Redevelopment

Thinking Outside the Box

Shop for Creative Approaches to Big-Box Redevelopment.

They once may have been superstores, category killers, or simply the biggest new store for miles around. But now they’re just empty.

In the frenzy of building more and bigger big-box stores during the last five years, many people worried about an eventual fallout. Towns could find their thriving retail strips dotted with enormous, vacant single-store properties set in vast parking lots. Finding suitable reuses for such spaces would pose challenges in an increasingly saturated retail market.

Today, both predictions have been borne out. Thanks to a variety of economic forces, empty big boxes are a common sight in otherwise bustling retail areas. Brokers and developers who are trying to fill them up again have found new tenants — but it’s taken some creativity.

Moving Up or Out
In some cases, empty boxes are the shells of stores that have failed. The store’s chain may have gone under (as discounter Venture Stores did last year, closing 73 stores across the country). Or the store’s owners have discovered that the local market could support one home-improvement store or electronics store — but it couldn’t support two.

In other cases, the empty box is a symbol of success: Its tenant has moved up to an even bigger box. A number of category killers such as Best Buy and Circuit City started smaller and now are moving to larger formats, says Jeff Kuchman, CCIM, a principal of Mid-America Real Estate Corp. in Oakbrook Terrace, Ill.

Target Stores is another good example. In 1990, the company began to open Target Greatlands that average 124,000 square feet — about 70 percent larger than regular Target stores. The chain added SuperTargets in 1995, which, along with similar stores developed by fellow big-boxers Wal-Mart and Kmart, offer complete grocery stores, banks, floral shops, and pharmacies, in addition to their standard merchandise.

Changes in the big-box arena indicate that more opportunities to overhaul empty properties will arise. "The overall trend has been falling off in big-box new construction," says Jim Valente, manager of new real estate product development for F.W. Dodge, a Lexington, Mass.-based real estate consulting firm. "And what is being built new," he adds, "tends to be mostly the owner-occupied larger super centers in markets where national retailers are still battling for market share. The two most active players in this arena are Lowe’s [Home Improvement Warehouse] and Home Depot. Overall though, the retail development trend has made a pronounced shift toward the neighborhood shopping center."

Dodge’s Real Estate Group reported 43 million sf in construction starts of freestanding stores between 75,000 sf and 150,000 sf in fourth-quarter 1998. That’s down from 51 million sf in second-quarter 1998 and 47 million sf in the third quarter. (Figures from 1990 show just how much the market has grown: That year’s first quarter showed just 27 million sf in starts in the big-box category.)

Retail Evolves
The biggest factors in the big-box construction falloff have been consolidation and competition among big-box retailers. Scott Shillings, CCIM, of Boyd, Page, & Associates in Houston, tracks 40 retailers in 150 big boxes in the Houston area. Shillings maintains that, with the exception of grocery and hardware chains, most big-box categories can support no more than two dominant retailers in an area. Since 1997, eight retailers have closed 34 big boxes in Houston, leaving more than 1 million sf of retail space.

"I think retail is going through another evolution," says Kathleen Rose, CCIM, president of Rose & Associates in East Granby, Conn. "We’re past the point of big-box and power development, as witnessed by the performance of some of the centers and retailers. Through bankruptcies, mergers, and acquisitions, we’ve now got fewer players than we did five, or even three years ago. Certainly there’s always going to be big-box users and players out there. The question is how are they positioned and how productive are they?"

It’s always possible to fill a big box with another big-box style retailer. But many well-known big-box players aren’t interested in an existing property, Kuchman says. "It’s not just a question of changing the locks, painting it, and making it work," he says. "Their use is so specific. The look and the prototype of their stores is so much a part of their image that they can’t afford to do it in an old asset."

At the same time, Kuchman adds, some retailers have found a niche reusing old big boxes, because it can be an economical way to get a store in a good trade area. Two chains that he cites are Stein Mart from Jacksonville, Fla., and Hobby Lobby, based in Oklahoma City. Hobby Lobby, a crafts and hobby store, is converting about 20 properties in the Chicago area alone, he says. "From most lenders’ and landlords’ perspective, it’s the path of least resistance," he says, since the new tenant doesn’t make dramatic changes to the property.

