Supermarket chains have exhibited a voracious appetite lately. Over the past two years, giants such as Safeway, Al- bertson's and Kroger have been spending millions to acquire smaller chains and expand their geographic reach. These same grocers now wield substantial power in making real estate decisions and controlling the destinies of grocery-anchored centers throughout the country. How will this shift in ownership affect the retail industry?

Foremost, it appears that the consolidation is far from over. "Many people in the industry are talking about trending toward a big five - five major chains. Personally, I agree with that," says Larry Pantlin, a managing director and principal in the Atlanta retail development office of Dallas-based Trammell Crow.

Supermarket chains are not just consolidating to grow larger, they are strategically merging with other firms to gain entry into new geographic markets. Pleasanton, Calif.-based Safeway Inc., for example, historically has had a strong presence on the West Coast. However, the grocer recently established a major stake in the Midwest when it shelled out $1.2 billion for Chicago's Dominick's Supermarkets.

"It's becoming a very national business for these large chains," Pantlin says. "They want to be on both coasts."

There's still an ample supply of grocers competing for customers and real estate in most markets, but industry observers wonder if that healthy competition will be sustained in the future. "We're starting to feel the impact of what the mergers and acquisitions mean," says Drew Gorman, COO of the Northeast region for Federal Realty Investment Trust in Rockville, Md. "As a developer, you're now running the risk of possibly losing your supermarket or changing over to another supermarket format."

At this point, the Federal Trade Commission (FTC) has been reluctant to see any of the stores that have changed hands closed due to redundancy. And in some cases, it has even safeguarded that competition by forcing the acquiring grocers to sell a portion of the stores to a third party.

For example, Safeway acquired eight Ralphs/Hughes supermarket stores in Southern California last December when the FTC required Fred Meyer Inc. to sell the stores as part of its deal to merge with Kroger.

Nevertheless, the growing bulk of supermarkets could impact the real estate community in two significant ways. First, the growth gives supermarket companies greater leverage in negotiating rental rates and lease obligations. Second, fewer supermarkets vying for existing sites and new developments have the potential to drive down rates. The real estate community is already seeing a drop in competition in some markets.

Gorman reports that in many cases, where there had been four chains vying for market share - and real estate - now there are only two supermarket operators. "So as a developer, that's got to make you take notice," he says. "Eventually they're going to have dominance. You're removing competitors."

Re-tenanting smaller stores "As a company, we've surveyed all the possible effects of different mergers," says Drew Alexander, president of Houston-based Weingarten Realty Investors. One conclusion of that analysis is that owners must do their part to update properties and help their grocer tenants remain viable.

The recent consolidation activity, along with a number of other trends, will separate the haves from the have-nots, Alexander says. "Good locations and good centers will have significant advantages over people who think real estate is a passive investment, like Treasury bonds that you can buy and forget about," he says.

In the wake of consolidation, store closings due to overlap have been minimal. The majority of re-tenanting has occurred among smaller, 30,000 to 35,000 sq. ft. supermarkets that require larger stores in order to compete with their growing rivals.

Last year, for example, Weingarten helped Kroger expand from a 30,000 sq. ft. to a 60,000 sq. ft. store at its River Oaks Shopping Center in Houston. The market has a considerable inventory of old 30,000 and even 20,000 sq. ft. grocers.

"Most astute investors with 30,000 sq. ft. stores are paying close attention to how the space can be expanded," Alexander says. "Does it lend itself to a non-grocer use, and does it make sense economically?"

Owners of obsolete-sized stores are exposed to greater risk as the consolidation trend continues. The location may be outdated for a supermarket because it's too small or doesn't offer enough parking.

"Centers that have undersized supermarkets, without the ability to expand to accommodate a prototypical supermarket, will be faced with losing supermarkets as anchors," says Ken Bernstein, president of Acadia Realty Trust.

Acadia has several smaller grocers within its portfolio, which has brought the issue to the forefront for the New York-based REIT. "I do envision, over time, a small minority of our centers losing a supermarket, and repositioning it for a new supermarket use," Bernstein says.

New Hyde Park, N.Y.-based Kimco Realty Corp. is another firm that has seen some of its grocers move into larger spaces. In some cases, the moves have been made possible by building a new store or relocating the grocer to a larger space vacated by another tenant. The vacated supermarket is typically re-leased to a single user, or cut up and leased to smaller tenants, says Patrick J. Callan Jr., Kimco's vice president of real estate.

Many of the vacated supermarket locations have been aggressively filled by office-supply retailers. "They're usually thrilled," Callan says. "It seems to be a good fit for them, and retrofit costs aren't that high."

New development in the cart Despite the capital that's fueling acquisitions, grocers are still coming up with funds for ongoing development. A strong showing on Wall Street has helped finance that construction activity.

"What's happening is that the public market wants to see expansion and growth," says Richard Tucker, president of Tucker Development Corp. in Highland Park, Ill.

