Retail

Big Box Breakup

Retail experts puzzle out shrinking store footprints and excess space.

As the economy has recovered, many in the retail industry were hoping to leave the deluge of store closings in the rearview mirror. Yet those objects are definitely closer than they appear. Despite the fact that the retail sector has once again found solid footing, retailers are continuing to shed excess stores, creating a steady supply of empty big box space.

Instead of declining, store vacancies have actually accelerated in recent years. U.S. retailers and restaurateurs closed 5,866 stores in 2015, which is up about 7 percent over the 5,483 stores that closed in 2014, according to a joint report by the International Council of Shopping Centers and PNC Real Estate Research. Cushman & Wakefield is estimating that store closings could rise even higher this year to reach 6,200 units.

“There is a lot of turmoil within the real estate market in general,” says Howard Meier, CCIM, MRICS, a vice president and commercial broker at Hummingbird Real Estate Brokerage in Toronto. Retailers are rethinking their brick-and-mortar strategies in light of competition from online shopping and expansion of their own e-commerce platforms. Retailers are closing underperforming stores, shrinking store footprints, or relocating to more favorable locations. Store closings run the gamut from department stores and grocers to apparel and electronics and include major big box retailers such as Office Depot/Office Max, Macy's, Sears, and Barnes & Noble to name a few.

 

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For example, Sports Authority made headlines in March when it announced that it would be filing Chapter 11 bankruptcy and is considering closing about 140 of its 450 stores. Walmart has said that it would close 154 stores in the U.S. this year, primarily its smaller Walmart Express format. Best Buy is quietly closing stores as leases expire, including 30 stores that closed last year. And the store closures are not confined to the U.S.; Canada also is seeing its share of big box woes, including the exit of Target that resulted in about 130 store closings.

Although small shop space often has a lengthy list of potential tenants waiting in the wings, big box stores pose a larger challenge. One hurdle is that there are fewer replacement options due to the consolidation and bankruptcies that have taken some players out of the market. In addition, many big box retailers that remain are not expanding as aggressively as they have in the past and/or they are downsizing their space requirements.

 

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Even if the size is close to being a match, retailers have their own specific site selection criteria in terms of what works and what doesn't. In Canada, for example, Saks and Nordstrom are both in expansion mode, but the former Target stores are not an option due to location or demographics. “As an owner you really have to think about the tenant mix. There may not be another retailer who can just step in,” says Meier. “So, you have to be very proactive and look at the opportunity for the project, and that may include other uses besides retail.”

Divide and Conquer

The list of alternatives to fill a vacant big box or anchor store is even shorter in secondary and tertiary markets. “Because of the size of our MSA, we are not candidates for some of the big box retailers,” says Richard Salem, CCIM, a vice president at NAI United in Sioux City, Iowa. “If we already have one of a big box brand, there is not enough population for them to have more than one store or location.”

One solution is to divide a large space into two or more smaller retail spaces that are easier to lease. For example, Salem worked on re-tenanting a former 50,000-square-foot Walmart in Le Mars, Iowa, which is a town of about 15,000 people just north of Sioux City. Walmart had built a new Super Walmart on the south side of town where more population growth had occurred. Salem represented a local tire company that was looking for 10,000 sf to buy. So, he approached the owner of the former Walmart building to see if he would be willing to split the building into condos and sell part of the building to the tire company. The owner agreed and also gave the tire dealer an option to buy the rest of the building.

 

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Wells Blue Bunny Ice Cream leased 20,000 sf at the rear of the building for warehouse space. A fastener company leased 10,000 sf of the frontage space. Based on securing those two new tenants, the tire dealer exercised his option to buy the whole building. The seller also leased the remaining 10,000 sf for his own use to display and restore his classic car collection. That example was a win-win for all parties, including Salem, who received the sales commission on the sale of the entire building and leasing commission on 40,000 sf of space.

“I definitely think cutting a big box up into smaller spaces is the most efficient way to help get these spaces leased,” agrees John B. Wright, CCIM, an agent at McCoy-Wright Realty in Anderson, S.C. It is easier to find tenants that are going to work in 10,000 to 20,000 sf than it is finding tenants who need 40,000, 50,000, or 60,000 square feet. “It allows you to cast that net wider and talk to more people,” he says.

Wright is involved in a partnership that recently acquired a former Winn-Dixie in West Union, S.C. The building is approximately 40,000 sf and half of the space had been leased by grocer Save-a-Lot. Wright and his partner were able to acquire the property at an attractive price per square foot, subdivide it, and separate the utilities, and then lease about 10,000 sf to Dollar Tree almost immediately.

“In order to attract a quality tenant like that, especially to second generation space with a dark anchor, we made some pretty aggressive concessions in terms of tenant improvements to help make the space work for them,” says Wright, who is finalizing a lease on the remaining 10,000 sf with a regional bakery concept.

Some of the biggest challenges in re-leasing are knowing what size spaces are in the greatest demand for that particular trade area, says Wright. Another major issue is managing the retrofit costs, such as building new storefronts and running new utilities to each space. The complex process also involves extensive demo, capping old plumbing lines, and having to upgrade bathrooms that may or may not be up to code, adds Wright. In addition, some retailers may be vacating a space at the end of a 20- or 25-year lease. Those older buildings may need new HVAC or roofing, and the layout or configuration of the space can be difficult for another user to modify.

