The Big-Box Nation
Big Box Is Retailing. Retailing Is Big Box.
Large, dominant retailers are where the retail business is at; small retail-especially mom-and-pop retail-is really dying," says Bill Mohr, CCIM. That appears to be true. A review of the phenomenal growth of this industry subcategory (see "Format Lifecycle" chart, page 27) supports claims of the relative health of big boxes. The investment market for big boxes remains active, helped by low interest rates. Furthermore, the subcategory itself is broadening; though Wal-Mart and Target continue to be the high-visibility leaders, big-box users include drug stores such as Walgreens, restaurant chains, bookstores, cinemas, and much more. Once almost exclusively found on cheap land in the outskirts of towns and suburbs, big boxes are now also moving into the cities in search of high-volume traffic. As a result, cities such as Chicago, San Francisco, and even New York City-long devoid of the mass retailer-are reconfiguring space to fit the needs of big boxes.
The future of big boxes is not all rosy, however. The state-of-the-art distribution and volume pricing by big-box retailers that have hurt many small competitors are also forcing a shakeout within the industry. Office supply and electronics superstores have seen a reduction in the number of players in recent years. In Chicago's suburbs, the shakeout has been building momentum; the overstored suburbs are now dotted with empty big-box properties that are difficult to reconfigure. Crain's Chicago Business recently reported that real estate professionals and municipal officials are concerned about the market's nearly 9 million square feet of vacant big-box space, some of which has been vacant for years.
Opposition to big boxes from affected communities is also growing. Media ranging from The Progressive to 60 Minutes have highlighted a small-town backlash against Wal-Mart-the easiest target, due to its size and visibility. The kinds of creative compromises communities and retailers will work out remains to be seen. Though big boxes can create traffic for nearby competitors, their traffic patterns are not as desirable as those found in downtowns, strip centers, and malls. And though much of the competitive loss can be chalked up to better service and prices that should galvanize competitors to improve their own stores, many of them lack access to the huge capital markets that big boxes can tap; thus, they simply are unable to survive long enough to retool. The good news for smaller retailers-and their shoppers-is that many are retooling to become more service-oriented.
To examine the state of the big-box industry, the Commercial Investment Real Estate Journal asked four experts to evaluate the industry's present and future, provide tips on working with big-box users, and answer critics of the industry.
Which is the placement of the future for big- and small-box developments: suburbs and small towns or big cities?
David Gustafson, CCIM: I expect to see continued growth in the small towns and suburbs, because retailers continue to seek to increase market share through sales growth and these locations are easier to procure. It is important to note that this does not necessarily translate to profitability. I also expect to see continued redevelopment of big-city "infill" locations for big boxes as the extraordinary sales achieved out of these locations justify the redevelopment expense.
Gary Ralston, CCIM: Superstore-format retailers are seeking very high-volume sales-thus they favor intensive commercial corridor locations, typically several million square feet and often anchored by a regional mall. The discounters and superstore-format commodity stores such as food and drug can also position themselves in secondary markets-small towns. Most of the superstore growth and development in the next five years will be concentrated in the 40 largest metropolitan areas and the top 20 metropolitan areas for population and job growth.
Bill Mohr, CCIM: What we are seeing in the entertainment as well as the reta il side is that tenants want to dominate a sector. If people build a 6,000-seat theater, they want to be the only theater to go to in the area. That's not unlike what Wal-Mart can do, with its buying power, and it can really shut down small retailers.
One of the different things about the movie theaters and the retailers is that big-box retailers compete on price, but movie theaters concentrate on the product offered. A 30-screen complex may be showing a big recent release on several screens at once. If you have a beautiful one- or two-screen theater but you can't get any good movies, nobody will go to your theater. That's [the theater owners'] version of being the dominant player.
Robert Rosenberg, CCIM: A corollary is that a lot of these companies are driven by their stock price, so they need to get their same-store sales up. So, they might get a bigger store in the same market with the same product line, just more of it. Growth comes from two ways: opening new stores and getting your same-store sales up; if you don't do one of those two things, the stock market can react quickly.
How are most big-box developments financed?
Ralston: Most developers obtain a permanent loan or a "presale" (sale prior to commencement of construction). Either strategy makes construction very feasible.
Gustafson: In terms of investment sales, most of the sales of big boxes I am involved with involve permanent life [insurance] company or securitized financing, either concurrently with or after the closing of the sale. To a lesser extent, there are selective institutional buyers that purchase and own them unleveraged.
Mohr: If you don't go to entertainment, they're traditionally done by credit companies. On the entertainment side, companies see the tremendous sales with these deals, and it's becoming its own market niche. If they develop large complexes, they go to Wall Street.
Rosenberg: Construction loan, then a takeout where they finish it, package it up, and sell it to REITs. There are several types of projects: where they build it and keep it in their portfolios; the capital gains builder, who builds it to sell the asset; and where they sell the project as a collection of pads that users buy individually.
