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Tenants become landlords

Wal-Mart, others face surplus-space boom

By Debra Hazel

There used to be a Sam’s Club here — but Wal-Mart has since leased the site to a Mercedes dealer.

Talk about trading up, at least in terms of price point: A former Sam’s Club in Pompano Beach, Fla., now houses a Mercedes-Benz dealership.

And not only does Sam’s Club owner Wal-Mart like the swap just fine, it actually arranged the deal.

“It’s now one of the largest dealerships in the state,” said Jed Harrison, director of building development for the discount king, which is now the Mercedes dealer’s landlord. It’s no surprise that the world’s largest retailer has substantial excess space, or in its parlance, “once-occupied property.” The company has an inventory of 30 million square feet of excess space, half of which is now “income-producing property” for the chain, Harrison said.

And Wal-Mart isn’t alone. As retailers continue to expand, redesign and consolidate, they find that older units no longer serve their needs. And they have to dispose of that space somehow, usually by re-leasing it to other chains.

“In 1999, we handled between 25 million and 30 million square feet of surplus, predominantly supermarkets and drugstores,” noted Michael S. Wiener, president of Huntington Beach, Calif.-based Excess Space Disposition, which specializes in re-leasing excess space.

While the practice isn’t exactly new, the amount of surplus property has increased dramatically during the superstore era, according to industry executives.

“We’ve done this for eight or 10 years, and with the exception of when Kmart was closing stores [in the early 1990s], I’ve never had so much inventory,” said Carl LaSala, president of LaSala-Sonnenberg Commercial Realty, Overland Park, Kan., which also deals with surplus units.

While a small portion of excess space can result from financially driven store closings, most of the surplus today actually is a sign of a healthy industry: As retailers have increased the size of their boxes, their older, smaller stores simply do not fit their new prototypes. Outmoded units must be sold, sublet or given back to a landlord to remove empty space from the company’s balance sheet.

“This is all nonbankruptcy work. We work with retailers wanting to be healthy, that want to improve their position,” Wiener said.

In Wal-Mart’s case, the 1987 creation and subsequent expansion of its Supercenter concept, which combines its traditional discount format with a supermarket component, has led to many of its older, strictly discount units becoming redundant. Finding a use for those stores rather than leaving them shuttered has become a priority for the Bentonville, Ark., company.

“Our first focus is to add value to our building and the community by finding a valuable tenant,” Harrison said. “If we can do an early termination with the landlord, we do or [if we own it] we sell it.” The company now has 700 Supercenters and 1,900 discount stores in the United States.

Another factor in the growth of surplus space is a change in location strategy. Drugstore chains like Walgreens and Eckerd, for example, increasingly have relocated from strip centers to freestanding units with a drive-through component.

“This means you leave the strip, but you still have the lease obligation,” said Kim Esposito, director of real estate administration for drugstore company Eckerd Corp., Largo, Fla.
Consolidation remains a factor, even years after the deals. Eckerd’s 1996 merger with J.C. Penney created duplication with Penney’s existing Thrift Drug stores in some markets, Esposito said.

“CVS can buy Revco and find they have units across the street from each other,” Wiener added.
And financial considerations are a factor as well.
“In addition, we had a complete review, so we closed a number of underperforming stores. So that increased our numbers dramatically,” Esposito said.

The amount of excess space, like the box below, has seen a dramatic upturn. Wal-Mart re-leased a Sam’s Club site, above, to a Mercedes dealer.

The original retailer then becomes a landlord itself. What doesn’t generally increase much is the retailer’s bottom line: The process really is geared toward slowing a financial drain rather than making money.

“The general rule of thumb is that it’s not a profit center,” Esposito said. “While a rent may be higher, there are administrative fees, and maintenance and repairs usually are our dime. We are definitely subsidizing the store.” But leaving a unit vacant would mean giving up millions of dollars.

Finding the tenants to sublease or, in rare instances, acquire the unneeded units isn’t always easy. And different retailers have chosen very different methods of eliminating the surplus property.
Eckerd, for example, outsources nearly all of its dispositions, Esposito explained.

“I’ve been in this program for two and a half years, and when I started out, it was around 100 properties. It was manageable,” she said.

But with the chain’s consolidation and continued move to freestanding stores, her workload increased exponentially: The chain has about 4.3 million square feet in excess space, with most stores ranging from 8,640 square feet to 10,000 square feet.

Charged with administering 300 subleases as a one-person department, Esposito uses Excess Space Disposition and Charlotte, N.C.-based Core Properties on a geographic basis.

“Both companies do a fantastic job,” she said. “But the outsourcing is not solely because of understaffing. We decided that their staffs are deal-makers. They get paid only when the deal is done. They supply the technology, the Web page, etc. They also will provide [potential tenants] the volume. It’s one point of contact. When Dollar General calls, they can say, ‘Here’s a list of potential sites.’”

Wal-Mart, on the other hand, has chosen to dispose of its outmoded property itself, forming its Wal-Mart Realty division in the mid-1990s.

“From a management standpoint, we wanted to take a direct role in a position that is important to our shareholder value,” Harrison said. The company does hire outside firms for a few dispositions as well.

Wal-Mart’s surplus stores tend to average between 70,000 square feet and 110,000 square feet, though some older units have been as small as 30,000 square feet, and Sam’s Clubs total 140,000 square feet.

“We have a list of about 500 contacts. We market our properties very aggressively, and we’re very quick to subdivide,” Harrison said. Because the vast majority of stores are basic rectangles, a 90,000-square-foot unit can be easily divided into three 30,000-square-foot bays, he said.
In Pompano, the auto dealership required a bit more work.
“There was a lot of construction: They had to put in a lot of glass,” Harrison noted.
Other potential tenants can come from outside the retail universe.

“One of the most interesting took place three months ago, when I saw grocery stores being converted to telecommunications centers. Of course, it’s not a very attractive use,” said Troy Peple, president of Chain Links Retail Advisers, a retail brokerage network based in Vienna, Va. The firm recently announced a joint venture with Melville, N.Y.-based DJM Realty Services, a Gordon Bros. Group division specializing in retail real estate disposition.

Industrial and office uses also are potential tenants, particularly for extremely large facilities that are being sold rather than subleased.

“I’ve put in post offices, churches, car dealerships. They have terrific parking lots,” said LaSala, who has disposed of units for the now-defunct home centers Builders Square and Home Quarters.
Often, patterns will emerge, noted Howard Makler, chairman of Excess Space Disposition.

“Dollar stores will take former drugstores,” he said. “For the supermarkets, we’ve put in everything you can think of, including an antique auction shop and hard goods.”

No one expects this segment of the industry to decline any time soon.

“Frankly, it’s going to become much more important. As the economy cools, we will not see growth for the sake of growth,” forcing companies to reorganize their existing stores, Peple said.

E-commerce, he added, may also be a factor. As Internet sales become a greater part of a retailer’s bricks-and-clicks strategy, store needs will change, both in terms of configuration and the number of physical units needed. And a new challenge may be coming up quickly: cinemas that could be closed as a result of multiple bankruptcies among chains.

“This is not so much huge now, but about to become huge. Everyone is watching for which company will tank and put its entire portfolio up,” for sale or re-lease, Peple said.

This could be just the beginning, Wiener added.

“Retailers are forever changing,” he said. “Surplus is a business that will continue to proliferate well into the future.