 

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One of the keys to making repositioning projects work is acquiring a property at a price significantly below replacement cost. “There are a lot of moving parts and all of those types of things add up. So, you have to make sure you are doing everything the right way, and also that the work is feasible based on the rent you are going to be able to get from the new tenants for these second generation spaces,” says Wright.

Catalyst for Change

Spaces in A locations are often snapped up fairly quickly, but B locations or older buildings may need to consider alternative uses. Second generation big boxes are often attractive to bargain or discount retailers such as thrift stores, dollar stores, or discount furniture sellers. The large open space and high ceilings of some big box stores also work for entertainment uses such as rock-climbing gyms, laser tag, and mini-storage, notes John Rebori, CCIM, a broker with Coldwell Banker Commercial/Wallace & Wallace Realtors in Knoxville, Tenn.

Rebori is currently listing a 45,000-sf former Toys R Us store in Knoxville. He also recently brokered the sale of a former Kroger store after the grocer relocated to a new store just down the street. After two years on the market, a private college acquired the building and spent about $3 million to renovate it.

Losing an anchor can sometimes be a catalyst for revamping an entire shopping center, as it allows an owner to review all of the leases and re-merchandise the property with a better tenant mix, Meier says. “As you reconfigure the project you may be able to make it more efficient and add square footage or pad sites that were restricted by the major anchor,” Meier says. The loss of an anchor that had been struggling also presents the opportunity to bring in a new type of use that can drive more traffic to a center, such as a gym, entertainment use, or professional services, he adds.

 

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State College, Pa., is home to the Nittany Mall, which is anchored by Macy's, Sears, and Boscov's, a family owned department store. “When one of these boxes goes dark, such as J.C. Penney recently did, it can often be difficult to backfill the space with another large tenant,” says Thomas Songer, CCIM, PE, a principal at Gambone, Songer & Associates Realty in State College. Many larger retailers are going into power centers, large strip centers, or outside malls vs. the traditional enclosed mall. They also choose to be in newer areas of town where there are newer facilities, restaurants, housing, and traffic, he says.

Giving the shifting retail landscape, shopping center owners are more receptive to alternative uses that can help drive traffic to a center, especially entertainment or services that shoppers can't get online, Songer says. He is currently working with a trampoline park and family fun center client interested in the vacant J.C. Penney space. There are some good synergies between a mall and a trampoline park, including cross-marketing and shared customers. Although the mall filled the Penney space with a new sporting goods retailer, the mall has another lease expiring that might create another opening that could be a fit for the trampoline park, notes Songer.

Many owners tend to react to a major tenant leaving by rushing to fill the space as soon as possible rather than researching how to add value, says Meier. Big boxes are often single story retail surrounded by a lot of parking, which may allow an owner to capture more density. An owner might be able to build vertically, such as with a residential tower, or create additional outparcels in the parking area. One of the first steps is to do an analysis of the area to determine what would be a good fit for the trade area and the demographics. Some of these centers need to be repurposed more as mixed-use centers to appeal to a younger generation who prefer to live, work, eat, shop all within a short walking distance, he says. “You have to think outside the box a lot of times at these centers, and look at it as an opportunity, because the highest and best use may not be a big box anymore,” he adds.

 

Retail Developers Battle Headwinds

by Beth Mattson-Teig

Despite improvement in the economy and real estate fundamentals, retail construction remains fairly anemic compared to the building boom that occurred prior to the recession.

For the past two years, retail completions have been hovering at just under 50 million square feet per year with the forecast for 2016 at 46 million sf, according to Marcus & Millichap. That is about one-third the volume of space being built between 2005 through 2008 when completions were at about 150 million sf per year.

Development has been slow to return for a variety of reasons, including a more challenging environment for construction financing. “You still have to jump through some hoops and have a pretty compelling story to get retail construction financing these days,” says Ryan Severino, CFA, senior economist and director of research at Reis. In addition, vacancy rates are still slightly elevated at 10 percent and rent growth is more muted, according to Reis.

Specific to neighborhood and community centers, Reis is forecasting that completions in 2016 will reach 10.4 million sf, which is about 25 percent higher than the 8.3 million sf completed in 2014. “That would definitely be the most that has been built since before the recession, but that is not saying much,” says Severino. The volume of neighborhood and community center construction is about one-third of pre-recession activity.

Another obstacle to development is the vacant space still available. There are a lot of centers that were built in the last decade in the run-up to the recession that should have never been built. In some cases, developers were going in ahead of housing demand that never materialized as some thought it would, and those centers are going to struggle for some time. In areas where the housing market eventually comes back, there are already centers that exist there. So, there will be no need to develop more in those areas for some time.

The smaller construction pipeline also reflects a retail industry that is in transition. A number of retailers are revamping their strategies related to both the size of store portfolios and the footprint of individual stores going forward. “Some of them are trying to figure out how to make their brick-and-mortar stores compatible and complementary to their e-commerce strategy,” says Severino. At the same time, shopping centers are moving away from a traditional model of serving consumers who need to buy things to hybrid destinations where people can shop, eat, and play. “They are migrating away from just being these pure retail centers into something that is a little more varied and dynamic,” he says.

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Beth Mattson-Teig

Beth Mattson-Teig is a business writer based in Minneapolis.

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