What are "small boxes" and how do they differ from big-box development? What kinds of companies are utilizing the small-box format?
Ralston: We define big boxes as around 100,000 sf and larger. Small boxes are typically 10,000 sf to 50,000 sf. We really focus on the site and setting to define properties between 50,000 and 100,000 sf. If they are closely oriented to the road-no outparcels-they are more like small boxes; if the site contains outparcels and is somewhat distant from the commercial road frontage, then it is a big box.
Both small and big boxes usually favor long-term leases. We focus on long-term leases of more than a decade in duration, which we believe bridge real estate and economic cycles. Further, we like net leases-the tenant is responsible for property taxes, property insurance, maintenance and repairs, operating expenses, and capital improvements. Superstore-format retailers are usually comfortable with triple net leases since they seek to control the property long term.
The development gestation period for a freestanding small or large box is 6 to 12 months versus 18 to 36 months for a typical strip or power shopping center.
Superstore retailers are typically larger-scale formats than their in-line counterparts. Size is still relative to the retail application. For example, drug stores located in a typical strip shopping center are generally 6,000 sf to 8,000 sf, while a freestanding superstore-format drug store, perhaps with a drive-through window, may be 10,000 sf to 20,000 sf.
The single distinguishing characteristic of superstore retailers is that they provide a dominant assortment of a particular product category-thus the descriptive name, "category killer." They combine this overwhelming assortment with value pricing. Office Depot, OfficeMax, and Staples are classic examples of superstore-format retailers using efficiencies and economies of scale to dominate an under-rationalized industry segment-office supplies.
Superstore-format retailers-small and big boxes-are expanding while traditional retailers are contracting. Superstore-format retailer expansion is driven by a number of factors: the proliferation of category-killer formats in a variety of retail lines of trade; increased growth of supercenters by the "big three" discounters-Wal-Mart, Kmart, and Target; higher productivity in freestanding locations that makes sites more attractive to retailers; and freestanding stores that appeal to consumers' need for increased shopping convenience.
Gustafson: I would categorize small-box retailers as the "category killer" retailers which occupy big-box style stores but contain less than approximately 75,000 sf. In my investment sales, these would include Ernst Home Centers, Orchard Supply Hardware, Linens & Things, Tandy Computer City, Comp USA, OfficeMax, Just for Feet, Sports Authority, Media Play, First National Supermarkets, Barnes & Noble, and others.
Other than the observation that most of these folks could not fill a bigger building with their merchandise, from my standpoint these "small boxes" are attractive because they are smaller-sized investments which are reachable for more of my individual investors.
What areas are ripe for more big-box development?
Gustafson: Those areas that are expected to realize the greatest population growth-the Southeast and west of the Rockies.
Mohr: Entertainment retail is a new growth area. You'll see the stronger markets get them first, and you'll see the larger places-the New Yorks and the LAs-get them first because that's where the people are. I'm sure it'll go all over the world in that kind of format; it's not American culture, but it's a marketing format, because people all over are willing to go a little farther to reach a desirable destination.
Are any areas saturated with big boxes? Are we nearing a shakeout in the industry?
Gustafson: All areas are saturated in what seems to be a never-ending race for market share. As many in the real estate business feel, I am concerned about the future of retail. An overbuilt situation appears inevitable, and we are already seeing difficulty and consolidation. The current woes of Kmart are most noteworthy. Kmart is under serious pressure to complete its divestiture of its noncore businesses and refurbish and remerchandise its own stores. Others are experiencing growth pains as well, but to a lesser and less well published extent.
Rosenberg: We're starting to see a slight shakeout and we don't know what all of the consequences will be. In the first round in the 1990s, you had a lot of leveraged buyouts and a lot of debt. They couldn't service the debt, so they were forced into bankruptcy. Then they emerged from bankruptcy without the debt. In the next round, you're going to see people dropping out. I definitely see places across the country getting saturated. Almost all of the large discount stores are in bankruptcy right now except Wal-Mart and Target. In the northeast, all of the major department stores, such as Caldor and Bradlee's, are in bankruptcy; they are not adapting fast enough to keep up with Wal-Mart. People keep predicting that this is the year for Kmart to go bankrupt; I'm not ready to write off Kmart yet-anybody who's got as much cash and locations as it does has a chance. Remember, that's what they were saying about Sears a while ago and now Sears is back in good shape.
Mohr: In California, there is 20 sf of retail space per person, and 10 years ago there was only 11. A lot of that square footage will move over to service retail; it's too small and not configured right for retail. There will be a market correction. Many regional shopping centers are experiencing declining sales.
If you were going to do a regional mall 10 years ago, you would have 75 percent of your tenants selling apparel, but today you'd only have 25 percent selling apparel because power centers have gone after that market segment.
