Renovate or Relocate?

By Ed Avis

 

When a Shaw’s supermarket in New Hampshire recently needed a facelift, the management decided that renovating the store was a better idea than relocating.

 

“They realized it was a good shopping center, with good tenancy and good traffic count,” says Karim Fadel, founder of Unison Realty Partners in Boston, which owns the shopping center anchored by the Shaw’s. “So they decided it was preferable to renovate than relocate.”

 

The decision to renovate or relocate often comes down to the suitability of the current location, as Fadel mentions, and related factors such as competition in the area, the demographics of the customer base, and the retailer’s recent sales trends.

 

“The first thing I look at is the existing sales per square foot relative to other stores in the market,” says industry consultant David Livingston. “If your store is performing below market, then perhaps consider a remodel. If your store is above market average, then consider expanding.”

 

FIRST, THINK RENOVATE

Grocery retailers commonly have leases ranging from 10 to 20 years, which means renovation is typically the first tactic management considers when a store needs to be refreshed. 

 

Furthermore, as long as the location is still ideal, there can be competitive advantages to keeping a store in the same spot for a long time.

 

“Some tenants elect to remain in the same location for a long period of time due to their customers’ loyalty and the location being in the path of travel of surrounding retailers,” says Lee Shapiro, executive vice president of brokerage at Kennedy Wilson, a real estate investment firm headquartered in Beverly Hills, Calif. “Their customers are familiar with their location and, as a result, the tenants have benefited from historically high sales.”

 

Not only do customers appreciate a store’s longevity in one location, but staying put can also keep rent costs a bit lower, since an existing store’s long lease often means that rent increases do not track with rising rents in the surrounding area.

 

This fact can be a competitive advantage. The long lease “allows the grocer to benefit in an appreciable marketplace, with stabilized rents that have limited increases over the course of the term,” Shapiro says. “As a result, the store has a financial advantage over competitors seeking space in the submarket at substantially higher future rental rates, which could encourage a tenant to renovate its building in lieu of relocating.”

 

Most retailers work on a basic remodel cycle of a minor refresh every three to five years, and a major remodel the next time around, says Peter Hsia, retail and private equity strategist at Kurt Salmon, a management consulting firm based in New York City. 

 

However, the decision to remodel at all—rather than just sit tight—comes down to economics. If the retailer feels a market warrants a better store, either via renovation or new construction, it will move in that direction.

 

“The first thing retailers look at is what the potential of the market is vis-à-vis the current performance,” explains Jeff Green, founder of Jeff Green Partners, a retail feasibility consultancy in Phoenix.

 

For example, Green notes that Kroger has recently expanded its stores, while Walmart has been opening smaller “neighborhood” markets. So each retailer saw something different in their respective markets.

 

“Walmart is realizing that they didn’t gain much sales by getting bigger, and they know that with a different format they can expand the market by getting into neighborhoods,” Green says. “On the other hand Kroger says, ‘If we have nicer, newer stores it will increase our market.’”

 

The bottom line? If renovation will bring a store up to speed with the competition, it’s probably likely the store will stay put rather than build new. 

 

“If a location is sound, a grocer will always get a better ROI from renovation rather than a relocation, since a relocation has higher buildout costs and risks losing traffic,” Hsia says. “Therefore, relocations tend to happen when there is shift in the real-estate situation that is unlikely to change: weakening of co-tenants, the opening of a better shopping center nearby, a change in the traffic patterns.”

 

Sometimes, however, even a renovation is not worth the investment. Hsia notes that if an area is depressed and moving out is not an option, some retailers simply stay put and let the store condition remain as it is. “That’s why you will see some fairly tired-looking stores in areas with weak economies,” he says.

 

EXPANSION ECONOMICS

Expanding a store, rather than just renovating it, requires even more careful analysis. Livingston says that a rule of thumb is that an expansion and remodel will net the retailer about 50 percent of current sales per square foot.

 

For example, if a store has 50,000 square feet and is earning $500,000 per week, its revenue is $10 per square foot. If the retailer expands, it should expect sales to increase by $5 per square foot for the expanded portion. So a 10,000-square-foot addition should add about $50,000 in sales per week. That increase means, however, that the store’s average sales per square foot drop from $10 to $9.17; if that’s OK according to the store’s strategy, then the expansion may be worth it.

