Commercial Net Lease thrives in growing niche

Orlando-based REIT's specialization in freestandingretail development proves a profitable venture.

As an owner/developer of freestanding retail properties, Commercial Net Lease Realty Inc.'s primary competitors are not other real estate companies; they are the retailers themselves. Operating in a highly fragmented segment in the retail real estate market, Orlando-based real estate investment trust CNLR has carved out a comfortable niche through efficient development practices, extensive research and focus on customer relations.

CNLR focuses on properties between 7,500 and 100,000 sq. ft., developed at a cost between $1 million and $10 million. Although most institutional investors eschew this size in favor of larger properties, CNLR's customer and market research, efficient operating procedures and long-term relationships have made the company's bottom line a strong one.

Research clarifies market, customers "We operate with retailers who we think are credit worthy and who are leaders within their respective retail lines of trade," says Kevin B. Habicht, CNLR executive vice president and CFO.

"We have a combination of primary research, research we purchase from industry consultants, and investor research which is available primarily through the investment banking community," says CNLR President and COO Gary Ralston.

Fully researching potential clients is vital in a business that is rapidly consolidating, according to Ralston.

"There is a consolidation in retail today," he says. "The strong, high performance retailers are taking marketshare from their competitors." Those that survive in this increasingly competitive market are looking more and more toward freestanding structures as a way to strengthen their footholds in the market.

"We really are at the emergence of this wave of high performance retailers who are very, very convenience oriented and want to be in a freestanding format," says Ralston.

Following a move to a freestanding format, according to Ralston, a drugstore will, on average, increase its customer traffic 10% to 15% while increasing sales 30% to 40%.

Ralston is not alone in his faith in freestanding retail's strength and potential. NAREIT recently identified freestanding retail as one of its property categories. Indeed, freestanding retail construction starts are on the rise, according to F.W. Dodge, a division of The McGraw-Hill Cos. In 1996, 2,981 freestanding stores were begun, while in 1997, 3,331 broke ground.

According to NAREIT, market capitalization of freestanding stores totals $3.2 billion, or 12% of the retail real estate market.

The future looks bright for the category; NAREIT estimates that between 1997 and 2001, 438.1 million sq. ft. will be developed.

Success in a fragmented market "We're the only third-party company, a company that is not the departmentof a retail chain, in the top 10 last year for the creation of space in that 7,500 to 100,000 sq. ft. range," says Ralston. The other top 10 companies were retailers.

"It is for the most part an overlooked niche," he says. "If you went to traditional real estate research sources and asked them the inventory of freestanding retail real estate in this country, they would have a hard time giving you an answer."

According to Ralston, the ICSC and other organizations tend to track shopping centers, malls and strip centers, while neglecting freestanding retail. One of the reasons for this neglect is the fragmented ownership base, primarily owner/users.

Why then has CNLR risen to the top 10 in this bustling commercial real estate sector?

"These are smaller-sized properties," says Ralston. "They typically would cost between $1 million and $10 million. The institutional capital normally seeks properties that cost more than $10 million."

"That is a unique barrier to entry," Habicht says. It is a barrier to entry that has served CNLR well.

"We own lots of smaller properties across the country," Habicht says. "That's a difficult environment for most investors to operate in."

"We've worked on bringing efficiencies to bear, to the extent that you can systematize and provide some standardization," says Habicht. "You can turn it into somewhat of an assembly line."

Although the company aims for efficiency and consistency, it retains a vehement focus on the importance of the customer. The intricacies of the freestanding retail real estate market aside, CNLR's top brass maintain that customer service is the cornerstone of the REIT's success.

"We look at who our customers are and then organize the development team around the customer," says Alex Dmyterko, executive vice president and chief operating officer of the company's build-to-suit division. Build-to-suit projects comprise approximately 50% of CNLR's annual business volume.

"We pride ourselves on our tenant relationships," says Joe Ciardiello, senior vice president of acquisitions. "We consider ourselves not landlords but land servants."

Dmyterko seconds that. "It's pretty clear that it's a customer-driven orientation," he says. "We take it very seriously to be a land servant rather than a landlord. We devise our development teams around the client. We become an extension of them."

"We thrive on a long-term relationship and doing lots of repeat business," he says.

Long-term relationships involving multiple transactions characterize CNLR's clientele.

"Our business primarily is a series of repetitive transactions, just over and over again. We have great working relationships with all of our leading retailers," says Ralston.

"They open these stores one at a time," he says. "Our entire business is centered around being able to execute efficiently one transaction at a time."

Growth in freestanding market niche Not only has CNLR come to the forefront in an unusual sector, the company has also grown by leaps and bounds.

The company was founded in 1984 as the Golden Corral Realty Corp., and in 1992 the senior management team came on board and renamed and repositioned the company to capitalize on the opportunity represented by the emergence of freestanding retail.

"We've come a long way in five years," says Habicht. "From $15 million in assets and one tenant to $560 million in 48 tenants in 37 states. There's been a lot of improvement in the quality of the portfolio."

That drive to grow has not abated.

"We currently have eight stores under construction. Six of those are Eckerds, four of which are in the Dallas/Fort Worth area, two of which are in the Georgia market," says Dmyterko.

"We also have a Sports Authority under construction in Memphis, Tenn., and a Home Place in White Marsh, Md.," he continues.

CNLR remains focused on growing the business, according to Dmyterko.

"Our goal for 1998 is to break ground on 50 projects this year," he says. "So that would be about one a week. We're excited about that."

"We want to become the dominant REIT involved in this net-lease, freestanding retail real estate sector," says Habicht. "Our portfolio objectives are to diversify the portfolio by tenant, retail line of trade and geography."

"Then of course we have financial objectives which are to grow our earnings per share and provide attractive risk-adjusted terms to our shareholders and our debt investors as well," Habicht says.

"When I started here we always had to tell people who we were," says Ciardiello. "People now know who we are. They also always say we have a good reputation, and if they have a deal they'd like to do it with us," he says.

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