A Look at the Grocery-Anchored Retail Sector
Since the pandemic was introduced, grocery stores have gained popularity with people looking for cheaper alternatives to restaurants and overall healthier lifestyles. It was initially anticipated grocery store sales would fall off during the pandemic, and the sector would see an online shift to the grocery delivery model. However, that is not what played out to everyone’s surprise, as many still prefer to visit their neighborhood centers in person. In this article, we explore the bright future ahead for grocery-anchored retail.
Restaurant vs. Grocery: The Battle for Your Food Dollars
2019 marked the first time in history that restaurant sales exceeded grocery sales. In April of that year, restaurant sales recorded $63.2 billion compared to $57.25 billion for groceries. Though this was only a small snapshot, many predicted this was part of a larger trend that indicated consumers would start dedicating more of their budget to dining out. It was expected that 2020 would follow this same trajectory until the pandemic. The COVID-19 pandemic flipped the scale, re-introducing food consumption trends to favor grocery stores. Many preferred to eat at home instead of going to a restaurant, due to rising COVID-19 cases, inflationary pricing, and easier access to healthier options. Higher food and restaurant prices will keep people eating at home.
Weekly grocery spend per person is up 17% from $163 to $190, and consumers are going into grocery stores less often but spending more per visit. (Source: Lending Tree Survey of 1,052 customers)
There was also a shift from shopping exclusively at health-food stores like Whole Foods and Sprouts to more traditional grocery stores, where people could shop their full grocery basket instead of making two to four trips to different stores. For example, Publix and Kroger saw same-store sales growth of 16 and 14 percent last year, respectively. After the pandemic, it was expected same-store sales would drop as people started to venture out, but that hasn’t been the case, and in some cases, sales have even comped up, on top of the already dramatic double-digit lift.
A Pandemic-Led Boom: Investors Eye the Grocery-Anchored Sector
Grocery-anchored retail is a breakout segment for investors due to its resiliency during market distress and long-term lease structure (ten years or more). As a necessity-based retailer, rents, sales, and occupancy are generally stable compared to other property types. Alongside this, grocers have pushed the rising cost of inflation on consumers and are doubling down by investing in their loyalty programs. Grocers or grocery-anchored shopping centers are also e-commerce resilient. While e-commerce has witnessed upward of 15 percent in growth, the U.S. Census Bureau data shows that 91 percent of retail sales still occur in physical stores. This data shows that 97 percent of grocery sales are still in physical stores, and e-commerce impact is limited to urban locations.
Grocery-anchored retail centers should continue to be defensive and deliver stable returns through adverse economic environments and the impact of e-commerce. This is good news for investors as grocery-anchored retail is well-positioned to provide high and stable income returns.
Performance of In-Line Tenants
In-line shop tenant performance during the pandemic depended on whether they were considered necessity-based or service-based. Grocers generate significant traffic and serve as a lifeline for coffee/donut restaurants, fitness tenants, retailers like dry cleaners, etc.
New Leases & Co-Tenancy Clauses
The in-line tenants outperforming include medical tenants considered boutique or offer premium medical care. For example, many medical practices are enacting annual fees to reduce the number of patients and provide high-touch, luxury services. QSR and fast casual restaurants are also performing relatively well, especially ones that offer drive-thrus. Many of these tenants rely on the take-out model, and shopping center operators see an increase in demand for drive-thru or restaurant space with limited dine-in square footage.
In-line shop tenants located in an open-air grocery-anchored center witness strong sales. However, smaller shop tenants may tie their occupancy in the center to the grocer’s performance. This means that in-line shop tenants have the right to cancel a lease should the anchor go dark. Larger soft good, junior-anchor tenants most often require these co-tenancy clauses. In these instances, there are risks associated because if the major tenant goes dark, the center falls like a house of cards. As such, many investors are wary of co-tenancy clauses, and a power center can see a 150 to 250 basis point difference in cap rates due to the risk.
The Million Dollar Question: Cap Rate Trends & Rising Interest Rates For Grocery-Anchored Retail
Cap rates can vary widely and are dependent upon the market in which the property is located and the specific grocery tenant that anchors the center. That said, grocery stores served as a haven from the chaos that engulfed other retail assets during the pandemic. Cap rates for grocery-anchored centers have remained relatively steady throughout the pandemic due to the enduring necessity of the items they sell, their ability to adapt to pandemic shopping trends, and their increased profitability.
Over the last 12 months, the sector has witnessed a cap rate compression of about 100 basis points in addition to record pricing. Markets like Baltimore, Charlotte, Dallas, and Houston have seen cap rates fall for retail sector properties with a grocery anchor – a sign of their enduring strength. In the next 12 to 14 months, expectations will be reset on what an acceptable yield is in the market as interest rates rise. However, cap rates for grocery-anchored properties in the most desirable locations with strong-performing tenants are expected to remain steady or compress.
Grocery-Anchored Development Trends & Future Outlook
Due to the scarcity of available redevelopment opportunities, many grocery-anchored centers are true ground-up developments. Developers and owners will find the most promising retail construction opportunities in 2022 in neighborhood and community shopping centers. These developments will primarily be in suburban or in-fill locations. There is momentum in grocery discounters’ real estate expansion as they witnessed substantial growth over the last few years and are competing for space with traditional grocers.
Several retailers, including Giant Eagle, Kroger, Stop and Shop, and Whole Foods Market, are repurposing brick-and-mortar locations as dark stores (space only dedicated to fulfilling online orders and does not serve walk-in customers), driven by the lack of available pick-up slots for online orders.
Design & Build Trends
- Artificial Intelligence
- Contactless Payments
- Distancing Customers
- Experiential Shopping
- Homelike Environment
- Integrated Online-Offline Shopping
- Sale and Resale
- Social Media Focal Points
- Specialist Stores Within Big Stores
From the dramatic rise in construction costs to limited available labor to difficulties in permitting, financing, and securing capital, the current environment is challenging, and many timeframes have been pushed. With the cost of ground-up development increasing, shop rents have been moving in concert with these prices. In the near term, shop rents will continue to increase, and grocery stores will continue to expand and benefit from inflation.