When Wal-Mart and then K-mart introduced grocery offerings into their stores, most people realized that the concept could modify the appeal of power centers. Few predicted that the idea would ignite revolutionary changes in grocery-anchored neighborhood centers. But it did.

Today, no one would think of building a new neighborhood strip with a grocery store footprint smaller than 50,000 sq. ft. Across the country, owners of older strip centers are scrambling to find tenants for empty 30,000 sq. ft. groceries. Some are scraping the buildings and installing new 50,000 sq. ft. stores, eliminating 20,000 sq. ft. of in-line space in the process. Still others are converting vacant non-grocery anchor spaces to super-sized grocery stores.

In the process, these larger grocery anchors have begun to alter the traditional tenant mix at neighborhood centers, introducing new anchor retailers to these centers and reducing the space available to traditional in-line tenants.

What has the neighborhood shopping center become today, and what market forces might inspire further changes in coming years?

"One trend that we have noticed is that the amount of small shop space has decreased in new neighborhood centers," says David F. Ballew, president and CEO of BVT Equity Holdings Inc. in Atlanta (for more information on BVT, see the profile on page 32). BVT buys grocery anchored neighborhood centers, folds groups of these centers into funds, and sells equity shares in the funds to limited partners located primarily in Europe.

At the end of 1999, BVT's holdings included about 35 properties and had attracted more than $300 million in equity investments.

The effect of super-sized grocery stores on neighborhood centers has provided BVT with a solid strategy for attracting investors. "We look for new centers with a credit ratio of at least 70% to 30%, anchor to in-line. These are class-A institutional-grade centers with 75,000 to 125,000 sq. ft. of retail space, always with a grocery store anchor."

Traditional neighborhood strips used to allocate 40% or more of their retail space to small, local retailers, with the grocery store, pharmacy, and perhaps a junior anchor taking the remaining 40% to 50% of the space, continues Ballew.

"The reasoning behind this was income," he says. "Small shops paid higher rents and increased cash flow. The flaw in this theory is that smaller shops are more labor-intensive. As consumer tastes change, it is difficult to maintain occupancy levels in small shop areas of neighborhood centers."

Since grocery stores have doubled in size, developers have been working that problem out of their tenant mixes.

While developers of new centers might be able to specify at 70:30 ratio of anchor space to in-line space, the move in this direction has created headaches for owners of existing centers - as well as opportunities for companies skilled in the art of re-positioning.

Recycling program Take Kimco Realty Corp., for example. One of the largest neighborhood and community center owners in the country, Kimco, which is based in New Hyde Park, N.Y., owns nearly 500 properties and frequently faces repositioning challenges. "In Poughkeepsie, N.Y., we have a center with a 30,000 sq. ft. Stop 'N Shop that plans to move to an 80,000 sq. ft. space previously occupied by Caldor - in the same center," says Scott Onufrey, director of investor relations for Kimco. "In one of our Illinois centers, we accommodated a grocery chain that wanted to build a 70,000 sq. ft. store."

What happens to the old grocery space in these cases? "We've been successful in finding new tenants for these spaces," Onufrey says. "For example, we have put an Old Navy into a 30,000 sq. ft. space formerly occupied by a grocery."

Old Navy probably won't become a staple of neighborhood centers, but the idea does illustrate that conventional thinking about in-line neighborhood center tenants is changing.

In fact, new super-sized grocery stores are affecting the mixture of tenants in many neighborhood centers.

Based in Chicago, Bradley Real Estate Inc. owns 100 neighborhood centers, predominantly with grocery anchors. Like its counterparts in the business, Bradley has been renovating to accommodate larger grocery store spaces. "Currently we are redeveloping several centers with large new grocery stores," says Richard Heuer, executive vice president with Bradley.

At Bradley's 30th Street Plaza in Canton, Ohio, for example, Burlington Coat Factory recently vacated a 45,000 sq. ft. space. In response, Bradley signed a deal for an 80,000 sq. ft. Giant Eagle, tore down the Burlington structure to make room for the new grocery, and ultimately turned a 175,000 sq. ft. center into a 150,000 sq. ft. center.

In the renovated 30th Street Plaza, the new Giant Eagle sits on a pad, with an in-line strip positioned across the parking lot. The strip contains another anchor store, a 31,000 sq. ft. discount pharmacy called Marc's.

In-line tenant space totals only about 39,000 sq. ft., a little more than 25% of the available space.

