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2020 saw continued growth of e-commerce and technology, thanks largely to COVID-19, which continues to change consumers’ day-to-day lives. Here’s an inside peek at the product types and triple-net (NNN) tenants that are recession and pandemic-resilient to guide investors towards their ideal tenant.
Single-Tenant-Net-Lease Finds Stability Through Pandemic
Investors look for investment-grade tenants with a history of longevity and a proven track record of staying profitable in all economic climates. Investment-grade NNN tenants should produce higher returns for investors over the next several years. These properties are finding stability through the pandemic, which in turn makes them stand out in the retail market. As the fastest-growing commercial real estate segment before COVID-19, these assets are now generating more interest. They also remain incredibly popular for 1031 Exchanges and have a lower risk profile post-coronavirus compared to other CRE assets.
CRE professionals predict cap rate compression in the market, although it will depend on the sector, location, and tenant quality.
DOLLAR STORES
Dollar stores not only thrive in a strong economy, but they also realize stable growth in times of recession. The target customer of dollar stores is a low-income shopper located in rural counties with few retail options. In these rural areas, dollar stores see an easier revenue stream because they lack competing grocery stores and are located where no other retailers will venture. They have more locations combined than Walmart, Kroger, Costco, Home Depot, CVS, and Walgreens – the country’s six biggest brick-and-mortar retailers. The unique real estate footprint for dollar stores, combined with their value and convenience, remains a competitive advantage in the current COVID-19 environment. Many customers only have access to dollar stores to gather essentials or are forced to shop at dollar stores due to strained finances. The market for dollar stores is only getting stronger as other retailers struggle to keep up. Dollar stores boast a small-box model, which provides convenience and ease-of-access to customers. Most tenants are accompanied by a strong corporate guaranteed lease with zero management responsibility and have a prominent, branded location. The retail locations are strategically placed in areas with solid demographics and phenomenal visibility. If they aren’t located near banks, pharmacies, and gas stations, they are situated on strong retail corridors. Growth, stability, location, longevity, and strong lease guarantees all add to the ideal NNN investment.
QUICK-SERVICE RESTAURANTS
Efficiency is key to stay relevant in today’s market, something that quick-service restaurants (QSR) are skillfully able to provide to their customers. QSRs prove to be recession and pandemic-resilient because they address their customers’ needs in the most convenient way possible and with minimal contact.This on-the-go concept has altered in the last year to include curbside pick-up and additional drive-thru capabilities to address COVID-19’s impact on consumer behavior. For example, Taco Bell recently introduced a new restaurant design that entails dual drive-thru lanes, pick-up shelves, curbside pick-up, and modern kitchen technology. Many QSRs had evolved critical aspects of the customer experience before the pandemic, including partnering with online platforms for delivery. Many franchisees improved their delivery offering and mobile ordering experience to serve customers where it was safe and convenient for them. If QSR brands can keep up with food trends, such as adding healthy options to the menu, there should be no major reasons why the product type would have problems in the COVID-19 era. QSRs like McDonald’s, KFC, Wendy’s, and Starbucks are stable, long-term net-lease investments with reliable, creditworthy tenants, consistent monthly income, periodic rent increased for 10-15 years, and few or no maintenance responsibilities.
FAST CASUAL
Fast casual concepts offer higher-quality food, with a focus on healthy ingredients and convenience. The pandemic has had myriad impacts on how consumers eat. While the challenges facing the fast casual sector will have long-lasting ramifications, the restaurant industry will survive, just as it has survived every previous crisis, economic or otherwise. Several vital tailwinds provide a bullish outlook on the fast casual segment in years to come, including rationalized competitive dynamics for better concepts. Over the last two decades, the proliferation of restaurant concepts has created an intensely competitive environment that caused returns on invested capital within the industry to narrow for all but the top brands. While the pandemic will lead to the unfortunate demise of many restaurant units and concepts, the silver lining is that brands with name-recognition will likely have improved competitive dynamics. As a result of industry-wide consolidation, there will also be more favorable real estate opportunities. In a recent update provided by Shake Shack, the brand stated, “The company has an identified pipeline of leases in negotiation for continued growth in 2021 and beyond and believes additional and improved development opportunities may be available over time due to the impact of COVID-19 on the overall retail and real estate environment.” It is expected that fast casual brands will take market share from other restaurant segments, including casual dining.