Stores, Churches, and Gyms
Richard Monaghan, CCIM, of Tulsa Properties, in Tulsa, Okla., says that right now, the big-box redevelopments he’s worked on are about half retail replacements and half alternative uses. "But as the big-box business matures and there are fewer players," he says, "I think alternative use is going to be something to deal with."

Monaghan says that several years ago, he sold an entire FDIC-owned outlet mall to a local church. Today the 300,000-sf building houses an auditorium, gymnasium, and classrooms, and the center’s big parking lot guarantees Sunday churchgoers a parking spot.

In the 10 years he’s been working on such conversion deals, Greg McDonald, CCIM, senior vice president of the Weitzman Group in Dallas, also has found churches to be a popular reuse. But he’s seen boxes turn into grocery stores, athletic facilities, and, in one case, a municipal convention/office center. McDonald started in the big-box reuse area in the late 1980s, when he got involved in the sale of 68 Handy Dan and Handy City stores in the Southeast. He’s also worked with a shuttered grocery chain — 48 supermarkets in Texas and New Mexico — and currently represents Kmart on 13 closed stores in north Texas. One of those has been turned into an air-conditioned self-storage facility, he reports.

One current — and extremely popular — tenant for big-box reuse is call centers, McDonald says. The centers handle telephone customer service operations for businesses. (See "Call Now," CIRE, January/February 1999.) Sometimes one client takes up an entire building or shares it with other clients with smaller operations. "You need a big empty box with wiring and heavy power," McDonald says. "And the main thing is that they need a lot of parking for employees. You can’t typically take an industrial building for these, because they don’t have much parking. But you can convert the retail buildings fairly economically." Call centers have become especially popular in his area because it’s in the Central time zone, he says, making it more accessible for callers on either coast.

Market Demand
Big-box conversions tend to be more successful in markets where there’s demand for a variety of reuses. "We’re fortunate here to have one of the better markets in the country," McDonald says. "Since 1990, the Dallas-Fort Worth area has added 700,000 new residents. We see a constant influx of people, and they have different needs. Companies [that move] in from another part of the country ... want to move in someplace quick and feel like a redevelopment might make sense for them. We’ve dealt with health clubs, school districts, storage people. There are a lot of different uses."

In Chicago, which Kuchman describes as a "very aggressive retail market," vacant big-box space experienced a slight decrease between 1997 and 1998, according to Mid-America figures. In 1997, about 10 million sf of space was available; in 1998, there was 8 million sf. (The figures include both empty space and space that’s still occupied but available, Kuchman says.)

He sees the biggest of the big boxes — 100,000 sf and over — split up for 25,000-sf to 40,000-sf spaces. Where retail trade areas have lost their luster, he says he sees more uses such as self-storage warehouses, light industrial (if the trade area has drastically fallen off), and congregate-care facilities. Municipalities also may investigate the properties for use as civic buildings, such as schools, libraries, or community centers, but again, he says, only if the trade area just isn’t viable — "otherwise they’ll be loathe to take them off the tax rolls."

In the Northeast market, says Rose, "I’m seeing adaptive reuse to continued retail, but they’re changing venue from power center/big boxes to entertainment/theme uses." She’s also seen conversions to distribution warehouse facilities in many cases, given the stores’ proximity to major highways and the fact that the necessary shipping docks already are in place in the building.

The Conversion Process
An imaginative vision alone isn’t enough to pull off a successful big-box conversion. The process can be fraught with legal, municipal, and economic twists. Shillings’ experience is a good example. Three years ago, he brokered an empty 106,000-sf Kmart in Pasadena, Texas, after the chain had opened a new prototype down the street.

Kmart had two years left on the lease; the original property owner was dead, and his widow had lost the property to foreclosure by an out-of-state lender. Shillings negotiated the sale with the seller, then negotiated a buyout for Kmart to cancel its lease. An environmental inspection found some contamination that had to be cleaned up before the buyer could take possession. He worked with the buyer to find tenants, contractors, and architects and also dealt with a few curveballs. For instance, the city "had incorporated new landscaping ordinances," says Shillings, "so we had to meet with the city and relandscape the parking lot — which we hadn’t planned."

Today, with a new facade and lining, the space is shared by three tenants, two of which are national chains: Hobby Lobby has 53,000 sf; Big Lots, a closeout merchant, has 30,000 sf; and a local crafts and antique mall leases 23,000 sf.