Heuer expects the in-line tenant mix in this center to differ substantially from the usual mix, again because of the grocery story. "Larger groceries tend to be all-encompassing," he notes. "The Giant Eagle in this center has a florist, a dry cleaner, a video store, and a bank - all inside the grocery store."

Each of these categories, of course, used to represent an in-line leasing opportunity. Since the grocery now offers those categories, Bradley must look elsewhere for in-line tenants.

Convenience food stores such as bagel shops, retail service companies such as brokerages, and fashion stores represent three categories that may become more important in-line tenants in coming years, according to Heuer.

Other Bradley neighborhood centers have experienced similar changes. For example, in Gladstone, Mo., a suburb of Kansas City, Wal-Mart vacated a 100,000 sq. ft. space in Bradley's 140,000 sq. ft. Prospect Plaza.

The move created an opportunity to reposition the center as with a new large format grocery store. "We converted the Wal-Mart space to a 64,000 sq. ft. Hen House grocery and a 30,000 square foot Hobby Lobby, a Midwestern craft, hobby and housewares chain," says Heuer. "Each has a separate storefront.

"At the same time, we reconfigured the parking lot and added two pads, one for a Starbuck's and another for a Hallmark.

"In many strip centers today, you're seeing a lot more pads. It's not uncommon to see a Hallmark store on a pad. Payless Shoes has been doing this for a while as well. Of course, drug stores are flocking to pads."

Some pads feature altogether new ideas. BVT's Ballew, for example, says that grocery anchors in several BVT centers have installed pads with gasoline pumps in the parking fields.

Gas and groceries? "The grocery stores are doing this because it's convenient for customers," Ballew says. "However neighborhood centers might change, they will always serve needs related to convenience and necessity."

Ballew has also noticed that more and more groceries are installing drive-through pads to enhance customer convenience. "Groceries are setting up drive-throughs for customers to pick up pharmacy products, just like most pharmacies are doing today.

"One of the newest trends that I've seen involves pads designed to accommodate electronic commerce pick-ups. At one of our Florida centers, for example, we recently sold an outparcel to the center's Publix grocery anchor, which is building a 5,000 sq. ft. facility on the outparcel to provide drive-through pick-up facilities for electronic commerce grocery orders," he says.

What's next for neighborhood centers? If the current re-allocation of space to larger grocery store anchors and fewer in-line tenants began with power center retailers such as Wal-Mart and K mart, perhaps the next neighborhood center trend will begin in power centers as well.

According to Stephen Coslik, president and CEO of Woodmont Cos., a Fort Worth, Tex.-based neighborhood and power center manager and developer, power centers have begun adding entertainment components. "I think we're headed in the direction of entertainment shopping in the power center industry," he says. "Developers are beginning to combine big-box retailers with freestanding restaurants and theaters in large 50- to 100-acre projects designed around an appealing architectural theme."

Vestar Development Co. of Phoenix has developed a number of these projects. "We have taken the growth elements of shopping centers - theaters and restaurants - and brought them to the power center," says Lee Hanley, president of Vestar. "These developments become large scale centers and range from 400,000 to 1 million sq. ft. in size. We lay out these sites with traditional power center tenants and some in-line shops surrounding or facing the entertainment portion of the facility.

"These centers require a minimum of 50 to 60 acres," Hanley says. Two of our developments, for example, Long Beach Towne Center in Long Beach, Calif., and the Marketplace at Desert Ridge in Phoenix, take up 100 acres and offer more than 1 million sq. ft. of retail and entertainment."

The concept solves several problems that have plagued power center owners in recent years. First, the land requirements are large enough to create severe barriers to entry for would-be competitors. Second, the theater and restaurants expand the hours of use for these centers far beyond what traditional power centers can generate.

Third, these centers draw customers from a larger, less static trading area. For these reasons, entertainment-based power centers attract high-credit tenants willing to pay high rents and absorb periodic rent increases.

What does this mean to neighborhood centers? Only time will tell, but it is possible to speculate that a super-sized power center will attract the best small in-line tenants in an area, eliminating those tenants altogether from nearby neighborhood centers. Nearby strips may also find it more difficult to attract fast-food restaurants to their pads.

On the other hand, the successful combination of entertainment and retail in urban centers, main street developments, and now super-sized power centers suggests that certain kinds of entertainment retail may make a good addition to neighborhood centers in search of in-line and junior anchor tenants.

Whatever happens, one thing is sure: the neighborhood shopping center industry has always flourished by changing with the times. That will never change.