PRINT THIS STORY:

CHANGE TEXT SIZE:

RETAILERS' NEWFOUND OBSESSION: REAL ESTATE

CHAINS ARE BOOSTING PROFITS BY BETTER MANAGING PORTFOLIOS

By Joel Groover

An old knock on retail chains is that selling merchandise is their No. 1 priority, and all else comes fifth. But it may be time to scrap this adage about their alleged myopia. Many retailers are rethinking a critical part of their operations: real estate.

More chains are turning to new software that puts all the members of their often sprawling, poorly organized real estate teams on the same page, according to Boston-based AMR Research. Last year AMR surveyed about 40 real estate executives at retail chains, on behalf of the Washington-based National Retail Federation. Because these departments and their contractors and consultants handle a property's entire lifecycle — from initial site selection and market analysis to construction/renovation to long-term lease and facilities management this technological transformation is no small undertaking, says Robert Garf, AMR's vice president and general manager of retail strategies. “The retail industry is making a massive shift away from Excel spreadsheets or paper-based management of real estate,” said Garf. “Retailers have realized that there is a huge advantage in putting all of those pieces together.”

Another way that chains are consolidating control of their real estate operations is by doing more of their own sales forecasting or market research, says real estate management specialist Jack Thompson, president and CEO of Southlake, Texas-based Tango Management Consulting. “Those projects have typically been in the hands of outsourced service providers that would build those models and tools, which sat on an analyst's desk in the corner,” he said. “That is actually starting to come in-house more.”

But perhaps the clearest sign of change is the growing personal involvement of CEOs and other senior executives in real estate decisions they once rubber-stamped. “It had predominantly been a situation where, as long as certain thresholds and criteria were met, the CEO would rely on his support staff and just sign off on it,” said Kenneth B. Noack Jr., Sacramento, Calif.-based senior vice president of Grubb & Ellis Co.'s land and retail group. “But what we're starting to see is a trend where the CEOs and CFOs are actually taking a more hands-on role in site evaluation and expansion.”

Others agree, such as Richard Leong, a New York City-based senior adviser at Sperry Van Ness/Butler Kane whose clients include chain restaurants. “There is definitely more CEO involvement or principal-level involvement [in real estate decisions],” he said. “It has gotten to the point where a bad location is very costly in time, human resources, even the mental psyche of the company. They just can't afford to make any mistakes.”

Urban rents are so steep that few restaurant chains can afford to open downtown flagships in Boston or Chicago or Los Angeles, Leong says. Prime sites on New York City's Fifth Avenue now go for a whopping $1,500 per square foot, and on Madison Avenue they range from $800 to $1,200 per square foot. Such rents are but one reflection of the same competitive environment that encouraged retailers to sharpen their focus on real estate in the first place, Leong says. Indeed, the imperative to find space and open stores quickly, particularly in the run-up to the housing boom's July 2005 peak, forced many to make their real estate operations more efficient. “The race is to get great sites fast,” Thompson said. “To the extent that you can do that better and smarter and faster than your competitor, you win market share.”

The aforementioned NRF-AMR real estate lifecycle report underscores this need for speed, saying: “The fastest retailers in the survey can open a remodeled store once a lease is signed in less than three months.”

Even as the retail world speeds up, however, it is also becoming more complex. If L.L.Bean had launched its brick-and-mortar expansion in, say, the 1980s, the task might have been relatively simple: to comb through a relatively small number of regional malls in its Northeast home territory for ideal store sites. But when the outdoors gear and apparel seller, chiefly a catalog retailer for its first 90 years, launched a major store rollout in 2006, it did so within a far more varied retail environment. The rise of lifestyle centers near affluent suburban neighborhoods, for instance, is a key part of L.L.Bean's real estate calculus, says Mary Lou Kelley, the company's vice president of retail real estate and marketing.

“Our preference is for a new lifestyle development, because one of our musts now is that customers must have direct access to our store from the parking lot,” Kelley said. “But we look at malls that are putting in streetscapes, and we look at stand-alone locations.”

