Over the past five years, Klaff Realty LP has become one of the best bargain shoppers in the world of retail. The Chicago-based firm is the corporate embodiment of that unflagging individual shopper who searches for hours through the bins of distressed goods for that small bit of treasure.

When retail chains enter reorganization, undergo corporate downsizing or are "distressed" financially and need to close stores, Klaff Realty has increasingly been one of the firms to which they turn.

Consider these deals. In May 1999, Klaff Realty acquired a 22-store portfolio of former Montgomery Ward stores totaling 1.935 million sq. ft. A year earlier, Klaff bought 40 stores from the same retailer. Also, last year, in its biggest deal ever, Klaff bought two national real estate portfolios totaling 4.7 million sq. ft. of space from Levitz Furniture Corp. for $93 million. And, just this year, Klaff purchased for $5.9 million at a bankruptcy auction an 11-property portfolio that belonged to the Hechinger Corp.

After a purchase Klaff Realty then rehabs or totally redevelops the site so as to lease to new tenants or to sell to other investors. A good example being two Kmarts bought in the mid-1990s. One of the sites was a former 200,000 sq. ft. store that was renovated to the tune of $10 million and re-tenanted with a Kohl's, Burlington Coat Factory and Petco. The second Kmart property was sold outright to Target.

Although Klaff Realty was founded in 1981, it remained a locally based and operated company until the mid-1990s when it began picking up small portfolios of properties vacated by big box retailers.

Hersch Klaff, a South African by birth, came to the United States 22 years ago as an accountant, but after just a few years here he turned to real estate. In 1982, his first big deal was arranging (with partners), to buy the old Marshall Fields men's building in downtown Chicago and redevelop it into a multi-tenant retail, office and medical complex.

Through most of the 1980s, Klaff focused his attention in downtown Chicago before turning his sights on the city's suburban retail market, which by the early 1990s was rife with distressed properties. After buying a number of significant suburban shopping centers and redeveloping them, Klaff began getting familiar with some of the big box retailers which were hitting hard times.

Klaff admits that initially these big stores held little interest for him. "They were boring, and with their long-term leases they were just coupon clipper opportunities for estate planning." Then the proverbial light bulb went off. "We realized as we started owning these shopping centers where companies had boring, long-term leases and 25-50 year options to renew, that there was no upside in owning them as a tenant, but there was upside in buying up the leases, dividing the stores into 25,000 to 30,000 sq. ft. floor plates instead of 100,000 sq. ft. and subleasing the space," explains Klaff.

Klaff came to understand the real asset in the shopping centers was not the income stream from the tenant but the ability to buy back the future, in certain cases, by dividing up the stores, re-tenanting the property, tripling the income and investing the money in a new transaction. The numbers are simple.

The old box retailers negotiated 25-year, renewable leases at very low sq. ft. rates. Even if Klaff Realty takes over the lease, that rate doesn't change. But, the market certainly changes and the going rate for retail space may be three times that old lease rate. Klaff Realty goes in and pays, for example, $3 a square foot, and leases it at $9 a square foot. "The difference pays for our risk and it's our profit," says Klaff. It has pretty much been the company's modus operandi ever since.

Today, Klaff Realty acquires, develops, finances, leases and manages mixed-use, office and retail real estate. It has a close relationship with a number of chains, some of which have opened in numerous Klaff Realty shopping centers: Kohl's, Burlington Coat Factory, Target, Old Navy, Gap, Bed Bath & Beyond, Linens & Things, and Marshalls.

To date, Klaff Realty has bought properties totaling approximately 13 million sq. ft. with a value in excess of $550 million. Almost all major deals are done with another financial partner, usually a private company or a fund which represents institutional investors.

Recent partners include Federal Construction Co. (Canada), Lubert Adler Real Estate Opportunity Fund, Black Acre Capital, Capital America, J.E. Roberts Companies, CMS Companies, and Blackstone Realty Group.

Most partners often do repeat deals with Klaff. For instance, Ira Lubert and Gene Adler, two Philadelphia financial entrepreneurs, originally raised $125 million for the first Lubert Adler Real Estate Fund.

A second fund raised $250 million and the two are now raising money for a third fund. Klaff Realty first joint-ventured with a Lubert Adler fund back in 1997 when Klaff, Lubert Adler and two other partners bought two former Lechmere stores. The two companies have since partnered on at least six other transactions.

Federal Construction Inc. based in Montreal, Quebec, has partnered in six deals over three years with Klaff Realty. "We have done redevelopments and joint ventures with Klaff," says Mark Hornstein, a vice president with Federal Construction. "They are very good, very professional. Klaff has an excellent analysis department and they present their deals in a very straightforward manner,"Hornstein adds. "These deals are always hands-on and Klaff operates the properties."

What Federal Construction likes most about the partnerships is that they have all been profitable. "Some are still in progress, but the ones that have been completed have been successful," Hornstein says. How successful? The completed deals throw off about a 20% return. "Because of the kinds of risk we take, we are usually looking for a leveraged return that is in the range of 20%," confirms Alan Saposnik, chief operating officer of the company.

A long time player in the commercial real estate industry, Saposnik had worked at LaSalle Partners Inc. and Walsh, Higgins & Co. before starting his own firm called Power Real Estate Services Inc. The two met when Klaff was attempting to purchase a building Power Real Estate managed. They hit it off and decided to go into business together.

Saposnik gave Klaff Realty deeper management capabilities. In fact, most of the company's growth has come since 1995 when Saposnik joined the firm. Five years ago, Klaff Realty had only one property outside the Chicago area and its portfolio was worth about $100 million to $120 million. Today, Klaff Realty boasts investments in 25 states and a portfolio worth about $250 million.

"In most cases what we are doing is buying vacant real estate," says Saposnik. "We find the vacant buildings, take a leasehold position or ownership and find a user or a buyer. For the retailer that is trying to divest, working with us allows them to get rid of multiple properties at one time. The retailer gets the cash it needs quicker."

Klaff Realty doesn't opt for just any opportunity involving a desperate retailer. "Hopefully, we are not buying something that doesn't have market value, or is located in a bad market or is too expensive to rent," Klaff says.

The company did very well when the big space retailers such as Kmart, Wards, Lechmere and Hechingers needed to unload properties, but the current spate of retailers that are in trouble are more in the 15,000 sq. ft to 30,000 sq. ft. range and Klaff feels there is already an oversupply of space in the category - one of the reasons being that there are just a small group of retailers that are still expanding for this size store, such as Best Buy or Bed Bath & Beyond.

"There has been a major restructuring of the retail industry in the United States over the last 10 years and there is still more to come as it is a never-ending process," says Klaff. "But, a lot of the juicy stuff has been done in the last few years."

Klaff, who keeps a close eye on this unusual corner of the retail industry, feels the peak may have come and gone. "We will continue to see an increase in supply because a couple of more retailers are going out of business or downsizing, but you just don't have the takers for the space. "

The solution to Klaff's dilemma has been to turn to the European market. The company is in the process of opening a London office and it is already looking into some deals.

"We think there are some pickings in Europe which hasn't experienced what is happening in the United States right now," Klaff says. "We'll look at the United Kingdom first and then ultimately the rest of Europe. It is the next big opportunity."