What's in store?

Over the past few years, retail has become a popular target for private equity and property investors alike, providing all manner of opportunity—and risk—for shop-savvy investors. By Aaron Lovell

In America, the day after Thanksgiving is known as “Black Friday.” It's widely considered to be the busiest shopping day of the year and is oftentimes the first day retailers find their annual balance sheets “in the black.” It also kicks off the lucrative holiday shopping season.

Most years the American tradition of over-thetop holiday consumerism boils over into another American tradition, that of wanton violence. As the country's largest chains open their doors at ungodly hours with once-a-year sales, the race to save can get ugly.

In 2005, shoppers at a Wal-Mart in Michigan, eager to get first pick at the low-priced goods inside, sparked off a melee that saw some early-risers get trampled. In California, shoppers were so enthralled with the idea of discountpriced laptops at a Best Buy that fisticuffs ensued.

In the private equity world, the rush to retail hasn't been nearly as violent, but it has been competitive. Over the past few years, newspaper headlines have been awash with retailers acquired by consortiums of LBO firms, property funds and/or real estate investment trusts. The targets have included national retailers like grocery store chain Albertson's, retailer Toys ‘R’ Us, Target cast-off Mervyn's, luxury department store Neiman-Marcus, airport mainstay Brookstone and discounter ShopKo. In many of the cases, the winning bidders faced fearsome competition.

While the retail sector may not be as competitive as a holiday run on the toy department of a New Jersey big box retailer, the industry is increasingly becoming a place of fierce, shirt-tearing competition.

As an operating business with a large real estate component—or, in some cases, as real estate with an operating business component—retail deals require a number of skill sets, which is why many traditional LBO shops will team up with a real estate specialist on the transaction. As the variety of retail deals increases, there are more and more roles for property firms looking to get in on the action.

Many of the transactions have been accompanied by corresponding sale and leaseback deals, as firms seek to harvest value from the stores' underlying properties. There has also been much talk of companies selling off real estate that is, to paraphrase Jimmy Stewart in It's a Wonderful Life, more valuable dead than alive. Or more valuable as a bath goods store than a toy store, in any case.

With a healthy retail chain, the real estate may simply be a part of the overall financing arrangement— the property can be leased back, turned into equity and taken off the balance sheet. In more complicated deals where some of the outlets are going to be sold off, a real estate partner may come in and reposition and redevelop the assets.

But for all the transactions being completed, retailing is a business fraught with peril. Market fundamentals, the ever-changing tastes of fickle teenagers and new Wal-Marts are all potential threats, along with more property-minded concerns like location and changing traffic patterns.

In the pages that follow, we sit down with three retail investors who approach the sector from three distinct vantage points, each providing a different insight into the world of retail investing. Christopher Volk, the chief executive officer of Spirit Finance Corporation, looks at the underlying profitability of individual retail outlets and how private equity investors can monetize the underlying real estate. Joseph Sitt founded Thor Equities to capitalize on the dearth of quality retail in American cities and has since developed urban malls and even launched his own retail chain along the way. And Sun Capital Partners' Gary Talarico has been busy applying his firm's turnaround buyout strategy to the retail sector in recent years with high-profile deals like ShopKo and Mervyn's.

While the retail sector may not be as competitive as a holiday run on the toy department of a New Jersey big box retailer, the industry is increasingly becoming a place of fierce, shirt-tearing competition. In such a cutthroat environment, it makes sense to listen to the experts.