Pity the grocery chain that doesn't dominate its market. It's always been tough to turn a decent profit in a business with prosciutto-thin margins, but it got even tougher to be an also-ran when superstores came along and heated up the competition.

Nearly 2,000 superstores now exist across the United States. Their prospects are bright: Willard Bishop Consulting expects them to account for nearly 16 percent of the grocery segment within three years. Wal-Mart expects to open some 200 superstores this year alone.

Owners of grocery-anchored centers have a right to be nervous in the face of such big changes. But Regency Centers is betting it can beat the challenge with a strategy that boils down to this: You win with winners.

The Jacksonville, Fla.-based REIT owns 262 retail properties with a value of $3.2 billion, and 86 percent of them are grocery-anchored. It's a massive portfolio, yet the key to Regency's approach isn't just size but careful choice.

Markets are screened and selected for their demographics. The average household income within three miles of Regency's properties is $87,000, compared with $64,000 in the nation's top 50 metropolitan statistical areas, according to Regency.

Moreover, 81 percent of Regency properties are in the 50 largest markets, where shoppers and money tend to be most plentiful.

In fact, the company notes, retail spending within three miles of Regency Center's portfolio accounts for 1.3 percent of all retail spending in the United States.

Regency insists that its grocery anchors be dominant. Seventy-three percent of Regency's grocery anchors are ranked first or second in the local market — standing that gives them some immunity from the supercenters. (Its three biggest tenants are Kroger, Publix and Safeway, all of which have defended their turf better than other grocery chains against the superstore onslaught. See chart on page 21 for top tenants.)

Non-grocery tenants are also selected with care. Regency has identified 30 business categories, and in each it seeks to lease to best-in-class retailers. Seventy-seven percent of its portfolio is leased to best-in-class tenants.

And Regency has an aggressive growth plan, one that favors development over acquisition — a reflection of the high cost of buying properties these days. Last year it developed projects worth $505 million, and it expects to complete some $300 million in projects this year. Most of the projects are sold to one of two joint ventures in which it's involved, producing income both from the development and the ongoing business.

“Regency typically goes for very high quality centers, and that's a strategy that works well in both good and bad times,” says Reza Etedali, vice president for Sperry Van Ness in southern California, who has extensive business with Regency. “They also tend to be very location-sensitive, and they avoid the B-minus locations. It makes them pretty immune to recession.”

Regency's approach draws praise from REIT analysts. In a recent report on the company, Merrill Lynch's Steve Sakwa wrote, “Regency's portfolio should stand the test of time and outperform similar portfolios over the next five to 10 years.” It's expected to grow 13.2 percent between 2001 and 2006, according to demographic consultant ESRI, higher than other REITs: 5.8 percent for New Plan Excel and 8.5 percent for Weingarten Realty.

That's the plan, says Regency president and COO Mary Lou Fiala, who joined the firm in 1998 from Security Capital Global Strategic Group, where she developed operating systems for retail projects. With 18 years of experience in the industry — including time as senior vice president and director of stores for Macy's East/Federated Department Stores — she brings an analytical focus to Regency.

For grocery-anchored centers, dealing with the superstore challenge is critical. Fiala concedes that the arrival of a Wal-Mart Supercenter hurts existing grocers in the short term. Those ranked No. 1 and No. 2 in the market take a small hit in the first year, she says, but the No. 3 grocer — probably already struggling — may see a drop of 15 percent or more. In the second year, No. 1 and No. 2 will see a recovery, she says — but No. 3 will continue to show losses. “Eventually it's going to close. Some of that business will go to Wal-Mart and some to the top two grocers,” she says.

Sakwa agrees. His analysis found that in six of the largest MSAs between 1997 and 2002, the top two grocery chains going up against Wal-Mart Supercenters did indeed see sales increases averaging 2 percent — a finding suggesting “that Wal-Mart success is coming at the hand of the non-dominant grocers.” That offers strong support for “partnering with the leading market share grocers in their markets,” Fiala says.