Putting together a well-matched tenant mix can be a difficult process, says Shillings, and can take anywhere from six months to two years. It starts with a demographic study of the surrounding region. In Shillings’ project, the property was adjacent to a freeway, so the developers used a more regional approach — a five- to 10-mile market area. They also looked at the "psychographics," which include factors such as local income and age.

Next, they developed a detailed brochure and a target list of potential tenants, Shillings says. He emphasizes that any sales material must be right on point. "Corporate real estate people are tough to get a hold of and they’re very busy," he says. "You’ve got to have a focused presentation that shows you understand the trade area and how it relates to their business." Shillings scouts tenant directories for possible tenants, but admits that the listings don’t always give enough of the information he needs.

What it boils down to, Shillings says, "is that you’ve got to be an expert in your market. You’ve got to know who’s doing well, who’s not doing well, and who’s thinking about moving up. You take it case by case, tenant by tenant.

"It’s much more complicated than ‘Here’s an old, closed Kmart,’ " he says.

"If you’re looking at the overall redevelopment of these types of properties, you’re going to be dealing with individual cities," McDonald says. "You have zoning issues, depending on the type of use you’re trying to put in." If a church buys the property, for example, there may be a problem if a nearby restaurant sells alcohol.

Such out-of-the-ordinary uses also can cause problems if the property is in a multiple-tenant power center, Monaghan adds. "You have lots of use restrictions in your operating covenants with other tenants. Sometimes you can’t put in things like bingo parlors, churches, pool halls. So what do we do within the confines of our operating agreement? There can also be a problem in the tenant mix itself. Say one tenant goes out, and you find another prospect for the space — but then you find that their product is already replicated in the center. It becomes quite a challenge for the developer to think these things through ahead of time, or for the brokers afterward."

Existing tenants also can become concerned about the operating hours of a new neighbor, he adds. Churches are busy on Sundays, for example, but don’t bring in many retail customers during the week; big movie theaters, on the other hand, bring in crowds after other tenants have closed for the day.

McDonald says he also runs a lot of demographic analysis on sites. "We end up working with a lot of economic development people to assure potential users that there are enough people there to hire. As there are more types of certain uses, there is more of a demand for certain types of employees, and sometimes there aren’t enough to go around."

Another big hurdle is straightening out the leases on the property, Shillings says. "Is [the store] on the lease?" he asks. "Will they sublease or do they just want a buyout? Then we take it to the next step. A lot of people don’t want to be in the sandwich position. They don’t want to just hold the lease; they want to own the property as well. We look at the leasehold interest: Is it owned? Do the owners want to sell it? We have done sub-subleases, but most of the time you try to get all of the leases out in the middle, so it’s a very clean landlord-tenant relationship."

Beyond the Four Walls
The most visible aspect of a big-box conversion, of course, is the store itself. "Some facilities are a lot easier to convert because they’re more generic," Shillings says. "The restrooms are in the back, the loading docks are in the back, they don’t have a vestibule, second story, or a garden center. Certain things like that can be hard to work around. But if it’s a really clean box, you can go in and subdivide it pretty easily." A more specialized use like a supermarket can be a little thornier, he says. "You’ve got offices on the second floor right above the front entrance; you’ve got freezers, trenching, freezer lines, structural concerns."

In some instances, it can be easier to convert than building new, McDonald says. "The zoning might be better, or it’s already on a high-traffic location — people can drive by and see it," he says. "Those are the same kind of things they’re looking for [when building new], but a lot of the infrastructure is already there for them. It’s already air-conditioned, it’s got a parking lot."

"You have to perform a physical audit on the building — the electrical, the mechanical, the dock," Monaghan says. "How much does it cost to redistribute the plumbing, the wiring? You’ve got fire code issues, separation walls, storefront entrances, parking codes."

"We get a lot into the utilities, especially the heating and air conditioning," Shillings says. On his Kmart project, the building had one big air-conditioning unit that cooled the 106,000-sf building. "That system was antiquated, so we had to come in and put separate individual air-conditioning units on the roof." He also had to deal with the city on electrical power, because new power had to be brought in.