L.L.Bean's devotion to brand integrity is, in Kelley's words, “fanatical,” and this adds yet another layer of complexity to its real estate decisions. Its co-tenancy demands are rigorous: It will not locate in a center with a discount anchor or dollar store, or in a mall it deems outdated, even if sales projections are strong. The company also sticks to store requirements that did not exist years ago, such as silver-level compliance with the U.S. Green Building Council's ecologically sensitive building standards.

A number of chains, including Staples and Gottschalks, are experimenting with smaller-format stores that can be squeezed into alternative sites such as urban mixed-use projects. “The menu of opportunities for these retailers today is becoming far more diverse than it ever has been in the history of retail,” Noack said.

Along with the potential benefits of real estate for retail chains, there is also the growing risk associated with managing property poorly. Spiraling construction costs add to the already huge capital outlays for store rollouts and renovations. And the more stringent corporate reporting requirements of the Sarbanes-Oxley Act of 2002 make accuracy in lease management a legal necessity. Inefficiency can lead to unwelcome surprises, too, says Garf. “Here in Boston there is a prime location where a high-end luxury retailer was a tenant in about a 40,000-square-foot space,” he said. “The lease came up, but the landlord never told the tenant, which kept paying rent for two years without a lease. Finally, the landlord turned around and tried to evict the tenant. [The landlord] had a much more lucrative deal on the table.”

A single real estate mishap once cost a national big-box chain about $5 million, says Mark Friedman, founder and CEO of Accruent, a Los Angeles-based real estate management software provider. That retailer, which had a portfolio of about 2,200 stores, was in the midst of a nationwide renovation program. After renovating a large store, the members of the construction group went to a meeting with the CFO and learned to their horror that the lease was set to expire. “They had just renovated a store for $5 million that another group was shutting down,” Friedman said.

Accruent's client list of about 200 retailers includes American Eagle Outfitters, Ann Taylor, Best Buy and RadioShack. The company's Web-based software helps chains connect the disparate parts of their real estate departments. The application can also be set up to allow brokers and other third parties to log in and check the status of the real estate process. In the case of that $5 million mishap, Friedman says his software could have marked the store with a red flag to prevent the construction group from touching it.

Certain day-to-day problems, too, though smaller in scale, can have an enormous accumulated cost, Friedman says. “We hear stories about store openings where the certificate of occupancy is delayed a week or two, but this isn't communicated to other parts of the company, so you have new employees showing up at a store that isn't open,” Friedman said. “Ad campaigns get launched at the wrong time. Inventory shows up that you're not allowed to put in the store, so the truck sits in the parking lot and you have to hire a security guard to watch it.”

The NRF-AMR report says that one out of four retailers used enterprise software to manage real estate in 2006. That number grew to nearly four in 10 last year. “We have reached the point where we have one new customer going online every 10 days,” said Peter West, Accruent's vice president of marketing. “This is something the industry has embraced, and it is a big change.” But now that the economy has many retailers pulling back on their expansion plans, their real estate needs are changing, Friedman says. “They're talking to us about how they collect rent, because they're either going to sublease stores or shut them down,” he said.

And this illustrates a truism: Real estate's importance is cast into sharp relief by either upward or downward economic trends, says Garf. “In a booming economy, you cannot open stores fast enough,” Garf said. “In an uncertain economy, each decision you make is scrutinized that much more, and there might be opportunities to create efficiencies.”

Or still more opportunities to grow. L.L.Bean is looking past the short-term real estate cycle in its ongoing brick-and-mortar expansion. After opening two stores in 2006 and three last year, with hopes to open four this year, the retailer plans to ramp up the program dramatically next year, Kelley says. In fact, L.L.Bean has already signed leases at some developments slated to open in 2009. “Our goal is to open about eight stores a year and to reach probably 60 stores eventually,” Kelley said. “The market will go up and down. It is slowing now, but that may be advantageous for L.L.Bean.”

For Vincent Corno, Saks Inc.'s new senior vice president of real estate (see page 101), the retail industry's heightened awareness of real estate's strategic importance is welcome news. Corno was vice president of development at Cleveland-based Forest City Enterprises before joining Saks in February. “Your real estate strategies are very important,” Corno said. “It could be argued that they are almost as important as your merchandising strategies.”

Old adages to the contrary, that clearly is an argument more chains are starting to buy.