INDEPENDENTS REPORT: The ownership edge

For supermarket retailers the benefits of owning their real estate far outweigh the risks. Trust me on this one. During 1994 my family, who operated a small chain of grocery stores in northeast Ohio, was approached by our then-wholesaler, Fleming Cos., about purchasing another supermarket in our market area. The store, Portage Lakes IGA, which was corporately owned by Fleming and a young couple who served as minority shareholders, was underperforming.

My family welcomed the challenge and purchased the ailing store. As part of the transaction, we signed a sublease with Fleming, which had executed the master lease with an Akron-based landlord. Within a year we turned things around and the 25,000-square-foot store became very profitable for us, netting earnings of approximately $400,000 a year. It was smooth sailing at Portage Lakes -- or so it seemed.

To make a long story short, nearly four years after purchasing the store, we decided that four of our locations would be supplied by Pittsburgh-based Giant Eagle, Inc. and that the store at Portage Lakes would continue to be supplied by Fleming.

Displeased with our decision, Fleming refused to renew our sublease and ordered us to return the premises to it at the end of our five-year lease term. As a last-ditch effort to save the store or perhaps sell it to another retailer, my late father flew to Chicago, where he met briefly with the Fleming chairman at that time, Bob Stauth. "You have nothing to sell because you don't have a lease," Stauth told him.

In January 1999 we turned the keys back over to the now-defunct wholesaler, knowing this wouldn't have happened if we had owned the property.

Besides the prevention of such a scenario, store development expert Bruce Kamph, v.p. of strategic development at North Canton, Ohio-based BridgePoint Solutions Group, says there are a number of reasons to own your property. Chief among them are the following:

-Supermarket/tenant rent amortization of real estate investment.

"Most supermarket operators who own their real estate have created separate companies that own and manage the properties," Kamph says. "The real estate company collects rent and the other occupancy expenses from the supermarket company and other tenants."

Kamph advises: "The supermarket operator must treat the real estate company as a separate entity. All rent collected must amortize the debt, as well as provide a fair return on the real estate investment. As the note is amortized, the real estate can be collateralized for additional deals, thus becoming another avenue of wealth creation for the supermarket operator."

-Favorable financing environment/historic low interest rates.

"The financing environment we've experienced in the last several years makes real estate ownership very feasible for many supermarket owners," Kamph notes. "Traditional and nontraditional financing sources are plentiful and generally desire supermarket-anchored real estate deals."

-Control of shopping center tenant mix. If the supermarket owner owns the entire shopping center, he or she has the ability to control tenant mix. According to Kamph, "As the landlord the storeowner can secure leases that are complementary to the supermarket and avoid those which will directly compete with the food store operation."

-Succession planning/sale of business. A succession plan is a must for every supermarket operator, and real estate is often an important part of that plan. "If the succession plan leads to an eventual sale of the supermarket," Kamph says, "the storeowner can sell the business and concurrently execute a lease with the new operator."

-No wholesaler lease/sublease relationship. "This is not the advantage of real estate ownership that it once was," Kamph stresses. "With the traditional lease/sublease relationship, wholesalers solidified the supply relationship in a given location through the lease. However, wholesalers have begun to distance themselves from the traditional lease/sublease relationships. This is due to many factors, but primarily relates to the suppliers' desire to keep these lease liabilities off their balance sheets. However, wholesalers are now utilizing other vehicles, such as written long-term supply agreements, to secure business."

-Increased flexibility to relocate/assign and sublet/change use.

Ownership of the real estate can provide some flexibility to relocate, depending on the lease terms executed between the supermarket company and the company owning the real estate. Assuming favorable supermarket lease terms (no continuous-operations clause, no specific-use clause, full rights to sublet and assign, no distance restrictions), the supermarket operator has the flexibility to relocate, change use, or assign/sublet the space, should the market and competitive forces make any of those situations necessary.

Despite all the positives, Kamph says the proposition is not without challenges. "Market desirability can change for a variety of reasons, including economic downturns, demographics, and new competition entering the market. In my opinion the operator must always concentrate on the growth and longevity of the supermarket. Ultimately, if the supermarket doesn't perform and cannot afford to pay its rent, the real estate company will suffer."

Kamph's parting recommendations are also worth heeding: "Real estate ownership can be a short-term hindrance to growth when a one-store supermarket operator desires to become a multistore operator. The retail supermarket business is very capital-intensive and can demand significant debt for an operator," which, if leveraged too far, could severely hinder operational growth.

"Every independent's situation will differ," Kamph concludes. "Individual analysis and strategy formulation are the keys to successful strategic growth and longevity."

Independent Retailing editor Jane Olszeski Tortola can be reached at [email protected].
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