The theater business has innovated itself into a marketing crunch. Customers love state-of-the-art, stadium-seating theaters. But when a stadium-seating theater goes into an area, patronage declines at nearby, older theaters.

Then again, when an older theater gets a hot movie, patronage falls at the new theater down the street.

In other words, because of the popularity and proliferation of new theaters, too many theaters are chasing too few customers. The latest count by the National Association of Theatre Owners (NATO) puts the number of all theater screens in the United States at 37,185, with more to come.

The NATO survey does not break out the number of screens in new, state-of-the-art, stadium-seating theaters. But industry analysts seem to agree that as new theaters come on line, older theaters will remain open at least for a while, adding to the total number of screens in an area and hampering the ability of operators to generate profits.

"In the movie business today, about 50% of total screens are or will soon become uneconomical, obsolete or outmoded, in locations that are too competitive," says Michael Landes, an attorney who consults with exhibitors and developers about theater development and redevelopment.

Even if Landes' estimate is high, the point is that a substantial number of older theaters has probably produced a financial crunch for operators that will soon spill over and hurt center owners. In terms of solutions, there are two or three choices, none of which are inexpensive.

First, a developer and operator might cooperate to convert, through renovation or demolition and rebuilding, an under-performing theater into a stadium-seating facility. Second, an owner might recycle a theater property by finding another use for it. This too would require renovation or demolition and rebuilding.

Developers Diversified Realty Corp. (DDR) of Cleveland, Ohio, has been monitoring the prospects of its theaters since this issue first arose. The company has 28 theaters with a total of 300 screens. Additional theater facilities are flowing through the company's development pipeline. About one-third of DDR's theaters feature stadium seating.

"We're tracking traffic in each of our theaters," says Dan Hurwitz, executive vice president with DDR. "We have found that business is stable in older theaters as long as there is no stadium-seating theater in the trade area. When new competition comes to market, attendance falls off at the older theaters."

What happens to older theaters after a year or so of declining attendance? Do the operators want out?

"We haven't had exhibitors ask for relief," Hurwitz says. "We have found that operators want to expand and renovate into stadium-seating facilities. In other words, they are interested in mounting a competitive response."

Converting theaters carries a high price and also leads to a significant loss in the number of seats, says Frank Moson, vice president of Irvine, Calif.-based MBK Construction Ltd., which has undertaken a number of conversions in recent years. "While the actual cost of a conversion depends on the facility, it can run to $20 per sq. ft.," he says. "I also think you'll lose between 15% and 35% of the seats compared to the old theater."

The cost of renovating or rebuilding plays a role in deciding what to do with an obsolete theater. But the value of a new facility is even more important in the decision, notes DDR's Hurwitz.

"You have to look at the incremental value that is created," he says. "If an old theater is paying $4 per sq. ft., and I can renovate or rebuild and get $18 a sq. ft., then I should do it. Cost is part of the analysis, but value creation determines your appetite for change."

MBK Northwest in Portland, Ore., a sister company to MBK Construction, owns and develops shopping centers in the northwest and recently dealt with the value creation question in a major center renovation in Seattle.

The old center, called Parkway Plaza, sat next to the Pavilion Mall, another aging property. "We owned Parkway, and we bought the Pavilion Mall," says Mason L. Frank, president of MBK Northwest. "We tore down Pavilion and a lot of Parkway to make way for a 700,000 sq. ft. power center called Parkway Super Center. It has 20 major retailers, nine restaurants and a 12-screen stadium-seating theater."

The old center had a vintage five-screen cinema set in line with other retail space. MBK Northwest built its new theater on the site of the old Pavilion Mall and retrofitted the old in-line theater space as a Zany Brainy. Because the space was in-line, it was possible to keep the shell of the original theater. "We gutted the space, leveled the floor and re-faced the exterior," Frank says.

The renovation replaced an obsolete theater yielding $4 per sq. ft. with an important national retailer willing to pay $18 per sq. ft.

CBL & Associates Properties has seen a theater problem materialize as older, undersized theaters come to term on their leases. "The operators of these facilities are deciding not to renew their leases," says Michael Lebovitz, a senior vice president with CBL.

In response, CBL has looked for productive uses for old space while building new facilities for their theater operators. Meridian Mall in East Lansing, Mich., for example, had accumulated three different theaters over a period of yeas. Two sat in the mall itself, and the third resided on an outparcel.

As the leases approached term, CBL developed a plan to renovate the entire mall, consolidate all three theaters into a single theater in a new location within the mall structure, redevelop the two existing in-line theaters into a food court, and recycle the outparcel theater for a conventional retailer.

"The plan persuaded the theater owner to forego relocating in another center and to stay in our center," Lebovitz says.

The key to solving the problem posed by an old theater is to expect the problem and plan a solution, says David Hull, director of retail leasing with Atlanta-based Jones Lang LaSalle. "Having been through the process several times, we feel confident that it can be done," he says. "If you look at old theaters as a burden, I think you will miss opportunities."

Hull keeps an eye on the leases of older theaters and tries to anticipate when the issue will arise. "We think about what to do with the properties ahead of time," he says. "We get cost estimates for renovating as well as for demolishing and rebuilding. At the same time, we start looking early for businesses that can make creative use of this kind of space. Using this approach, we've converted four theaters to alternative uses. In each case, it's been a positive experience."

The 1 million sq. ft. Oglethorpe Mall in Savannah, Ga., offers an example of how to deal with the worst kind of obsolete theater: the one with low visibility in the back of a mall, with a separate entrance.

"We were able to locate a women's fashion design company in that space," Hull says. "The designer appreciated the architectural possibilities of the space, kept the high ceilings, built a ballroom staircase, and created a private studio upstairs where brides could try on gowns and plan weddings. We renovated the space for this company in 1991. The company is still there today and thriving."

Better yet, so is the center. The 12,000 sq. ft. renovation cost $500,000 but allowed a rent increase from $1.25 per sq. ft. to $12 per sq. ft. - and paid for itself in short order.

At Westmoreland Mall in Greensburg, Pa., Jones Lang LaSalle moved early to deal with an old four-screen Carmike theater approaching the end of its lease. Before the lease ran out, the property management team developed a plan to keep the theater nearby and to recycle the old theater property.

"We managed both the mall and a strip center behind the mall," Hull explains. "We went to Carmike with a plan for a new 52,000 sq. ft. theater for the strip center if they would surrender their existing facility in the mall. They agreed.

"Then we took a renovation concept for the old theater property to Kaufmann's, the anchor department store in the mall. Kaufmann's had spoken to us previously about a merchandising need for furniture. Their existing store was too small to include a furniture department. Because the old theater was adjacent to the Kaufmann's store in the mall, they decided to expand into the renovated space."

Hull declines to reveal the differences in rent, citing client confidentiality. But he does say that the economic return for the Westmoreland Mall owner, a group of institutional investors, has remained essentially the same.

For owners and property managers, the problem of obsolete theaters has yet to strike with full force. Sooner or later, it will. Those who have scripted alternative plans for individual properties may find renovation and recycling opportunities hidden within these problems.

Those who fail to take an early look at alternatives, however, will have to live with the possibility of a very unhappy movie ending.