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The Skeleton's Out

Innovative technological and financial strategies can nudge the often intractable problem of surplus property toward a solution. CB Richard Ellis, in fact, has virtually eliminated an enormous disposition problem for K-Mart through the application of advanced technology - and a lot of legwork. Likewise, the Trammell Crow Co. Inc. has developed two off-beat but effective financial strategies to deal with disposition headaches faced by RadioShack and CVS.

The fact that more and more retailers are willing to entertain new ideas about dealing with surplus property illustrates a fundamental change in this segment of the retail real estate market. Instead of falling to the bottom of the pile in a retail real estate department, surplus property today often receives the same level of attention as any large, underperforming corporate asset.

"Years ago, surplus space was a kind of skeleton in the retail closet," says Michael Wiener, president and CEO of Excess Space Disposition Inc. of Lake Success, N.Y., and Huntington Beach, Calif. "But retailers are taking this skeleton out of the closet today, as they work to reduce the costs related to surplus space. Today, surplus space disposition is an important business area for any retail real estate group."

A five-year effort undertaken by K-Mart illustrates Wiener's point. In 1995, a time when the big box discount chain's fortunes were waning, the company decided to undertake a major effort to identify and dispose of unused assets. The company's real estate group evaluated more than 2,000 K-Mart locations and discovered a wealth of excess land within the parking fields.

Are parking lots the key? "This is a problem that many big box retailers may have," says John Austin, a senior associate with CB Richard Ellis in Sacramento. "In the 1960s, with the big push to build out shopping centers, retailers overbuilt their parking facilities. The goal was to pull people away from main street parking meters by providing and advertising ample free parking. There was no science to sizing parking lots in those days, just an interest in making sure there was room for a lot of cars. No harm was done because land was cheap, and the free parking offer attracted shoppers."

By the mid-1990s, the expansive parking fields had begun to strain K-Mart's resources. The retailer retained CB Richard Ellis to develop a plan to deal with the problem. The first challenge was to acquire and organize all of the data about thousands of parking lots and to create an efficient method of bringing that land to market.

"The undertaking was so large that the only way to get our arms around it was to use technology," says Austin. "We developed a program that we call RE-TRACK, based on MicroSoft Access, which enabled us to log information and images on each property."

To fill the data base with information and images, more than 80 CB Richard Ellis people traveled more than 60,000 miles to evaluate potential outparcel locations, to document the relevant site and trade area characteristics, and to take pictures. Out of 2,100 K-Mart locations, CB Richard Ellis evaluated 1,200 locations, developing a marketing concept for each.

Today, five years after K-Mart made the decision to think about marketing its parking lots, CB Richard Ellis has completed transactions related to 400 of the original 1,200 properties. "We have sold or groundleased to traditional outparcel users such as fast food restaurants, video stores, banks, and other retailers interested in pad locations," Austin says.

Is a joint venture the answer? While K-Mart's surplus parking field property grew out of the company's history, Radio Shack Corp. found itself saddled with 21 empty Incredible Universe stores when its new big box concept failed to catch the imagination of consumers.

"Retailers with large surplus property portfolios have recently begun to realize that managing these properties purely from a real estate point of view often produces only limited returns," says Mike Scimo, senior vice president and principal in the Dallas, Tex., office of the Trammell Crow Company. "When Radio Shack closed its Incredible Universe chain four years ago, it was left with eight leased properties and 13 owned properties. During the next two years, we sold or leased a third of those properties, leaving 14 to be dealt with.

"Radio Shack did not want to continue to deal with the problem for another two years," Scimo elaborates, "They didn't want to take any more write-offs. Second, the properties were distracting management in the real estate department, whose focus is supposed to be on growth. The company asked us to develop alternatives."

Trammell Crow came back with a financial strategy designed to deal with the real estate problem. The idea was to create a joint venture. As a limited partner, Radio Shack would contribute its surplus properties to the venture, by selling owned properties as well as their leases. Trammel Crow would serve as the general partner and own 51% of the venture, investing its capital for retrofits as needed. The joint venture would also pay the rent and debt service on the properties.

"This strategy would create an investment in a subsidiary," continues Scimo. "It would allow Radio Shack to remove the surplus properties from financial statement categories such as discontinued operations. The properties remained on the balance sheet, but showed up as an asset instead of a liability."

