NEW PROPERTIES

LIZ PARKS / CHRISTINA VEIDERS

For as many store casualties and market exits reported by large, publicly run supermarket companies over the last two years, there are savvy independents ready to seize opportunities by turning underperforming real estate into a growth asset.

In some cases, independents who have established a strong identity and good reputation within their local markets are being courted by communities needing a supermarket. Consequently, grocers can take advantage of reasonable lease rates as well as other incentives offered by communities to attract the supermarket operator of their choice.

But growth through acquisition or new store development remains a risky business. The stakes can be high. Witness the fall of Buehler's Foods, Jasper, Ind., the 66-year-old family chain that filed a Chapter 11 bankruptcy last year after purchasing 16 Winn-Dixie stores. Buehler's cited delays in taking control of the stores as the reason for its bankruptcy. It faced between $50 million and $100 million of debt at the time of the filing. The company is in the process of a reorganization.

Meanwhile, Rob Rowe demonstrated how a single entrepreneur saw an opportunity in the food retailing business and purchased seven Albertsons stores in Jacksonville, Fla. Albertsons decided to exit Jacksonville because it could not be the market leader with underperforming stores. From 1997 to 2004, Albertsons' market share in Jacksonville had dropped to an unacceptable level, from 7.9% to 4.2%, according to newspaper accounts of the sale.

Rowe, a former executive with Albertsons who started his career as a butcher, sold one store to a developer, and last summer after remodeling, he reopened the other six under the new banner of Rowe's Supermarkets, specializing in a broad assortment of perishables advertised as "incredibly fresh products at incredibly low prices."

Rowe's company spokesman Larry Beck explained that Albertsons' exit strategy "gave us the opportunity to acquire stores large enough to do the format we wanted to do and it made it possible for us to enter the Jacksonville market with an impact, with the clout of six stores and with all the synergies in advertising and marketing that clustering provides."

In addition to being large stores, averaging about 55,000 square feet, and with liquor stores attached, the former Albertsons units were an ideal fit for Rowe in several other ways, Beck said. "They were all in good locations, they had all the necessary equipment and they were ready to go. It wasn't an easy process, but acquiring those stores made everything move a lot faster."

As large chains like Albertsons, Ahold and Winn-Dixie move from an acquisition to a divestiture mode, "there are increasing opportunities for financially strong independents as well as chains to pursue and seize new growth opportunities," said Jim Hertel, senior vice president with Barrington, Ill.-based retail experts Willard Bishop Consulting.

Neil Golub, president and chief executive officer of Schenectady, N.Y.-based Price Chopper Supermarkets, said his company has done very well growing through acquisitions over the years.

"Acquiring the Big D stores in Worcester, Mass., some years back got us into and gave us a foothold in the Worcester market," Golub said. "Those stores were substandard by our calculations, but we took the locations and were able to develop them and, over time, we were able to replace them with new facilities. They've done very well, and there are still plenty of opportunities for Price Chopper to grow, and a number of avenues for us to follow."

He noted that big stores in big markets are harder to come by than they were five to 10 years ago. Golub recently purchased six stores from Buffalo, N.Y.-based Tops Markets, a division of Ahold. These stores were among 31 in Tops' eastern New York region slated for sale or closure. "Those stores were in towns where we already had a presence so they were very beneficial to us," Golub said.

One of Price Chopper's growth strategies is to build or buy stores of various sizes, which allows management "to situationally determine which size fits a location that we may be interested in," Golub added.

Ground-up Construction

Jack Brown, chairman and CEO, Stater Bros. Markets, a 163-unit chain based in Colton, Calif., said independents "have a good opportunity if well managed and well financed to grow their businesses. The biggest decision a retailer makes is when he goes from one to two stores."

In his 26 years with Stater Bros., Brown has seen the company grow from 69 stores and 3,300 employees with sales of $475 million in 1980 to 163 stores and 17,000 employees with sales of $3.7 billion today.

One advantage Stater has over others is its own construction company, Stater Bros. Development. The company prefers to build from scratch. "We can build stores for 12% less than a chain that builds them using a contractor," Brown said. "And when we build them ourselves, we get exactly what we pay for."

But in 1999, Stater Bros. made one acquisition of 43 stores from Albertsons. After that purchase and the subsequent remodeling, Brown said sales of those stores grew by over $100,000 a week per store, "so I knew we had the right package, but also we hired 3,000 of the employees who had been working in the stores. Customers liked that. They liked seeing the familiar faces."

