Fresh & Easy Neighborhood Market (Selectively) Bullish on Commercial Real Estate In California

News/Analysis

Tesco's El Segundo, California-based Fresh & Easy Neighborhood Market may be struggling to stem what appear to be its no-end-in-site losses - around $900 million so far since November 2007 and about $300 million in Tesco's latest fiscal year ended February 26, 2011. But that's not stopping it - instead perhaps it's encouraging  it - from being bullish on commercial real estate in selected parts of California.

Fresh & Easy Neighborhood Market, which Tesco set up as an independent U.S.-based corporation when it launched the food and grocery retailing venture in Southern California in 2006, has closed on two major commercial real estate purchases in Southern California over the last four-to-five weeks, including its biggest deal we're aware of to date.

That deal: This week Tesco's Fresh & Easy Neighborhood Market closed on a $7-million purchase of 21815 Hawthorne Boulevard in Torrance, California, where the grocery chain plans to turn a 10,720-square-foot vacant building on what is a 1.69 acre parcel into one of it small-format fresh food and grocery stores. The now vacant building previously housed a CoCo's family-style restaurant.

Fresh & Easy Neighborhood Market bought 21815 Hawthorne Boulevard from the Kinoshita Family Trust, according to Woodspear Properties, the commercial real estate firm that represented the seller, and Highland Partners, which represented Tesco's Fresh & Easy in the deal.

The $7 million purchase comes on the heels of another multi-million dollar commercial real estate deal Tesco's Fresh & Easy closed on the second week of June, which is the $2.1-million purchase of a 1.12 acre parcel in the Central Coast California city of San Luis Obispo, where the grocery chain plans to build and open its first Fresh & Easy food and grocery market in the city.

According to our sources, Fresh & Easy Neighborhood Market is currently planning an early 2012 opening for its first store in the coastal city, which is home to one of the largest, most popular and top-ranked California State University campuses, Cal Poly San Luis Obispo.

Fresh & Easy Neighborhood Market bought the parcel in San Luis Obispo from Halfterty Development Company.

According to Stephen Leider and Clarice Clarke, who head up Lee & Associates' Central Coast offices in California, the parcel Fresh & Easy bought is one of three the real estate firm is marketing at the Village at Broad Street development in the city's popular downtown area . The three-parcel development is set to include a mix of residential housing and retail, they said.

The San Luis Obispo store will mark an important geographical milestone for Tesco's Fresh & Easy in its coastal route march from Southern California to Northern California, which is one of the two south-to-north paths it's taking as part of its strategy to have stores throughout the Golden State.

The other is the inland or valley route, which goes from Southern California, over the Grapevine and into the Central Valley - where there are 14 Fresh & Easy stores in the Bakersfield and Fresno regions and one unit about 100 miles north (of Fresno) in Modesto so far - and on into Northern California's Bay Area - where there are currently 12 Fresh & Easy stores - and eventually into the Sacramento region and other parts of the northern portion of the Golden State

The San Luis Obispo store will mark the nearly midway point in the coastal route between Southern California and coastal Northern California. The closest store in that south-to-north coastal route march so far is a recently opened Fresh & Easy market in Santa Maria, which is about 50 miles from San Luis Obispo on the south Central Coast.

Fresh & Easy has a future store location in Seaside on the Northern California coast and is currently negotiating with the landlord of a vacant roller rink in next door Monterey for another location in the region.

Seaside and Monterey are at the northern end of that south-to-north coastal route march, which follows the Pacific Ocean and offers some of the most scenic views in the U.S.

Fresh & Easy Neighborhood Market owns a few of its 176 stores, although the majority of the units are leased.

For example, it owns its store in Pacifica, California, which opened on March 9 of this year.

Fresh & Easy also owns the store in the 5800 Third Street development in San Francisco's Bayview district, which is set to open August 24, along with not-yet-opened Northern California store locations in the East Bay Area cities of Antioch (at Lone Tree & Golf Course) and Vallejo (two units), as well as a few other future store sites in the Golden State.

Fresh & Easy bought both future store locations in Vallejo, at Oakwood Avenue & Springs Road and Tennessee and Tuolumne, about a year ago after getting what its real estate chief thought was a good price due to commercial real estate values having dropped significantly in the city as a result of the recession and housing crisis. Vallejo has been one of the Northern California cities hardest hit by the recession. In fact, a couple years ago the City of Vallejo filed for bankruptcy, making it one of the first municipalities in the U.S. to do so.

The grocery chain paid about $1.5 million for the about 1.2-acre Oakwood Avenue location and a little over $1 million for the Tennessee and Tuolumne site, which is a vacant about 14,000 square-foot building that once housed a Grocery Outlet store.

