PLEASE RE-LEASE ME

GLASSBORO, N.J. - In an ideal world, A&P's Food Basics discount concept would prevent stores from going dark in the first place. But here, the birthplace of A&P's new-generation discount banner, Food Basics occupies a former A&P storefront that turned its lights out long ago.Officials of A&P, based in Montvale, N.J., are quick to mention that the Food Basics store here is still in the "tweaking stage,"

GLASSBORO, N.J. - In an ideal world, A&P's Food Basics discount concept would prevent stores from going dark in the first place. But here, the birthplace of A&P's new-generation discount banner, Food Basics occupies a former A&P storefront that turned its lights out long ago.

Officials of A&P, based in Montvale, N.J., are quick to mention that the Food Basics store here is still in the "tweaking stage," and so use caution when it comes to predicting how large the concept may become. But it's their hope that Food Basics can become not only an alternative concept for existing stores in changing neighborhoods, but also a solution for the dozens of sites where A&P no longer operates a store, but continues to pay rent.

Food Basics "wouldn't go into a huge number of [dark] sites," Christian Haub, A&P's executive chairman, told SN in a recent interview, "but it could go to areas where we don't currently operate stores."

In that way, Food Basics offers a promising solution to a problem plaguing all manner of U.S. retailers. While real estate investors and savvy developers can make a fortune on the past mistakes of food retailers, food retailers themselves often struggle to realize a satisfying resolution to the dilemma of closed stores on their books.

If the experience of stores in Canada is any indication, dark-store programs that replace one store format with another operated by the same company have real potential for U.S. supermarkets, according to Perry Caicco, a Toronto-based analyst for CIBC World Markets. A&P in particular could succeed, Caicco noted, seeing as it not only has plenty of former supermarket real estate in need of a new use, but because of Eric Claus, a chief executive with experience doing the very same thing in Canada.

"In Canada what occurred was that conventional supermarkets in neighborhoods that were deteriorating usually managed to convert to a basic discount box store operated by the same company," Caicco told SN. "They'd strip out the assets and give it a limited number of SKUs, take out the service counters and lower the prices substantially. It makes it good for the neighborhood again."

U.S. retailers, including A&P, have only recently begun to operate multiple formats, and very few have programs in place to use those new formats as a means to salvage their old real estate, sources said. Food Lion this year introduced a discount box called Bottom Dollar, but at this point it has used the store only as a means to convert existing Food Lions. There are no plans to use Bottom Dollar to fill dark space, Jeff Lowrance, a spokesman for the Salisbury, N.C.-based retailer, told SN.

Replacing a dark store with a new format can be risky, since re-developing the space can be costly and pays off only when the new format succeeds. A&P learned as much when an earlier incarnation of the Food Basics concept failed to become the answer for the retailer's struggling stores in the Midwest.

"If you run a negative operating profit you're better off leaving the space alone and paying the rent," Caicco noted.

However, he said he is more confident that the Canadian model Claus is bringing to A&P can succeed.

"Companies that tend to operate classical, full-price, conventional supermarkets can't work when the neighborhood they're in goes downhill. A supermarket rarely works in an economically depressed area," Caicco said. "That's why there's so many dark stores in the U.S. The difference for A&P is that they have a format that works in lower-income neighborhoods."

Playing by the Rules

Typically, supermarkets with closed stores on their ledgers attempt to sublease the locations to other uses. But many retailers find that disposing of stores is not their specialty.

"Think about an acquisition or an opening - the landlord wants you, you're anxious to do business, everybody's happy," Michael Weiner, chief executive officer of Excess Space Retail Services, Lake Success, N.Y., told SN. "Disposition is another story. It's bad news, you're closing down and the landlord's not happy, there's a lease in place with restrictive covenants and unhappy co-tenants. There are a lot of hurdles you have to learn to jump."

Wal-Mart Stores, Bentonville, Ark., and Kroger, Cincinnati, tend to work with local real estate brokers in the markets they sell stores, and market their properties for sale or lease on the Web at WalmartRealty.com and KrogerRealEstate.com, respectively.

"The guy who subleases a store requires a completely different skill than the guy trying who does a deal to open it," Ted Kraus, chief executive officer of TKO Real Estate Advisory Group, Mercerville, N.J., told SN. "They need a softer touch. They have to be humble."

In some cases, food retailers choose to exercise lease clauses that prevent a competitor from taking over their dark space, limiting the potential candidates in a sublease, angering landlords and co-tenants, but ultimately strengthening their competitive market positions. This has become a topic of debate in places like Chicago, where some neighborhoods are stuck with a dark store leased to a supermarket operator with a newer store in a nearby neighborhood. Legislation to prohibit such practices was discussed last year.