Companies such as Albertson's and Safeway are very cash-rich, and they are able to make acquisitions while continuing to expand through development, Tucker notes. Annual sales at Safe-way, for example, exceed $26 billion.

Chicago has been an extremely active market for supermarket expansion in recent years. Dominick's and Jewel-Osco have been the two dominant brands. Minneapolis-based SuperValu Inc. also has become more aggressive of late with its Cub Foods stores. Tucker Development broke ground in March on a 335,000 sq. ft. center in Niles, Ill., which will be anchored by Cub Foods, Wal-Mart, Babies R Us, Office Depot and Walgreens.

"What's interesting is that Cub was out of the market for a while, so now they're playing catch-up," Tucker says. Cub has been repositioning older stores as well as building new ones to expand its presence in the Chicago area.

Although competition is sparking new development, one negative for developers is that grocers are using their deep pockets to do their own development. Albertson's, for example, has always favored self-development. There are still leases being done, but many grocers prefer to control their real estate where possible.

But even the super grocers don't have access to an endless supply of capital. "All the supermarket retailers have gone through an enormous expansion mindset over the past couple of years," Pantlin says. "We might see that activity slow so that supermarkets can catch their breath a little."

Supersize it The move to grocer superstore formats also is influencing real estate as it relates to the size of stores, as well as overall tenant mix within those centers. Supermarkets have continued to experiment with new offerings that run the gamut from flower sales and video rentals to in-house restaurants and pharmacies.

Grocers have been expanding their wares for the past 15 years, as they have seen increased competition from non-grocers such as Target and Kmart. With such a variety of products and services, it's no wonder that footprints among some prototypes are pushing 75,000 sq. ft.

According to Pantlin, grocers will continue to bang out a variety of larger stores where the demographics are right. "Given the fact that they are consolidating, capital is going to have a premium put on it," he reasons. "So they will be going for stores they know will generate big volumes."

Supermarkets' expanding territory has made it harder to lease the neighboring space. "Banks, florists, bakers, butchers - clearly we've seen a lot of evolution in the supermarket business," Callan says, noting that lease exclusion terms sometimes make it impossible to market to traditional tenants.

As a result, owners such as Kimco have become more creative in leasing grocery-anchored centers. "You do have to think a little differently than five or 10 years ago," Callan says. These days, tenants are frequently more service based, and also include non-traditional tenants such as childcare, health clubs and even office space.

The question remains as to how much bigger these stores are going to get. "Supermarket merchants themselves are tinkering with what is the precise right size in a market," Pantlin says. Some chains have determined that the larger, 60,000 sq. ft. and 75,000 sq. ft. stores are ideal, while other chains prefer to stick to a series of prototypes that range from 27,000 sq. ft. to 50,000 sq. ft. depending on the neighborhood.

Others believe that the grocery superstores reached their peak a few years ago, and now those footprints are actually coming down a little to 55,000 sq. ft. or 60,000 sq. ft. prototypes. Supermarkets over 60,000 sq. ft. have become counter-productive. Those large sites and spaces are difficult to find in mature markets, and some shoppers feel overwhelmed when the supermarkets get too large, Callan says.

Investment outlook Over the past few years, supermarket-anchored centers have been a popular buy, and such properties have been trading at a premium. The situation is not likely to sour anytime soon.

"From an investor's perspective, I still love this product type," Pantlin says. "If the grocery-anchored centers are built where demographics are strong, the population is in place, and household incomes are high, they're just great investments."

Supermarket traffic draws from 500,000 to 1 million people each week, and all of the center's other tenants benefit from that traffic, he says.

However, the consolidation has prompted buyers to scrutinize those deals more carefully. As Bernstein cautions, "Whether it's due to consolidation of supermarket chains, consolidation of discount chains, or the looming presence of the Internet, investors have to be comfortable that their locations can withstand the potential drops associated with those consolidations."

Acadia primarily buys older real estate with low rents per square foot in relation to sales, Bernstein explains, so it could sustain a 10% to 20% drop with the location still being profitable. "It's these kinds of investments that, if the tenant goes out of business and we get the lease back, we make money," he says. "And if the tenant stays in business, we've bought it at a return that ensures that we make money."

Location, of course, is key, says Dick Heuer, executive vice president in the Minneapolis office of Northbrook, Ill.-based Bradley Real Estate. "So if something like that does occur (tenant bankruptcy), the real estate speaks for itself," he says. "When we go into a market, we usually want to have the No. 1 or No. 2 grocer in that market."

The consolidation activity is prompting some landlords to place more emphasis on lease language. "Quite frankly, oftentimes our interest and the supermarket's interest are not quite the same," says Alexander. The grocer would rather have its vacated space leased to a non-competitive tenant - particularly if they have other stores nearby. "We try to control our real estate so that if an anchor tenant closes, we can control our destiny and put someone else in."