Brown noted, however, that acquiring stores is like acquiring products. "If you don't buy it at the right price, you can't sell it at the right price. If you acquire a store at the wrong price you can never make money on it. You can't get caught in an action mentality where you just keep bidding until you get it. You have to set up your criteria, do your business plan and then you have to be able to finance that business plan. There has to be something left in case something goes wrong."

Steve Smith, president and CEO, K-VA-T Food Stores, Abingdon, Va., and its 91 Food City stores, said that while it is "hard to beat being able to build your own format that meets your needs, if there is a reasonable property available, we will look at it. We take both strategies. We will look at an acquisition if we see it as an opportunity."

Danny York, senior vice president, store development for Spokane, Wash.-based Yoke's Fresh Markets, noted Yoke's can invest $2 million to $3 million in remodeling an acquired store to suit their style. "While we can't build a brand new one for $2 million or $3 million, when we do build a new one, we know it is brand new and that we won't have to start remodeling again in four or five years," he said.

Owner/Lease Advantage

At a time when real estate costs are escalating in many high-density-population markets, most supermarket retailers have no one set strategy as to whether it is more profitable to own land or to lease.

Rowe's has a dual strategy of buying the land, which helps keep operating costs down, as well as leasing, which requires less of an up-front investment.

K-VA-T Food Stores has a similar philosophy.

"We own some land and we lease, but we prefer to lease," Smith said, "because I think we're better retailers than real estate tycoons. The more we can put our capital to work selling groceries, the better we like it, but we do both."

Brown said Stater Bros. builds its own stores on a sale/lease back arrangement.

Yoke's, which currently operates 12 stores, does not retain ownership of its real estate, but, to keep its rent down and for other financial reasons, negotiates for and buys the land, then transfers ownership to a landlord before the closing. That landlord, usually a real estate firm, then forms a partnership that helps Yoke's build the supermarket, handling everything except equipment, dTcor and inventory.

"To keep our rent down, it's better for me to go out and negotiate for the land than to have someone else do it for me," York said, "because I just wind up paying twice as much for land."

Sometimes, Yoke's will buy a site and "sit on it for two or three years because we can see it's an up-and-coming area," York said. Yoke's is always looking for real estate opportunities and York said he would not pass up the right acquisition opportunity, but management believes it can get its best return by building from scratch.

On the other hand, John Catsimatidis, CEO of the New York City-based Red Apple Group, which owns and operates 49 Gristede's stores in the much denser New York market, aggressively looks for acquisition opportunities, and likes to own the land as an investment with a high rate of return. Red Apple has owned the Gristede's banner since 1986. It began buying units of Sloan's Supermarkets in 1991, and when it acquired the balance of Sloan's in 1998, the company went public. Catsimatidis took the company private in 2004. He had owned 90% of the stock and acquired the remainder of the publicly held shares.

"Whether you look at Albertsons, Gristede's or whatever, the intrinsic real estate values far exceed the enterprise values sometimes," Catsimatidis said. "Also, companies outside the supermarket industry are looking at supermarkets as turnaround investment opportunities, and the downside is minimized by the real estate value of a supermarket site, which can always be used for other types of businesses."

If a supermarket as a business is worth $100 million, Catsimatidis said, "the real estate value of the company, aside from its supermarket business, is probably worth three times as much, which makes it a very good investment or a good divestiture."

In markets with high real estate costs like New York, it's much more difficult for supermarket operators to find new sites "because you are competing with people who feel the business is worth two or three times as much as you're willing to pay," Catsimatidis said. "That's why you see mergers like Sears and Kmart. Kmart bought Sears because the leases and underlying real estate were worth more than the company."

In a recent bid for a New York location, Gristede's lost out to J.P. Morgan Chase because they agreed to pay $1 million in rent for a 7,000-square-foot store, he said. "We couldn't compete with that."

Catsimatidis said it is becoming harder for traditional supermarket retailers to raise investment money for new locations because of investor concerns about competition from the organic/natural food markets, superstore operators, drug stores, etc.

Red Apple has itself profited substantially from owning the real estate for some of its stores. The company recently sold one property on Broadway for $42 million. "Forty-two million for one location," Catsimatidis said. "We're not going to make that money in 42 years."

Red Apple then opened a Gristede's three blocks away in a new building built by Columbia University. Columbia had sought out Gristede's and offered them the space at what Catsimatidis called "a reasonable rate because the community told the landlord they wanted a supermarket in their neighborhood and they wanted us as that supermarket."