Radio Shack liked the idea and told Trammell Crow to proceed with a pro forma and joint venture agreement.

Upon reviewing the pro forma, Radio Shack executives decided that the idea looked so profitable that it made more sense for the company to invest its own capital in the concept and to retain Trammel Crow to provide necessary services. "We ended up performing the same services that we would have under the proposal," Scimo says. "But we didn't apply our capital and weren't a partner in the joint venture."

The concept appears to have wide application. Scimo recently proposed a similar concept to CVS, which is exploring ways to deal with 400 surplus locations.

Sometimes a surplus property cannot move because a retailer refuses to adjust to market conditions. Trammel Crow recently worked out a problem for a big box retailer that wanted to dispose of a property valued at $5 million for the original $7 million purchase price. "I found a buyer, another retailer, willing to pay $5 million for the property," Scimo says. "But our client refused to take the $2 million write-off."

Normally, such a situation would herald the end of any possible deal. Scimo, however, began to look for another way to structure the deal. He came up with Ikon International, a Stamford, Conn.- based barter company.

Is bartering an option? Scimo arranged a meeting between the retailer's executives and Ikon. The two companies struck a deal in which Ikon paid the retailer $5 million in cash for the property, while issuing $2 million in trade credits or coupons for a variety of services. The retailer recorded the $2 million in coupons as an asset and avoided a write-off.

"The coupons are good for things like hotel rooms, airline travel, even advertising media," Scimo says. "For example, a television spot may cost $25,000. The coupon allows the holder to buy the same spot for half that. In the convoluted process, the cash flows to the owner of the spot, in this case, Ikon.

But Ikon had bought the advertising time, as well as the other products and services in the coupon deal, at an even larger discount than what the coupon allowed the retailer."

According to Scimo, Ikon earned about $1 million from the $2 million in coupons and took title to the property. Within a few months, Trammel Crow sold the property on behalf of Ikon for the market price of $5 million.

Plan in advance Yves Mizrahi, senior director, retail strategic planning services, with CB Richard Ellis in Seattle, Wash., suggests still another strategy for dealing with surplus property: plan to prevent the problem when signing leases.

"When you are planning for growth, you have to have a strategy in the back of your mind to manage the risks that may arise," says Mizrahi. "More and more retailers are doing this right, today.

When they enter a market, they go to great lengths to lease properly sized stores, they insist on outs with fewer penalties in the leases. If they can't get those outs, then they insist on shorter leases. A number of top retailers such as The Gap and Starbucks have no disposition group. They don't need one, because they cover all the bases at the beginning of the process and remain flexible enough to close stores that don't work out."

While innovative thinking before or after the problem develops can solve certain surplus problems, the overall retail market continues to suffer from surplus property problems in the categories of grocery stores, drug stores, and cinemas. All of these industries have undertaken new strategies in recent years and made many of their existing properties obsolete.

Excess Space Disposition Inc., for example, represented retailers holding leases on 25 million sq. ft. of excess property during 1999. Many of those properties fell into the grocery store, drug store, and cinema categories. "In all categories of retail, excluding bankruptcies, the market probably contains a couple hundred million sq. ft. of surplus property," says Michael Wiener.

According to Wiener, dealing with problems of this magnitude takes a structured approach to individual properties focused on the goals of assigning leases, terminating leases, subleasing, or reducing rents.

In other words, surplus properties offer some opportunities for innovative solutions. But the bulk of the market will respond only to the hard-nosed, inch-by inch application of basic disposition techniques.

Excess Space Disposition, Inc., of Lake Success, N.Y., and Huntington Beach, Calif., has specialized in the disposition of surplus retail property for nearly a decade since the company's founding in 1992. Michael Wiener, the company's president and CEO, offers the following advice on disposing of surplus retail property.

Analyze the market and develop realistic pricing expectations for leases you want to sub-let or sell.

Advertise the properties and their locations consistently in trade magazines targeting the retail and shopping center industries.

Broadcast fax appeals to potential users.

Send regular direct mail appeals to prospects. Add a surplus property page to your web site. Include features and benefits in all property descriptions: size, parking, drive throughs, ceiling heights, ease of conversion, etc.

Retain a third party specialist who may be able to negotiate more objectively with potential lessees as well as owners.

"Most importantly, you need to devote time, focus, and energy to a disposition program," Wiener says.

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