Built-to-suit boxes bring their own problems, particularly for developers left holding the lease when the tenant moves out, Monaghan says. "The developer does everything from floor coverings to lighting to making it ready for fixtures and merchandise, so he’s got higher-than-normal cost per sf in the box to start with. If the tenant fails, and he gets the building back, he may find potential tenants for it — but they may say, ‘I’d rent this if I could get a $10-a-foot allowance.’ "

One thing an empty big box usually has in its favor is its location; generally, that’s one reason the original tenant took the spot in the first place. "That’s why I think we’ll continue to see reuse more and more," says Shillings, "because you can’t duplicate an intersection, so that box is liable to have five, six, seven different tenants over its life because it is so well located. Even though there’s space available down the street, people will still pay a premium to be at a particular intersection."

"All analysis begins with the trade area," Kuchman says. "Is it still viable?" Each project is very much an individualized process, he says, based on the use and the existing property. Some retailers look at the whole package: first the trade area, then whether the assets work for them. But others "look at it strictly as trade-area analysis. If the asset works, it’s just a bonus." Instead, he says, "they’re looking at it like it’s a cornfield" — a good-sized parcel of land in an area where there may not otherwise be empty land.

Community Acceptance
Brokers and developers also need to be aware of any big-box landscaping and architectural standards that a town may have. Some communities have instituted regulations to make big boxes more compatible with the local character and aesthetics. Fort Collins, Colo., for example, adopted a set of regulations in 1995 that prohibit uninterrupted lengths of facade greater than 100 feet, mandate roof line variations to increase visual interest and reduce scale, and require adding public amenities such as a plaza with benches or a fountain.

Community reaction also can be an issue when a big box is converted. "Neighbors would like to have the buildings filled," says Monaghan. "Big boxes sitting empty are perfect targets for vandalism, loitering, truckers dropping their trucks off for the weekend."

It also becomes a challenge to market an empty property. "How do you keep the property in good, marketable condition and at the same time keep the vandals away?" he asks.

At the same time, says Shillings, the neighbors already may be a little stung that the original tenant moved out, and "you’ll have some neighborhoods that are a lot more conscientious about what types of box they want in that space. It depends on how well they’re organized, but they may want more of a buffer — a higher wall, brighter lighting. You’re seeing that more and more with these high-traffic uses."

Finding the Money
When it comes to financing, big-box conversions don’t differ a lot from more-conventional deals. "Lenders still look a lot to the credit on the lease. That’s probably the main thing they look at when they give you the quote," Shillings says. "As long as it feels like the tenant is going to pay the rent for the next 10 to 20 years, it doesn’t really matter whether the building’s new. Shopping centers last a long time."

"The nice thing about it is that you’ve already got something you’re starting with, as far as an asset base," McDonald says. "You’re not selling the idea that I’ve got this piece of dirt and I’m going to do something with it — it’s already got some properties to it. So sometimes that makes it easier to visualize. But does it change the economics of financing? Not really. If I’m selling to somebody who’s going to convert it to a particular use, it’s going to depend on their financial capabilities — are they credit-worthy? Can they get the financing? It’s strictly a function of what kind of credit the people have — if you’ve got a plan to make the payments, you can get the money."

Creative Skills Pay Off
Opportunities for leasing, site selection, and brokering exist in the reuse area, although those interested in getting into the field need a thorough understanding of corporate real estate departments, as it can be difficult to get a foot in the door.

It helps to start with a good track record, Shillings says. "And you need to have your ducks in a row: your financing, your time line, your business plan, your tenants. You have to have everything put together."

"From a site selection and development standpoint, certainly there are opportunities for someone who has the expertise to understand and do market feasibility to determine and put together an adaptive reuse plan, in terms of understanding zoning, etc.," Rose says. "From a leasing perspective, there’s an opportunity if someone has the vision — and does the background analysis — to reconfigure and remarket. A lot has to do with the relationship that brokers or developers or leasing people have with these users — it’s very much a relationship business. [Corporate retailers] rely on their existing relationships to make determinations on site selection and new stores or facilities. That’s an important component."

"You have to think creatively," McDonald says. "Read the newspaper, read trade articles, drive around, and see something that might make sense. It helps if you’ve been doing it for 20 years, but anyone can use the creative skills they have to do it.

"It’s a function of continuing to work, continuing to dig. I had one property that took almost four years, and when it was done, everyone was saying, ‘Why didn’t I think of that?’ It just took a long time to find the right person. I just kept plugging along."

Sarah Hoban

Sarah Hoban is a business writer based in Chicago.

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