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The Heat Is On

Grubb & Ellis, a Chicago-based outsourcing provider for retailers nationwide, has seen its outsourced lease-administration assignments from retailers grow rapidly over the last five years, said Michael Dee, the company’s senior VP and national director of retail. “Outsourced lease administration provides tremendous cost savings compared to what retailers can do themselves,” he said. “Outsourced providers make fewer mistakes that increase penalty and interest payments.”

As commercial real estate markets, including retail real estate, have run up in price in recent years, retailers have turned to outsourcing as a way to manage rising costs of real estate and lease acquisition.

But higher prices are not the only forces driving retailers to re-think corporate real estate departments. When a private-equity group buys a publicly held retailer, real estate management becomes a way to ensure the value of the acquisition and generally requires reorganizing the real estate group, which is wedded to past programs. A third form of pressure to change comes from the stockholders of publicly held companies that demand continued high growth.

Wherever a retail real estate executive turns today, he or she feels pressured to do things differently.

Managing higher costs: Retail real estate departments handle cost-cutting pressures in different ways.

Retailers in the high-growth phase of business tend to outsource site selection with commercial brokers. They also use outside construction firms and outside law firms. Pure real estate functions such as analyzing markets, picking new sites for stores and negotiating deals generally remain in-house.

When a retailer’s strategy calls for opening lots of stores, “lease-administration and site-selection and construction outsourcing ramp up, while the in-house organization swells to handle strategic planning,” said Dee.

But there are no hard and fast rules. FedEx-Kinko’s, the modern-day high-growth retailer based in Dallas, has embarked on a new-store program but has outsourced the task.

However it is happening, personnel roles are declining. Naveen Jaggi, senior managing director of retail services with Los Angeles-based C.B. Richard Ellis, estimates that mature retailers today have likely trimmed real estate personnel by 10% to 20% by automating and outsourcing.

Private-equity buyouts: In late June, a Dubai private-equity firm announced it would buy Barneys New York for $825 million. A couple of weeks before, a Los-Angeles-based private-equity investor purchased Paper Source Inc., a Chicago-based retailer.

In recent months, Sun Capital Partners of Boca Raton, Fla., bought Edwin Watts Golf Shops of Fort Walton Beach, Fla., and raised its holdings in San Francisco-based Sharper Image to 20%.

“More and more private-equity groups are buying retailers,” said Jaggi, who traces the trend to the three-year-old acquisition of Sears by Kmart. How could a Chapter 11 company on the brink of bankruptcy buy a company as big as Sears? “The private-equity group controlling Kmart realized the value of an underperforming company sitting on top of a lot of valuable real estate,” Jaggi said.

Since the acquisition, the private-equity owners of Kmart and Sears have altered the real estate strategy of those chains by opening Sears Hardware and Appliance stores in suburban markets. These smaller business units are not as cost-inefficient as Sears department stores, which, after all, cannot compete with stores like Macy’s.

Private-equity owners, according to Jaggi, tend to outsource retail real estate management. “They don’t have their own real estate teams, and they are buying chains with real estate groups that have underperformed. So they outsource real estate analysis, and in some cases, lease-management, project-management and transaction-management functions—because they want to cut those costs by moving from salaried labor to transaction-driven labor.”

Stockholder demands: On June 1, Bentonville, Ark.-based Wal-Mart Stores announced a significant cut in capital investment in new U.S. Supercenters. The company said it would cut its growth program to 200 new U.S. Supercenters this fiscal year and 170 during each of the next three fiscal years. Previously, Wal-Mart had committed to 265 to 270 new Supercenters annually.

Why the cuts?

“Wall Street investors complained that Wal-Mart’s new-store plans were too aggressive and urged management to shore up existing-store sales instead of opening new stores,” Jaggi said.

That plan will alter the way Wal-Mart’s real estate department moves forward.

Likewise, stockholder pressure is changing the way Pier 1 Imports manages real estate. At the end of 2003, the Fort Worth, Texas-based home-accessories retailer was trading at about $26 per share. Today, the stock is worth less than $9 per share ($8.18 on July 10).

Understandably, stockholders are angry. But stockholders may have created the problem themselves. When the stock was soaring, stockholders demanded greater heights. So the home-accessories retailer opened a furniture line, which took up square footage and hurt sales.

“Now the pressure is on Pier 1 to open new stores and to improve performance at existing stores,” Jaggi said. “That becomes a drain on resources and exerts pressure on the real estate department which is trying to get rid of bad leases, but can’t—because of the pressure to grow gross numbers of stores.”

In the end, retail real estate departments are dodging bullets fired from all directions. Senior executives want to cut capital spending and leasing costs for real estate. Private-equity groups buy retailers and then fire the real estate group. Shareholders want growth at all costs.

What’s a retail real estate manager to do?