Tesco's Fresh & Easy Serving as an Economic Stimulus Package of Sorts for California's Troubled Commercial Retail Real Estate Industry

Tesco's Fresh & Easy Neighborhood Market venture is providing a major benefit to the troubled commercial retail real estate industry in Southern California: it's giving the region's suggish commercial-retail building economy a big boost by buying and renovating numerous long-empty retail buildings, purchasing abandoned lots to build new stores on, and in some cases signing leases in mixed-use developments which have long been searching for a retail anchor.

Of the about 30 -to- 35 Fresh & Easy grocery stores currently open in Southern California (out of 50 total stores open to date), the majority of those units have gone into previously empty retail buildings, which the company has gutted and completely remodeled to fit its 10,000 -to- 15,000 square foot Fresh & Easy grocery market format.

Many of these previously empty buildings were former Albertsons' supermarkets. Before Boise, Idaho-based Albertsons, Inc. sold the supermarket company a couple years ago to SuperValu, Inc., it closed numerous underperforming Albertsons' stores throughout Southern California. Tesco's Fresh & Easy has leased many of these empty supermarkets and remodeled them for their Fresh & Easy stores. In addition, Fresh & Easy also has leased a number of empty CVS and Rite-Aid drug stores, along with a few other empty retail buildings, for their Fresh & Easy grocery market locations in the region.

Tesco decided on this combination strategy of renovating abandoned commercial retail buildings and building some from-the-ground-up new stores for a couple of reasons.

First, with the existing stores, since the building's shell, electrical, plumbing and other infrustructure is already in place, it's much more inexpensive to simply gut the store's interior and redo the outside, and create a Fresh & Easy store, rather than having to build from the ground-up. The cost savings can be considerable.

Additionally, because most of these retail buildings had been empty for some time, Tesco was able to get rather favorable lease costs and terms on them. This combination of lower building costs and cheaper rents allowed the retailer to have lower upfront costs and overhead, which makes sense considering Fresh & Easy's low-price positioning on basic grocery items and prepared foods. Since the stores average only about 13,000 square feet, the ongoing operating costs are much less than for example the previous tenent, Albertsons, which operated 35,000 -to- 55,000 square foot stores in the same boxes.

Further, since Fresh & Easy's strategy is to open as many stores as fast as it can, especially in Southern California, the rapidity in which the grocer can renovate one of these empty retail buildings is such, compared to building a store from the ground-up, that it allows for it to meet this goal of opening a critical mass of stores in a very short period of time.

In the situations where Tesco has thus far build stores from the ground-up, such as the just-opened store in the Southern California city of Compton, the grocer was able to negotiate very good financial terms for the location because the city of Compton offered the retailer a package of financial incentives to build and open a store in that community which is underserved by grocery stores. Before the Fresh & Easy store opened in Compton last week, the city of 100,000 had only one decent-sized grocery store.

Commercial real estate agents in Southern California have told us Fresh & Easy is grabbing locations nearly wherever it can--the empty retail stores, locations in shopping centers that are looking for a retail food store anchor, and in lower-rent districts which are avoided by most other grocers.

For example, one commercial real estate agent told us about a Fresh & Easy store set to open late this year in the city of Murrieta. The store is located in a shopping center that won't even be completed when the Fresh & Easy store opens. The neighborhood is a relatively new one in the city. Most of the houses and condominiums in the area were just completed in 2004, the agent told us. Further, there are numerous vacant lots where houses have yet to be built.

The Fresh & Easy store is nearly right next to the residences, the commercial real estate agent said. The neighborhood isn't expected to actually have enough residents to support a store until at least two years from now. However, he told us Fresh & Easy wanted to grab the location and get the store up and running long before that happens, or if it happens.

City officials and commercial landlords in Southern California communities ranging from Anahiem and Orange in Orange Country, to Riverside and Upland in the Inland Empire, to Fallbrook and Vista near San Diego, are all happy that Tesco has been renovating so many of these abandoned retail buildings at such a fast clip. The chain has become a corporate commercial real estate stimulus package in and of itself for the region's depressed market.

We do wonder though, with such rapid new store development, if the grocer won't have to take a hard look in a year or so at many of its locations and seriously evaluate the store performance in those neighborhoods. Keep in mind that Albertsons and the drug chains abandoned those locations--and the buildings--primarily because the stores were underperforming. While its true because of their smaller size and start-up nature that Tesco will likely define performance much differently than Albertsons did for example, many of these locations still are suspect in the medium -to-long run.

Right now though Tesco isn't concerned about that. In fact it's employing a similar strategy in its plans to move into Northern California, opening its first stores in the San Francisco Bay Area in late 2008 or early 2009. The grocer has already inked deals for 18 locations throughout the Bay Area. Many of these 18 locations are leases on empty commercial retail store buildings--and a number of those buildings are, you guessed it, former Albertsons stores, which were closed as part of that acquisition a couple years ago and have remained vacant.

Additionally, Tesco has worked two deals in the city of San Francisco similar to the Compton deal. The retailer is locating two stores in the low-income Bayview-Hunters Point neighborhood in the city, and will receive incentive packages for doing so. Both of these stores will be built from the ground-up, like the Compton store. Bayview Hunters Point is an underserved (by grocery stores) neighborhood in San Francisco which has been actively trying to lure a grocer which sells lots of fresh foods to locate in the neighborhood for over two decades.

Tesco's Fresh & Easy Neighborhood Market venture in California comes at a much needed time for retail commercial real estate in the state. Unemployment is rising rapidly in the Golden State, the state government is facing a multi-billion dollar deficiet, three of the state's counties are numbers one, two and three on the top ten list of U.S. counties with the most foreclosed homes, and California's commercial and residential building industry is at a standstill. Many economists in the state believe California is already in a recession.

In the commercial real estate sector layoffs are growing. Many agents are leaving the field before being layed off. Retail building landlords are seeing numerous tenants go out of business. Empty buildings in the main are staying empty. For many of those in the commercial retail real estate industry Tesco's British invasion of California is welcomed with wide-open arms. Right now, it's the hottest deal working in the industry.

Tesco's Fresh & Easy Neighborhood Market's new store building and opening program is serving as a healthy economic stimulus to the state's depressed commercial retail industry. This should continue for the rest of 2008 and through 2009.

The jury is still out on whether many of these stores have medium to long-term viabiltiy in certain locations. We believe a major evaluation by Tesco of many of these stores will come in about two years, towards the end of 2009. We also believe that when that evaluation comes, many of the locations will be deemed underperforming.

However, Tesco doesn't seem the least bit concerned with that issue at present. And, local governments, retail commercial real estate agents, and retail building and shopping center landlords in California aren't complaining. Right now, many of them are competing for the Fresh & Easy account, trying to be the one who can find the British grocer the best locations and empty retail buildings the fastest, and for the best deal.