Grocery anchors are selected after a careful examination of supply and demand in the area, Fiala says, using both internal research and that of the prospective tenant. “What we've learned as a result is that a key component of success is average household income. The higher the income, the better the grocer will do,” she says.

“Common sense says a customer earning $87,000, or an income above the local market, can choose shopping experience and convenience over price. They'll go for convenience and drive to the Publix a mile away, as long as it's reasonably competitive with the Wal-Mart Supercenter,” she says. “But if you're making $50,000 and have a family to support, you may have to go to the Wal-Mart. Price is more important than the shopping experience.”

Regency's strategy has produced a roster of anchors that's more resistant to price competition. Its grocers “produce 23 percent greater sales than in their chain averages,” she notes.

THE STRONG SURVIVE

Also helping to keep Regency's numbers strong is its willingness to eliminate any weakness in its portfolio. In recent years it has culled about 10 percent of its holdings annually by selling underperforming assets — about $186 million worth last year, Fiala says. The number is expected to fall to about $150 million this year, she says, “and going forward should be about 3 percent of our properties. It's important to do this.”

This disciplined approach has helped keep the REITs' occupancy rates high — about 9.5 percent in the past three years — and rent growth solid. Rents rose 10.5 percent in 2001 and 10.8 percent last year.

Although Fiala says Regency has about $100 million a year in its budget for acquisitions, mostly for strategic purposes such as bolstering its position in the mid-Atlantic region, the high cost of properties — coupled with the company's insistence on the right demographics — is making it more profitable to develop instead. The company has more than $400 million in construction or renovation projects underway, and those projects are already 75 percent leased.

The grocery business has changed considerably since Regency was founded in Florida in 1963 by Joan and Martin Stein (it went public in 1993), and it continues to change — with grocery-anchored centers feeling the impact. But Regency, under Chief Executive Martin Stein Jr., or Hap as he is known, believes that they can anticipate the changes and meet the challenges.

“There is not going to be just one grocer in this country — the one called Wal-Mart,” says Fiala. (For more on the Wal-Mart challenge, see Convenience or Low Prices in our June issue.)

Rather, Fiala says, there will be a more differentiated grocery lineup with room for variety. “We believe there'll be three pieces. First is the more moderate income level, the superstore category. Then you'll have the next level, where we see ourselves — the upper upper-moderate, with dominant grocers. The next component, even a step above that, is the specialty grocer — Trader Joe's and Whole Foods, for instance. You have to figure out where you're positioning yourself.”

REGENCY'S TOP TENANTS ARE TOPS
Tenant Total GLA Base Rent % Of Base Rent
1. Kroger 3,508,194 $29.85 million 9.11%
2. Publix 2,017,604 $19.77 million 6.03
3. Safeway 1,533,132 $15.26 million 4.66
4. Albertson's 386,986 $9.24 million 2.82
5. Blockbuster 702,097 $7.43 million 2.27
Source: Merrill Lynch

John Benjamin, a professor of finance and real estate at American University's Kogod School of Business in Washington, agrees. The best-managed upscale centers will survive and prosper despite the supercenter threat, he says: “There is plenty of room for the quality grocery-anchored centers with strong locations acquired years ago by REITs such as Regency.”

PORTFOLIO MANAGEMENT

GOAL

Superstores are springing up everywhere, and traditional grocery-anchored centers are in the cross hairs. A major owner and developer of food-anchored centers, Regency Centers needed a good strategy to rise to the challenge.

METHODOLOGY

The company is taking the high ground by concentrating on affluent markets and leasing to dominant grocery chains, which are better able to resist price competition. Regency also concentrates on leasing to best-of-class tenants in each of the 30 other business categories represented in its centers.

BUZZ

The REIT gets high marks for its disciplined approach, and its stock is at or near its 52-week high.

DATA

Regency's $3.2 billion portfolio consists of 262 retail properties, 86 percent of which are grocery-anchored. Seventy-three percent of its grocery anchors are ranked No. 1 or No. 2 in their markets — a strong indicator that they will be able to thrive despite the superstore attack.