 

“This rule does not apply if there are new competitors coming or a population is declining, and vice-versa,” Livingston says. “Sometimes, like in California where we saw the implosion of Haggen, or in New York City, with the failure of A&P, stores can see better-than-average increases [when they expand]. Or if you are in an economic boom area like North Dakota or West Texas that experiences large population increases, your gain can be unpredictable, but in a good way.”

 

Green suggests that retailers often do not analyze the size of their store as carefully as they analyze its location. He notes that stores have sophisticated models of sales potential and what products to stock, but not store size. “They know how to merchandise, but when it comes to right-sizing, they tend to get lost,” he says.

 

THE NEW STORE

As Hsia notes, a relocation is generally driven by something more profound than just a run-down store. The decision to relocate is not made lightly.

 

“It’s very expensive to relocate, so they don’t do it unless the competitive environment has changed,” Green says.

Livingston emphasizes that building a new store may seem appealing when a retailer is losing ground, but it’s not always the right solution. If something is happening in the store or its immediate market area that is hurting business, building a new store might not fix that.

 

“A big mistake retailers make is replacing a poor performing store,” Livingston says. “The problem is a new store will often not solve the core issues—bad location, bad neighborhood, wrong demographics, crime, high prices, unmotivated employees, poor management. Solve the internal problems first. Some problems are out of your control, so there is no point in trying to put pearls on a swine.”

 

When making a decision in this regard, Livingston suggests examining what the competition is doing. For example, if the Walmart down the street is barely keeping its doors open, take that as a warning that the local market would not support your new store. On the other hand, “if your average sterile, plain vanilla, private-equity-owned grocery store is doing well, your ears should perk, and you need to check it out. Because if the sterile grocers can do well, it’s a sign the market is underserved.”

 

Should a decision be swayed by tax incentives from the local government? Livingston says no, because tax incentives are typically used to entice retailers to a bad location.

 

“If a location cannot be successful on its own without the help of subsidies, run,” he says. “If you have to be paid to build there, the customers will probably want to be paid to shop there.”

 

Another factor that may affect the decision to relocate is a contractual restriction. For example, if the retailer is a franchise, such as a convenience store, it may not be able to move closer to another outlet of that franchise.

 

“There are unique situations with franchisee/operators that have radius restrictions that prevent moving too close to sister stores or franchise agreements that require them to operate in the same location,” says Tom Smith, owner of Retail Site Services, LLC in Marietta, Ga.

 

FOLLOW THE MONEY

Of course, financing also plays a role in the decision. During the recession, getting money to invest in a new store or a renovation was tough. That situation has improved.

 

“Now credit is flowing again, and there are some properties that could have used some upkeep or remodeling but didn’t because of the lack of money,” says Jesse Tron, spokesman for the International Council of Shopping Centers in New York City. “So what we’re seeing now is some really good properties out there that just need money pumped into them. From the point of view of the owner or developer, you might get a better return by putting money into one of these properties than building new.”

 

Kroger, Walmart, and all other major retailers that need to make the remodel/relocate decision base those decisions on the mountains of data available to them. Data from their customer loyalty programs, mixed with demographic information, can help them paint a clear picture of the market, and potential market, in their geography or nearby areas.

“The margins in grocery are so small that grocery retailers have very sophisticated models of understanding sales potential,” Green says. “They look at the population, the demographics, the money spent per person on groceries in certain demographics, and other factors. They are pretty darned good at it. Supermarkets are more advanced than other retailers since their margin for error is so low.”

 

Tim Hughes, president and CEO of Dallas-based Falcon Realty Advisors, concurs: “All retailers are constantly involved in staying close to, not only who their customer is, but what products they are buying and more importantly, why they are buying those products.”

 

When retailers can determine who is buying what and where they shop, making the decision to move or stay put is much easier.

 

The decision to renovate or relocate is affected by many factors, and grocery retailers are masters at analyzing the data. 

 

“Ultimately, it always comes back to the expected future sales of the current location as compared with relocating in the submarket,” Shapiro says. “If the retailer’s sales are consistent from a historical perspective, and they are positioned in a location that has grown around them with other complementary businesses, it is often a wise idea to remain in that current location and renovate. However, if the market has shifted, relocation is a good option.”  RL