"Wal-Mart will close a store because they think a new one can do better, move a mile away and pay rent on the old site for nine years if necessary," Kraus noted. "They'll try to sublease the old site, but Wal-Mart is a good enough retailer to make that situation work for them."

According to Weiner, supermarkets tend to carry excess properties in part because selling them in bulk is a rarity except in cases such as the recent Albertsons breakup, or bankruptcy situations such as Grand Union or Winn-Dixie, where a company surrenders all its locations in a market. This is because every location includes differences in lease terms, rent and other attributes that would tend to be "hedged" by an investor.

"Unless you have a lot of under-market leases, or you're willing to take a huge financial hit, a bulk sale is a very unlikely scenario," he explained. "Most surplus portfolios are not made of properties that are well under-market. So if you're selling a property and getting 70 cents on the dollar, in a bulk sale you'd get 20, 30 or 40 cents on the dollar because somebody would have to hedge their position.

"Albertsons sold a ton of locations but that was only through selling the whole company," Weiner continued. "Most retailers don't want to sell their whole company - they just want to get out from under some of their real estate."

Generally, sources say, old supermarkets make attractive properties for a variety of uses. Though supermarkets tend to be more expensive to convert to new uses than a similarly sized discount or clothing store, they also tend to feature long-term leases at attractive rates and close-in locations with good visibility. These attributes can and often do trump conversion concerns, Kraus said.

Where supermarkets encounter difficulty re-leasing space are situations where neighborhoods are deteriorating, or existing rent is unusually high.

"Ideally, a supermarket wants to sublease their closed stores at a profit - that's the American way," Kraus said. "But if that doesn't work, they'll sublease it at a loss. The number-one rule in real estate is to make a profit. Rule number two is to minimize your loss."

Remembering Grand Union

Real estate sources and retailer comments indicate interest is high for the Albertsons sites put up for sale earlier this year by Cerberus Capital and its partners, which gained possession of some 600 Albertsons stores deemed unworthy by Supervalu, which bought Albertsons' prized assets in the same deal.

Hedge funds like Cerberus tend to buy retail chains as a "back door" into real estate, relying on the perceived value of the portfolio as an exit strategy, sources said. This strategy was famously deployed by Kmart, which according to Kraus, "was a complete failure as a retailer but made a lot of money on real estate."

However, the real estate analyses used by such firms tend to focus on broad financial projections and give no regard to "the specifics of locations that determine their marketability, such as access, visibility, demographics and competing retailers in the trade area," Tom Dwyer, principal of Dutch Hill Consulting, Poughkeepsie, N.Y., told SN.

Such concerns ultimately determined the fate of Grand Union, the supermarket chain that liquidated 216 stores in 2001, Dwyer said. In the five years since, its portfolio became a subject of controversy in some communities and a spark for re-development in others, according to Dwyer, who is currently completing a study of the former sites. Much, he said, depended upon location (stores at major intersections tended to find more users faster than neighborhood locations along secondary roads) and factors like options to expand the property and the local competitive mix.

In Woodstock, N.Y., a Grand Union lease acquired by the drug chain CVS faced fierce community opposition, even from government officials, outraged at the loss of a community grocery store, Dwyer said. Since a drug store was an as-of-right use under the existing zoning, the store was ultimately allowed to occupy the space - though sign regulations were apparently something the chain could not circumvent.

"Although pylon sign visibility is near the top of the list of CVS's site criteria, the signage in front of the Woodstock store is so minimal that I drove right by it when I went to Woodstock to inspect the site - and I was looking for the store," Dwyer noted.

Small Grand Union stores in hot retail locations required their new owners to be creative. In the high-income Long Island suburb of Port Washington, N.Y., for example, Stop & Shop purchased a 24,000-square-foot Grand Union store, and then purchased a neighboring oil storage terminal. The retailer subsequently had the latter site re-zoned and environmentally remediated, then combined with the Grand Union site, all of which was re-developed into a new 68,000-square-foot Super Stop & Shop.

"Many of the small Grand Union stores were in densely built-out suburban markets where large sites were difficult to come by," Dwyer said. "So acquisition of the leases were used more as bargaining chip to facilitate a deal to build a larger store."

As of early this year, at least 24 Grand Union stores remained dark, excluding those sites that may have partial vacancies due to subdivisions. Several, Dwyer noted, are located within a mile of a Wal-Mart.