Consumers, owners and investors have a love/hate relationship with strip centers. Sure, these 30,000- to 150,000-square-foot, grocery-anchored properties make up the majority of U.S. retail space. They are considered the least economically sensitive retail format and have held up extremely well in the current downturn.

But in terms of aesthetics, cachet and community planning, strip centers offer something for everyone (but owners and tenants) to hate. In the past decade, strips have become symbols of not-so-smart growth. They seem to be everywhere, creating traffic congestion, and they are often indistinguishable from one another. “Strip center” has become one of the vernacular's latest four-letter words.

No wonder developers prefer to call these grocery-anchored properties “neighborhood centers.” The next step is to reposition these centers to live up to the name — and, in doing so, to respond to communities and consumers who no longer want a grocery store with a bunch of inline shops. “Everyone wants a lifestyle center now, and communities are going to make you go toward that,” says Lyle Darnall, vice president of retail development at Columbia, S.C.-based Edens & Avant, an owner, developer and manager of grocery-anchored “necessity-based” retail centers (see Case Study on page 20.)

But giving strip centers the appearance and amenities of the open-air marketplace is just one obstacle toward a larger goal. That goal is to reinvent these properties so that they can withstand the rising competition from big-boxers such as Wal-Mart, which are building supercenters to take on strip centers.

Bear Stearns REIT analyst Ross Smotrich believes neighborhood centers have one inherent advantage.“Consumers will always appreciate the convenience and basic goods and services found at neighborhood and community shopping centers, particularly in infill locations,” he says. “These centers are close to their core customers' homes, as opposed to the supercenters, which are located on the outskirts of urban centers and require a longer drive.” He projects that neighborhood centers' vacancy rates will stay within their historical 5 percent to 10 percent range over the next several years, with rental rates advancing 2 to 3 percent each year.

But reinvention is not just an option; it's a requirement for neighborhood centers facing an onslaught of supercenter competition — and it depends on how the grocery chains react.

GROCERS UNDER PRESSURE

The perennially low-margin grocery segment has grown more challenging with consolidation and the onslaught of the supercenter concepts from Wal-Mart, Target, Fred Meyers and Meijer. According to Willard Bishop Consulting, supercenter concepts will command 15.8 percent of the grocery market by 2006. Typically 185,000 square feet with a broad range of merchandise categories, these stores are neighborhood shopping centers unto themselves.

Retail Maxim says the number of U.S. supercenters increased nearly tenfold between 1992 and 2003, from only 197 to more than 1,946. Wal-Mart alone plans to add 100 to 210 units per year during the next five years. In contrast, growth of new neighborhood centers and community centers (lumped together as centers under 400,000 square feet by the National Research Bureau) has declined from 8.21 percent in the 1980s to 2.98 percent in the 1990s and to 1.95 percent thus far in the current decade. Community centers — ranging in size from 100,000 to 350,000 square feet — typically feature a grocery anchor plus one or more big-box anchors such as Kohl's or Lowe's.

Grocers themselves will have to do one of two things to remain competitive, notes Mary Lou Burde, a director in the retail group at Standard & Poor's. They either reduce prices to come closer to Wal-Mart's or significantly differentiate their store from Wal-Mart. “You can point to convenience, better service or better perishables — something that would entice a customer to pay a higher price for the shopping experience,” Burde says. Small, ethnic grocers are in a good position to differentiate themselves from a corporate giant, says Todd Caruso, a managing director with CB Richard Ellis Retail Services in Chicago. He says that Wal-Mart-driven consolidation in the city's suburbs has provided opportunities for niche players such as Nash Finch Co.'s Hispanic-targeted Avanza to expand into the market.

BIGGER IS BETTER?

At the strip malls, the grocery store shouldn't be the only tenant worried about the big boxers. Wal-Mart's 2002 supercenter sales were 22 percent grocery, candy and tobacco; 21 percent hard goods, such as furniture; 18 percent soft goods, such as bed linens and towels; 9 percent pharmaceuticals; 9 percent electronics; 7 percent sporting goods and toys; 7 percent health and beauty aids; 3 percent stationery; 2 percent one-hour photo; 1 percent jewelry; and 1 percent shoes. That reads like the tenant lineup at a typical neighborhood center. Says Bear Stearns' Smotrich, community center owners should drop any weak, poorly capitalized tenants in these categories, because they're usually the first victims when a supercenter rolls into town.

Overall, incumbent retailers tend to lose 5 to 10 percent of market share in the first year or so after a Wal-Mart supercenter enters their trading radius, Smotrich says.

One recent grocery strategy could exacerbate this threat to strip centers' co-tenants. Grocery stores are dallying with new products and services to increase margins and woo shoppers and come closer to superstore variety. Some prototypes include prepackaged foods among new products offered, as well as floral, video, banking, photo finishing and dry cleaning shop-in-shops. Gasoline, sit-down cafes and even day care are also among the services being tested.

Taken to an extreme, this mass merchandising bent by grocers could signal the demise of the grocery-anchored shopping center, because the inline stores would not be able to compete. “I have spoken to supermarket operators, who themselves don't quite understand why they would be good anchors,” says Scott Wolstein, chairman and CEO of Developers Diversified Realty, a Beachwood, Ohio-based shopping center REIT. Many of today's grocers compete directly with retailers that were once their neighbors, which has generated more leasing challenges due to co-tenancy restrictions. “There will certainly always be a place for grocery-anchored centers, but their growth profile isn't going to be very robust,” he adds.

Another scenario that would bode ill for the strips involves the possibility that grocery stores would leave the strip centers and relocate in the lifestyle centers, power centers and power towns where they share traffic and anchor duties with big-box retailers such as Bed Bath & Beyond, Best Buy — and, yes, even Wal-Mart. Grocers recognize that they need to move to the larger retail centers because the consumer has already made that transition, says Wolstein: “The business will move with or without them, because Wal-Mart is taking it there.”

DEMAND FOR FLEXIBILITY

A more upbeat future for the strip mall unfolds if you believe that grocers will not try to clone their supercenter rivals.

Some developers expect grocery chains to create smaller, more efficient supermarket anchors. For example, a 45,000-square-foot store may trim down to 40,000 square feet, and reduce the product offering to focus on high-demand items that turn over inventory quickly.

“I don't think grocers are going to go from 45,000 to 25,000 square feet, but they will be refining the footprint and getting more focused and targeted,” says Michael Phillips, the chairman of Cincinnati-based Phillips Edison & Co., a community shopping center developer and owner.

He expects that grocers will ask developers for greater flexibility — in adjusting the size and format of the business, and in accepting different financial terms.

Phillips also expects more co-tenancy issues. “Those anchors will be getting more cautious and more restrictive, which is a trend that is already developing,” Phillips stems — as long as the retailer does not exceed a certain amount of dedicated square feet to food sales. Those restrictions will get harder and harder to negotiate, he adds.

In the future, developers will be forced to work closely with grocers to ensure the success of their anchor, and ultimately the success of the neighborhood shopping center. It could mean emphasizing convenience, niche marketing, or inventory selection.

“The trend for owners and developers is to really understand the grocery business and work hard to recognize that there is a lot of competition,” Phillips says. “If retailers are going to be successful, you're going to have to play more of a part than in a traditional landlord-tenant relationship.”