Fresh & Easy's strategy is to purchase rather than lease selected parcels in places with historically solid commercial real estate appreciation, such as the San Francisco Bay Area, coastal California (north, south and central) and certain other regions in the state.

The strategy is a continuation of what Tesco has been doing for many years at home in the United Kingdom, which is to purchase selected properties its stores sit on, hold the properties for a given period of time and after they've reached a certain level of appreciation, bundle a set number of the properties into a portfolio and sell them, taking multi-year lease backs on the stores. Tesco then uses the proceeds from these sales to finance existing store remodels and new store construction. It's worked well for the retailer in the UK over the years.

The global retailer plans to do the same thing with the properties it's been selectively acquiring in the U.S. since about 2008 through its Fresh & Easy Neighborhood Market. Most if not all of the properties it's bought are either stores in California or parcels for future store development, like Torrance and San Luis Obispo in the Golden State.

Fresh & Easy Neighborhood Market operates a fairly large real estate department out of its El Segundo, California headquarters, particularly for a chain of 176 stores located in just three states with annual sales of about $800 million, which is currently the case for the Tesco-owned grocer.

Tesco's Fresh & Easy operates over a dozen real estate regions in California, Nevada and Arizona. Each region has a real estate director who is employed by the grocery chain. The real estate directors each work with a commercial real estate brokerage firm in each region, which it has named as its broker of record. For example, Pacific Retail Partners is Fresh & Easy's broker in the two real estate regions it has in Los Angeles.

Although the commercial real estate slump that hit the U.S. - and California, Nevada and Arizona, the three states Fresh & Easy operates in, particularly hard - most of the regions in California where it has bought properties have historically strong long-term appreciation levels, although the slump that still continues will result in Fresh & Easy Neighborhood Market getting far less of a return over a ten year period than it would have had it bought and sold the properties in the 1990's, for example.

However, the Bay Area and coastal locations remain excellent long-term commercial real estate investments, unless the last century of commercial real estate history in the state is proven wrong.

Meanwhile, Tesco's Fresh & Easy Neighborhood Market has a commercial real estate problem of its own, in our analysis. That problem is the grocery chain is sitting on, based on our research and calculations, about 60 sites it either owns or holds leases on (the vast majority being leased) that it hasn't yet opened and 13 locations - six each in metro Las Vegas, Nevada and metro Phoenix, Arizona and one in Southern California that it closed in November 2010 - it's paying monthly rent on (in most cases) but generating zero sales from.

Many of these locations, including about 30 (a few have been opened this year) in Northern California, were acquired by Fresh & Easy in late 2007-early-2008, which means in most of these cases it's been paying monthly rent on what are mostly vacant buildings it plans to turn into stores for going on four years. Many of the other units are early-to-mid-2009 acquisitions as well.

Having so many future locations it's making lease payments on is a major financial drag on Tesco's Fresh & Easy Neighborhood Market.

Tesco plans to open many of these Fresh & Easy stores between now and the end of 2012. Tesco says it will have 300 Fresh & Easy stores open by February 2013. There are currently 176 units, which means opening 124 new stores between now and then.

But there are also a number of Fresh & Easy units - particularly in metro Las Vegas and Phoenix but also in Southern California's Inland Empire region and the Central Valley - Tesco hasn't decided if it will open or not. Because Fresh & Easy has long term leases on these sites, coupled with the continued commercial real estate slump in California, Nevada and Arizona, it's basically stuck with the locations regardless if it opens those stores or not.

As a result, until it opens or disposes of these numerous non-producing store sites, their existence will continue to be a financial drag on Fresh & Easy Neighborhood Market and Tesco, in our analysis.

Related Stories

July 5, 2011: Fresh & Easy Neighborhood Market Preparing For A Spate of New Store Openings Beginning in August

May 18, 2011: Major Changes Coming to Tesco's Fresh & Easy Neighborhood Market Stores

January 14, 2011: Tesco 'Banking' on California in 2011 For Fresh & Easy Neighborhood Market USA

November 4, 2010: Fresh & Easy Neighborhood Market Confirms Our October Reports On 10 New Stores Opening in Early 2011

May 15, 2008: Fresh But Never Easy: Tesco's Long But Rapid South-North March in the Nation-State of California

April 19, 2011: Tesco's Fresh & Easy Neighborhood Market Posts Biggest One-Year Loss Yet - $307 Million Loss on Sales of $818 Million

February 19, 2008: Tesco's Fresh & Easy Serving as an Economic Stimulus Package of Sorts for California's Troubled Commercial Retail Real Estate Industry

[Also: Click on the following links - new store development, California, Fresh and Easy and commercial real estate, Fresh and Easy Northern California, Fresh and Easy Southern California, new store development, Tesco Fresh and Easy California March - for more related stories.]