In 2004, construction costs rose in nearly every major city in the United States.
According to Engineering News Record's construction cost index, labor, materials and land prices skyrocketed, adding to growing development costs in cities from San Francisco and Seattle to New York and Atlanta. Recent data from the U.S. Bureau of Labor Statistics revealed prices for construction materials increased nearly 2% in just the first two months of 2005, including prices for concrete, plastics, asphalt, air conditioning and refrigeration equipment -- all necessary components of developing supermarkets.
For grocery store developers and retailers, this means developing judiciously, and in select markets. New stores are smaller, and averaged 34,000 square feet at the end of 2003. This is the smallest they've been in a decade, according to Food Marketing Institute's 2004 Facts About Store Development report. Overall, new construction equaled only 3.1% of all stores. Most retailers chose to modernize their stores and add such features as deli departments and more prepared foods rather than grow by new store expansion. Yet, in FMI's study, even those renovations were down, to only 5% of the total stores from 7% the year prior.
"If you look at where grocers are spending their money, they have better food presentation areas, better lighting," said Mark Harrigian, senior vice president of investments, Regency Centers Corp., Jacksonville, Fla. "But margins are getting pinched, and construction costs are not getting any cheaper. Typically, a grocer will invest upwards of $15 million just to outfit a store."
"The cost to fixture a grocery store is almost as high as it is to build it," said Martin Debrovner, vice chairman, Weingarten Realty Investors, Houston. "The refrigeration, the front-end equipment -- it's all very expensive."
However, the costs aren't dissuading the most powerful grocers from updating their real estate. Publix, for example, had its developer New Plan Excel Realty Trust knock down an older 50,000-square-foot store outside of Tampa and build a more efficient 44,000-square-foot store on the same site. New Plan is executing a similar deal with Kroger, which is replacing a 1950s vintage market in Cincinnati with a 77,000-square-foot store across the street.
Food Lion is revamping its portfolio, too. It expects to open 30 to 35 new stores in 2005, but will renovate nearly five times that many in North Carolina, Maryland and Delaware this year. Much of the work will involve creating consistent Food Lion stores across primary markets.
Giant Eagle, for its part, invested in building the country's first sustainable supermarket. Its 80,000-square-foot store in Brunswick, Ohio, was certified last December under the Leadership in Energy and Environmental Design (LEED) Green Building Rating System, administered by the U.S. Green Building Council.
"The top supermarket players are proactive. They're not sitting back," said Stuart Kans, president and chief executive officer, Pan Pacific Retail Properties, Vista, Calif., which is the largest owner of grocery-anchored shopping centers on the West Coast. It cites Albertsons, Kroger and Safeway as major tenants. "The retailers are not so much growing or shrinking their real-estate portfolios, but redesigning the layout of their stores and creating more efficiency within them."
Hot Markets = High Costs
How much a developer or retailer spends on renovation or development varies tremendously based on the specific demographics of the region, but like any recipe, there exists standard proportions.
"On average, today, you can make the assumption that a grocery-anchored shopping center could range from $120 to $135 per square foot to build," said Debrovner, whose company averages $400 million in grocery acquisitions and $50 million in development of supermarkets annually, mostly in the South.
Much of the development expense is devoted to product that ultimately does not generate any revenue. Developers, for example, might spend up to $20 per square foot just establishing the parking lot and landscaping -- and that is just the cost of land. For every square foot of building area, retailers generally have to gear up to provide up to three feet of parking space.
Like anything in high demand, the regions where supermarkets want to develop are the most expensive, of course.
"Right now, the higher-growth markets are in concert with the higher cost of construction by about 15% to 20% over the rest of the nation," said Harrigian, whose company spends $300 million to $350 million on ground-up construction every year. "Most of that is labor-related. When I have a framer do a job for me in California, I'm competing against 1,500 residential projects. We're all fighting for the same craftsmen."
Likewise, in Las Vegas, "it's been the most dynamic market for the past five years. From a retail perspective, it's one of the highest in terms of a tenant base, but it's running out of land," said Kans. "Grocery stores are going to start to go vertical."
The West Coast continues to appeal to investors and retailers, but not all markets are experiencing the explosive growth of Las Vegas and similarly booming areas like Southern California and Phoenix. These are particularly attractive due to strong housing and job growth. Developers and retailers are also chasing deals in markets in the Mid-Atlantic and Florida.
Breaking into these new markets without a pre-existing foothold, however, can be near impossible for retailers.
"It's very expensive to launch into new markets," said Terry Evans, chief executive officer, Edens & Avant, Columbia, S.C. "We see retailers investing further in markets where they are already dominant. That's where they will generate the highest returns."
Real-estate developers are doing the same. Edens & Avant currently has roughly $200 million in active redevelopment plays in its portfolio, and is focusing on repositioning its centers cosmetically and tenant-wise.
Since the cost of developing is so high and time-consuming, real-estate investment trusts and retailers focus on acquiring real estate rather than building. Regency, for example, recently closed on a massive $2.7 billion acquisition of 101 properties in the Mid-Atlantic.
For developers, buying a property does not reap the same kinds of returns as building from the ground up, however. Weingarten, for one, is primarily an acquirer of property, but has grown its company recently through ground-up development. "It has a much better initial return," said Debrovner.