Best practices: Developing grocery-anchored centers
Over his 34-year commercial real estate career, Stephen L. Hittman has been developing supermarket-anchored shopping centers for 20 of those years. In 2001, he founded Crossroads Companies. As president and CEO of Crossroads, he has built a regional portfolio of supermarket-anchored centers valued at more than $200 million.
Last year, Hittman formed the Supermarket Consulting Group to provide development clients with market research, site location and project development services. The firm’s geographical expertise encompasses New Jersey, Philadelphia, Fairfield County, Conn., and the surrounding suburban communities; urban locations for New York City boroughs of Bronx, Brooklyn, and Queens; southern New York State, Rockland and Westchester counties up through the Hudson Valley Region of New York State, north to Albany.
Recently, Chain Store Age sat down with Hittman to discuss best practices for developing supermarket-anchored centers. Here’s what he had to say:
Let’s start at the beginning with best practices for site selection.
Developing a supermarket-anchored shopping center begins with market research. You need to understand the character of the trade area: population density, income levels, population mix, and the character of the urban or suburban location. Next, a competitive analysis is necessary to determine potential sales volume for the prospective food anchor. Sales volume will determine, in part, the rent the food anchor can pay.
From a tenant’s perspective, rent is a function of sales volume and the percentage of fixed costs to sales volume. Fixed costs include base rent, real estate taxes, common area maintenance and utilities. From the developer’s perspective, return on equity is commensurate with the underlying risk. Developers measure return on equity by dividing the net operating income generated by the investment over the total project expense, including the cost of land, building, leasehold improvements, approval and financing expenses.
How might brownfield cleanup expenses factor into site selection?
Brownfield problems include both perceived and actual expenses, as well as liabilities associated with soil and groundwater contamination. Typically an environmental engineer will evaluate the cost and liability that may be associated with a brownfield site. Assistance may be available from local, state, or federal agencies.
Soil contamination can be less complicated to solve than ground water contamination. Both will give pause to a developer. The least expensive alternative for brownfield cleanup is to encapsulate (pave over) the contaminated area, treat the contaminated area with a chemical solution, if possible, and hope that the chemical treatment dissolves the contaminant. This in combination with exposure to natural attenuation (air) will often address the problem over time. Monitoring wells are usually placed on the property after encapsulation. Quarterly testing ensues, often for several years, until such time as the state department of environmental conservation or protection agrees that the levels of contaminants have been reduced to acceptable levels.
Certain contaminants require removing the contaminated soil, which in large volume can be prohibitively expensive, as well as trucking contaminated soil to a licensed disposal facility.
Groundwater contamination is more problematic, as it takes longer to dissolve the contaminant and often becomes embedded in underlying bedrock. This is particularly problematic if the surrounding properties do not have a municipal water system (meaning that neighbors rely on private wells for drinking water). Either type of contamination can be part of an expensive and time-consuming cleanup process and often an impediment to closing a deal.
These issues are typically addressed as a contingency in the purchase contract. The developer needs adequate time (a due diligence period) to assess the underlying risks, including brownfield contamination. If the problems appear insurmountable (too expensive), the developer can terminate the purchase agreement during the due diligence period.
Is there a fast way to deal with entitlements?
Very funny! Short answer is no, as the municipality is charged with the responsibility to protect its constituents. Each municipality has zoning laws and a building code. The best solution is to work in tandem as a team. Both developer and municipality have legitimate concerns. Informal meetings with decision makers, such as the fire & police department, the town manager, engineer and planning departments will go a long way to making the process less adversarial. Work methodically through every issue.
Start with zoning. Is the use permitted by code? If not, the development approval process will take longer and will entail greater risk. It is also more vulnerable to an appeal (lawsuit overturning the decision). There are occasions where the municipality will elect the board of adjustment (zoning) or planning board to hear both zoning and planning applications. One entity reviewing both zoning and site plan approval is preferable.
It can cost upwards of $350,000-$450,000 for legal, architectural and civil engineering and other services to obtain site plan approval, sometimes more. The review process can take from 12-18 months or longer, as municipal, county, and state agencies such as the state department of transportation or environmental protection agency may have need to review and comment as well.
Finally, property owners — and sometimes competitors within a certain distance from the project — can institute a lawsuit (an appeal) of the use variance or planning board decision. Unfortunately this can add months and even years to the process!
A golden rule is: does the planning board and its constituents — voters — believe the project is in the best interests of the community? If the residents want the project, the planning board will often work with the developer to solve difficult issues. If its constituents oppose the project, the chance of obtaining a site plan approval is significantly diminished.
Obtaining unconditional site plan approval can take 15-18 months. Upon a vote by the planning board or board of adjustment, the town attorney will publish a public notice in the local papers announcing the decision. The public then has 45 days to appeal the decision. The appeal process can take anywhere from several months to years, even if the court eventually decides the appeal is without merit. Given the time, money and risks, it is reasonable to conclude that real estate development is not for the faint of heart.
How has the recession changed construction finance?
A recession results in less economic activity and declining demand. Vacancies rise, and rents fall. Lenders become more conservative. Loans are more difficult to obtain, terms and conditions of loan commitments become more onerous.
If a developer has a credit-worthy anchor tenant (strong balance sheet), particularly a supermarket anchor tenant, the lender may offer more favorable terms.
A speculative shopping center developer with no anchor tenant will have a much more difficult undertaking. Lenders may be more reluctant to make a loan; the lender may insist upon recourse debt and the loan-to-value (cash down as a percent of total loan) will be higher.
In conclusion, a good development site is a location that is zoned for the intended use, reasonably welcomed by the community and planning board and anchored by a credit-worthy tenant. These factors usually result in a positive outcome.
What kind of loan to value are lenders looking for today?
It’s always a question of underlying credit of borrower and tenant and the anticipated income of shopping center. If the developer has investment grade credit or a food anchor tenant with a good balance sheet, the lender may still require a 20%-25% downpayment in the current lending environment. For non-investment credit tenant, or non-anchored center, the downpayment can be as high as 50%. In a recessionary environment the downpayment requirement will be higher; in a booming economy, it will be lower.
After making it this far, what best practices do you apply to managing a property?
A property owner wants their tenants to be successful at their location. If they stay in business and prosper, so will your shopping center. The success of both tenant and developer begins with the old adage: location, location, and location!
Of course, tenants will sometimes have problems. A good landlord will often work with good tenants to help them through a rough patch. Sometimes, the shoe is on the other foot!
Mutual success also revolves around shopping center design. Are property ingress and egress, traffic circulation and curb cuts user friendly? Do shoppers feel safe in the shopping center environment? Is the center well lit, properly striped, and swept daily? Is snow removed promptly without impeding the availability of parking spaces or egress?
Today, more than ever, advances in technology have resulted in energy savings. Efficiencies in design and materials result in reduced operating expenses. As a portion of operating expenses is borne by tenants, low operating expenses can provide a competitive advantage in competition for tenants with neighboring centers.
Finally, there is the consideration of the day-to-day operation of the shopping center. Are potholes quickly repaired? Are sidewalks and curbs in need of repair? To both retailer and property owner, a well-managed shopping center is a sure formula for success and customer satisfaction!