Another challenge for expansion-minded supermarket retailers is the rapid rise in construction costs in the wake of Hurricane Katrina. With steel and lumber costs up as much as 15% to 20% this year compared to increases averaging about 2% in previous years, retailers have to go back and take another look at their pro formas, and determine whether a store can still come out ahead after adding in the additional costs, Golub said.

But surges in construction costs should not keep retailers from expanding their base of operations, he added. "You always have to keep growing in this business or you die, so we have to find a way to be more aggressive and more creative and figure out different ways to make things work. You have to be aggressive and work hard."

Community Support

SPOKANE, Wash. - Yoke's Fresh Markets, an upscale specialty supermarket operator here with 12 stores, 10 of them operated under the Yoke's Fresh Markets banner, is being wooed by growing and prosperous communities trying to attract mid- to higher-income residents to their neighborhoods.

Eleven of Yoke's supermarkets are 56,000-square-foot stores with "bells and whistles" departments like coffee houses, pharmacies, pizza shops, cafes, big delis, large seafood departments, cheese shops, wine shops and other specialty areas.

In the case of their West Richland unit, now under construction and scheduled to open this April, Danny York, senior vice president, store development for Yoke's, said city officials "just grabbed us and said we want you, not a typical supermarket."

York estimates that Yoke's saved approximately "a good half a million in this store with all the infrastructure the city is putting in such as sidewalks and street lights as incentives for us to build here." Another new store will soon be built on the south side of Spokane.

York typically builds a new store every 12 to 18 months. They built two stores in one year and opened their last new store two years ago.

They bought the land for the West Richland store from a group of developers that wanted to build a shopping center with a Yoke's Fresh Market as the anchor tenant.

"We've always found that that's a wonderful position to be in," York said, "because we can drive the price down. We point out to developers that while they aren't going to make anything on us, if they can get us as their anchor tenant, they can easily fill up around us and that is always exactly what happens. They make a lot of money from the tenants around us."

Underwriting the Independent

WASHINGTON - Conditions remain favorable for independent retailers to grow through acquisitions or new construction despite rising interest rates and construction costs, said lending officers with the National Cooperative Bank here, a financial service organization that provides commercial funding to cooperative members, including independent grocers.

"It's a good environment," said Patrick Connealy, NCB's managing director. His optimism is based on large chains that are struggling and have "repositioned and reconstituted themselves" over the last few years. Often, that translates into real estate opportunities for independents.

"Independents are looking at their options. Clearly, if you are in a market where Albertsons has stores that may be on the market, you are probably going to be less likely to build. You'll wait to see how it shakes out and who your competitors will be. We have some of our customers hoping to be successful bidders [if former Albertsons stores become available]," he said.

The trend over the last year has moved away from acquiring closed or abandoned stores, and toward building new stores. "A lot of folks have realized that to improve their chances for success, you need to have the store facility that is appropriate for your community and format," said Jeff Minster, vice president development officer, NCB. "So independents have been building exactly what they want, where they want it and in the configuration they want it."

NCB makes the case for their members to own their own real estate rather than lease. Connealy said it becomes a question of economics. "If you have the ability to develop something that is more than a stand-alone grocery store, that is where it becomes compelling," he said. If, for example, a grocery store is the anchor in a plaza and is the main traffic draw, it then makes sense to own the property and offset the overhead costs by owning the plaza and leasing out space to others, Connealy said.

In underwriting a loan, NCB looks at the existing operation, the profitability of the operation and the market. "We look at everything you would think of from a credit standpoint," Connealy said. The intangible is the management, he said. "Management is key. You make loans to good managers and good mangers will typically make things work."

NCB also examines what makes the retailer special among the competition. "We are looking at their niche. We know they are competing against a multitude of competitors out there and we need to understand why they think they can succeed in the market they serve," Connealy said.

Last year NCB provided $60 million to $70 million in funds to the grocery sector. The average loan is about $1.5 million, and loans can range from $500,000 to $15 million. NCB expects its loans to remain about the same this year. The reason is the maturity of the grocery industry, Connealy said. "We want to make sure we are working with retailers that have reasonable leverage, good cash flow, good historical performance and have a way to compete in their market."

"We are on the verge of folks jumping in and developing new stores and grabbing their share of the market or waiting another year or two," Minster said. "I think it is time to move."

CHRISTINA VEIDERS