HEALTHCARE
With an aging population, a pandemic, and demand for safe and prudent healthcare services, healthcare real estate demand is at an all-time high. The sector’s performance is incredibly strong, despite the pause in activity during the peak of the pandemic. Elective surgeries are still on hold for some patients, but accelerating trends such as telehealth, drive-thru testing, and teleworking administrative staff, serve as great supplements and demonstrate patient’s growing acceptance in new operations. As traditional retail tenants are losing ground, medical tenants are gaining. A growing trend is physicians expanding their reach into retail, where healthcare tenants are securing their space in shopping centers. Aging demographics and changing consumer preferences take credit for shifting healthcare to retail settings and into more investment portfolios. In recent years, out-patient healthcare facilities have met the needs of an increasing patient base. More patients have access to care due to expanded healthcare coverage, and as of recent, patients will be more attentive to their health due to habits created from the COVID-19 pandemic. Further, having a qualified physician in shopping centers provides patients with accessibility and convenience. For these reasons alone, medical can be considered one of the most recession and pandemic-resilient tenants.
AUTO SERVICE
Despite a decrease in wear and tear on vehicles, due to a large portion of the nation teleworking, car owners have dedicated their new found free time to improve their vehicle’s performance or look. It is also fair to assume more people will prefer to use a car instead of public transportation for fear of being in close proximity to others during a pandemic. Secondly, and paradoxically, fewer people will want to purchase a new car, given the uncertain environment. They will either pay for services and repairs on existing older cars or continue to use rideshare. While auto parts can be purchased online at a discounted rate, auto repair and service is resilient and should continue to prevail through this siege on retailers. The main reason for this is that even if Amazon or other companies can ship parts, people will have a tough time replicating the expertise required to perform these services. Auto service retailers are located in out-parceled malls or dense retail corridors, which provide convenience for customers. They also capitalize on fleet services, an organization that needs commercial vehicles to function, which generates a higher volume of business to business sales. While customer preferences may be changing rapidly within retail, wholesale, fleet service customers are less likely to be affected by these trends, and convenience will always prevail.
CONVENIENCE STORES
Convenience stores (c-stores) play an essential role in communities, especially those located in rural areas. Fortunately, they remained active and open throughout the pandemic, providing a lifeline for many of these communities. C-stores tend to be less crowded than a grocery store and offer grab-and-go products. During recessionary times, people have limited disposable income and only spend on essential goods which make c-stores a prime option for many. Given the small square footage of many c-stores, they only offer limited products, further providing convenience to consumers. Many were also quick to pivot to COVID-19 safety measures and consumer demands. Whether it was enhanced cleaning protocols or removing self-service stations, c-store operators were quick to address COVID-19. In effect, this has expanded their loyal customer base, with many operators seeing new customers rediscovering their local c-store. In fact, large c-store chains saw more revenue generated during the pandemic than the year prior. The key strategies that will help c-stores remain relevant during changing economic times are increasing the speed of service, improving consumer experience, and implementing personalization of product offerings. C-store chains, such as 7-Eleven, are adding fresh food to their product offerings specifically to cater to millennials. It is unlikely that c-stores will become obsolete in the near future if they continue to adapt to modern consumer preferences.