Ralston: We believe that there are a finite number of viable superstore sites per retail line of trade-1,500 to 2,000, except for food and drug which are significantly higher-and there is a "land rush" right now with retailers vying to capture the best sites. In many cases, retailers are relocating-repositioning-existing in-line stores to high-visibility destination-oriented freestanding sites.
What retailers are expanding the most?
Mohr: Home fix-up stores have been a big part of the marketplace. Bookstores and music stores have taken off, and restaurants are doing very well. Food is the classic American entertainment. The growth has been in casual dining; fine dining has been declining, except in the big cities. It's projected that by the year 2000, half of the meals you eat will be out of the house in restaurants. It really comes down to being convenient.
Gustafson: Wal-Mart and Home Depot [are expanding], and virtually all of the small boxes including the home improvement chains, home electronics and appliances chains, bookstore chains, and the computer and office equipment chains.
Ralston: The big three of discounting-Wal-Mart, Kmart, and Target-will continue to expand, albeit at a slightly slower pace than recent years. Category-killer formats are rapidly expanding and seeking new sites. There will also be consolidation, which may generate duplications resulting in a search for second-generation users. Again, the office supply sector is a good example; at one time there were nearly a dozen office superstore retailers-now there are three. Look for food and drug retailers to pursue aggressive relocation strategies to protect key markets.
Do big-box retailers use mostly in-house real estate professionals or outside consultants? How does one go about getting involved in big-box development?
Rosenberg: It depends on what it takes to get the deal. A lot of times, the company prefers an in-house expert.
You have to build relationships and show that you add value. The hard part in getting involved is getting their attention. As they get bigger, there are less opportunities, and they want to go with someone with experience.
Mohr: If you're in the local market where the home office is, they have a lot of those services in-house. The best way to get in is to be in a market where they want to be involved but aren't yet. There certainly is the opportunity for the CCIM to provide those roles. Networking is something from which CCIMs can benefit: build teams from across the country.
Ralston: Most of the expanding superstore retailers have sophisticated internal real estate departments. However, they need local real estate expertise to identify and control the very best sites. If you have a reputation in your local market as a retail site-selection "guru," they will probably call you. If you don't have that reputation, then get well acquainted with the retail landscape and players-the International Council of Shopping Centers deal-making sessions are a good place to start. Subscribe to retail publications such as Chain Store Age. Remember that the public retail companies will telegraph expansion plans to the market via press releases, annual reports, etc.; you can discover a lot of information in the Wall Street Journal.
Gustafson: Most of the big-box retailers use a combination of in-house personnel and outside consultants or developers. Many do both self-development and use third-party developers for their stores. Those self-developed stores are often ultimately sold and leased back with the most notable exception being Home Depot, which would rather own its own real estate. Breaking into the development business is more difficult today than it used to be as a result of the equity or take-out currently required to finance a project.
Big-box retail developments have been receiving a lot of criticism lately from small, independent retailers forced out of business-especially in very small communities.
Mohr: What all retailers are looking for is to draw from a larger area, to dominate an area. And entertainment companies are doing the same thing. The essence of what makes a mega-store go is being able to draw from a larger trade area. They locate in suburban areas where they can get cheap land and good access. There isn't always a tremendous cross-sell [generation of traffic that helps out neighboring businesses]. With power centers, often they get the opposite effect of what you get with regional malls, where people walk around and see the other stores. With power centers, people tend to park their car in front of the store they want to visit, make their purchases, and not walk to other nearby stores.
Ralston: I believe that for the foreseeable future, retailing is basically a "zero sum game." Thus, the expanding superstore retailers are taking market share from competitors, and only the strongest will survive. We have accepted this economic fact and are seeking to establish working relationships with the expanding superstore-format retailers across the country.
Rosenberg: Some of the criticism is fair and some of it is not. Operators who do not want to change how they do business are in trouble; people who don't want to take care of customer service are in trouble. You do not get to pick the rate of change; you have to react to it. Wal-Mart is in touch with its suppliers to the point where the supplier knows how well-stocked they are and just when the stores need just-in-time delivery. Another trend is the entertainment development. People demand more and more to be wowed. Soon people get bored with it, but you can't stop trying to wow them.
On prices, how does a mom-and-pop operation compete when they have to pay more wholesale than their competitors can charge retail?
One New England town recently worked out a compromise with Wal-Mart, in which the retailer bought an existing building in the downtown area. Are we likely to see other creative compromises in the future (and what might they be)?
Mohr: That would be the role of a redevelopment district, and its role is to make the market do what it generally wouldn't do. That's one of the things I work on, because movie theaters are often used to reinvigorate a downtown area and we need city help with all of the parking spaces.
Gustafson: I would imagine the answer is yes, but only to the extent that the retailer really wants to be in a particular location. Otherwise, their "destination" nature will create an attitude of indifference and they will locate elsewhere.