive due to the increased traffic.

Do The Research: While any sensible developer could easily know that a large, discount drugstore would be a guaranteed big box winner, the developers that went with Phar-Mor and F&M can now sell you their vacant stores. And there is no way that a 30,000 SF store can sell nothing but pet supplies, don’t tell that to PetsMart or Pet Care Plus. Rational, gut thinking is not enough when the downside risks are so high. Utilizing the latest GIS supply and demand data analysis and local focus groups, leads to better decisions and re-development projects that make sense are easier to fund.

Ignore Historical Cost Basis: Just because the investor paid too much for the property does not dictate what the next tenant is able to pay for rent. While re-developed costs and possible rents for the future can be considered, the amount of the prior investment is irrelevant in the selection for the new use. One developer calls this the "take the clean-sheet-of-paper approach" by ignoring what was spent for the tenant that is no longer there.

The analysis must examine stabilized cash flow and not simply net operating income. The feasibility must take into consideration a replacement reserve for future capital expenditures.

Financing: The comments from lenders regarding the re-development of big box space focused not on the bricks and sticks but rather focused on the viability the proposed new operation, the credit of the new tenant, the history of the tenant, and the market demand.

The People Factor/Labor Supply: An increasing problem for retailers is finding good employees. If the previous user vacated the property due to the inability to find and keep a sufficient number of quality employees, this could limit the re-use choices for the big box space.

Whether it is the greeter at Wal-Mart, someone to answer your questions at Home Depot, or simply interacting with other people, the people factor is an important constraint or asset in the re-positioning of retail big box spaces.

First Round of Redevelopment Verses Later Rounds of Redevelopment: While there was 2.5 million SF of big box space re-developed last year in the first major round of re-development, the level of absorption will fall off as the second and third tier locations are considered. The level of non-retail re-development will increase.

Summary:

There is a lot of vacant retail big box space and the volume is about to increase even further.

Retailers prefer their own built-to-suit developments over 2nd generation space which is difficult and expensive to retrofit for new retail tenants.

As one developer stated, "finding new uses for the vacant big boxes will be the challenge for the next decade".

Developers need to be creative such as facilitating a good labor supply, offering competing and complementary retailers to allow customers to cross-shop, offering other services that customers use, finding niches that are not overstored, adding an entertainment component to the stores, obtaining public assistance, offering lower base rent and higher percentage rent lease terms, or developing an institutional use component.

Do the research, ignore historical cost basis, and utilize a stabilized cash flow analysis (deduct a capital expenditure reserve).

As one retail broker stated, "Don’t generalize".

The person who gets to determine the success of the re-development is not the developer nor the tenant, but the customer who votes with his dollars.