DRUGSTORES/PHARMACY
Drugstores have very little competition amongst established players in the market as two companies dominate the drugstore sector – CVS Health and Walgreens, which recently acquired Rite Aid. This makes the threat of a new competitor or concept slim; Pair this with health being at the forefront of consumer minds, drugstores will continue to fare well. Recently, Amazon announced its online pharmacy, where customers can place online orders for medication and prescription refills to be delivered to their homes. However, CVS Pharmacy and Walgreens both have a loyal customer base and already have delivery services in place. CVS Pharmacy and Walgreens also utilize local pharmacists which provide on-the-spot medical information, as well as COVID-19 drive-thru testing. Before the pandemic, drugstores were already making strides to improve customer experience through partnerships and technology investments. CVS has remodeled locations to focus on health services through HealthHUBs and have expanded and stepped up protocols through MinuteClinic. Walgreens recently partnered with VillageMD, a national provider of primary care, and PWNHealth, a national clinician network that provides safe and easy access to diagnostic testing. Further, both brands have incorporated free prescription delivery as part of their services. Recently, federal health officials have reached an agreement with pharmacies across the U.S. to distribute free coronavirus vaccines after they are approved and become available to the public. With these continued improvements, it is evident that drugstores will remain recession and pandemic-resilient.
GROCERY STORES
With the retail landscape being at its most pivotal point, service-based retailers are at the forefront of sustainability, including grocery stores. Although e-commerce poses a threat to traditional grocery stores, the threat is minimal, and the industry is still resilient for various reasons. As seen at the beginning of the pandemic, grocery stores vastly benefited from being among the few tenants to remain open. For shopping centers with a grocery store as its anchor tenant, it served as a lifeline as surrounding retailers shuttered. For example, Sprouts Farmers Market paid their rent on time during the height of the pandemic, 100 percent in June, and 99.7 percent in July. The grocer also recently announced 20 new locations by the end of 2020. Discount grocers, such as Aldi and Walmart Neighborhood Market, will also stand to thrive. These budget retailers benefit as consumers cut back on discretionary spending but continue to buy food and household essentials. Aldi has also increased the number of stores they have in the U.S. in recent years, as consumers prefer the proximity and small-size stores make them desirable to shoppers seeking convenient options. With stay-at-home orders directing consumers to cook at home, more groceries were purchased as dining rooms continue to see the effects of COVID-19. This has forced consumers who wouldn’t otherwise cook at home, pick up a new habit of preparing home-cooked meals. It is expected that grocery stores will remain resilient for years to come, even with e-commerce delivery lurking.
SUPERSTORES
Target, Walmart, and Costco have all seen sales jump in-store and online amid the COVID-19 outbreak. Along with the effects of the pandemic, these superstores are changing the retail landscape. With many consumers skipping mall shopping trips, many have found their nearest superstore instead. Leaders of Walmart, Target, and Costco attribute their success to a diverse mix of merchandise. Target CEO Brian Cornell has touted the retailer’s role as a one-stop-shop. In the early weeks of the pandemic, consumers flocked to stores to stock up on pantry staples, toilet paper, and hand sanitizer. But as the pandemic has stretched on, they shopped for bikes, puzzles, hair dye, home décor, and other items to help entertain themselves or adjust to more time at home. While other retailers see apparel revenue drop industry-wide, mass retailers such as Target and Walmart, on the other hand, are expected to see apparel revenue grow by 10 to 20 percent in 2020 compared with last year. In Q3 2020, the COVID-19 pandemic fueled a surge in Costco shopping, lifting its annual profit to about $4 billion for the first time. Even as consumer tastes change, these stores are prepared to address the demands of the extensive product mix.
HOME IMPROVEMENT
At the beginning of the pandemic, when stores across the nation followed state mandates to close, home improvement stores saw the initial increase in foot traffic. Houzz, a home renovation website, reported that requests from homeowners increased by 58 percent in June compared to last year. Lowe’s online sales reported a 135 percent surge from the coronavirus do-it-yourself boom. Named one of the digital transformation winners during the pandemic, Home Depot also saw incredible traffic and sales spikes. Home Depot has been on a journey in recent years to move to a One Home Depot architecture that connects logistics, delivery, supply chain, customers, digital channels, and associates. One key effort revolved around curbside pick-up, which the company was able to move in a very agile manner and build a solution. For Home Depot, cloud architecture was critical to managing a 300 percent spike in traffic and an 80 percent order volume increase. The company has now become one of the top five e-commerce platforms in North America. Home Depot is a prime example of a company that could pivot to consumer changing demands, and not only prove to be e-commerce resilient but also recession and pandemic-resilient.
For more information, please contact a Matthews™ specialist.
