Supermarket operators rethinking their property portfolios

When Loblaw, the Canadian supermarket chain, spun off its property assets into a separate company last July, it underlined the potential of supermarket assets to property investors. The sector has undergone fundamental changes in developed markets, with Walmart in the US, Tesco in the UK and Carrefour and Metro in continental Europe among operators under pressure from a combination of factors.

“There are a lot of changes in the supermarket sector generally. But the constant is the investor appetite,” says Michael Rodda, head of European retail investment at property consultancy Cushman & Wakefield.

Across developed markets, cash-strapped shoppers have been moving away from the traditional big weekly shop. According to J Sainsbury, the UK supermarket chain, consumers for the past couple of years have been buying one less thing in their weekly shop, then picking it up on a top-up shop during the week. This is prompting supermarket chains that traditionally have been associated with large superstores to open smaller outlets.

Meanwhile, other alternatives to big stores are springing up in developed markets. Aldi and Lidl, the German so-called “hard discounters”, are expanding around the world, as their no-frills offerings gain favour among more affluent consumers.

At the same time, online grocery shopping is gathering pace across the developed world. The UK has the most advanced online grocery market in the world, accounting for about 5 per cent of total grocery sales, according to OC&C, the consultancy. In the US, the figure is about 1 per cent, but retailers there are doing their best to catch up, with online giant Amazon expanding its AmazonFresh grocery business. At the other end of the spectrum a plethora of speciality food sites are springing up in the US, such as Goldbely and Mouth.com.

Against this backdrop, supermarket assets remain attractive to investors on both sides of the Atlantic. The main reason is that despite the turbulence since the economic crisis, people still need to buy food.

“It is not a controversial sector to be investing in,” says John White, a director of Osprey Equity Partners, the investment company.

“Whatever else happens, people have to eat. More importantly, food retailers have been very adept at adapting to changing customer habits and have been quick to roll out multichannel formats.”

Osprey, which invests in supermarket assets on behalf of private investors, also notes that in the UK, supermarkets are typically let on 25-year leases, commonly linked to the retail price index. In continental Europe, leases tend to be much shorter, often as a result of less restrictive planning regimes. And despite the challenges in the global grocery market, supermarket operators still have very strong balance sheets and profitability. The stable cash flows generated by supermarket leases are well suited to institutional investors seeking income to meet pension liabilities, property experts say.

The size of new supermarkets being built is shrinking, reflecting the changing dynamics of the market. But Simon Lee, a director at Osprey, notes that even for bigger stores, for the right location, the big supermarket chains are still prepared to take space.

“Although there has been a lot of press about big food stores being out of favour, we still see – for the right locations – supermarket operators taking good-sized stores,” he says.

“Partly this is because operator profit margins are often higher at traditional-format stores than from convenience stores and online home deliveries. But it is also due to the fact that the physical stores form a large part of the online platform – both as a point from which goods are delivered to the home and also as ‘click-and-collect’ sites from which online orders are collected by customers.

“Large car parks and prominent locations make food stores natural click-and-collect destinations. In addition, where retailers do not have representation in existing stores, special click-and-collect points are emerging.”

Rodda says appetite among investors for supermarket assets across continental Europe remains strong, as long as leases are reasonably long and the supermarkets taking the leases have solid balance sheets.

“There is appetite across the board, from central Europe to Iberia,” he says. “There is appetite for both single-let supermarkets, which will be sold to a single high-net-worth individual, and large portfolios being sold to big insurance companies and specialist sale-and-leaseback investors.”

The one area of concern, Rodda says, is in big hypermarkets in continental Europe where up to one-third of the store is devoted to non-food items, such as clothing and hardware. These have been hit hard by the economic downturn and by the rise of online retailers.

But Lee says the changing shape of the supermarket sector may create further opportunities for investors. So-called “dark stores”, in effect stores without customers from which online grocery orders are fulfilled, could make attractive investments, as could convenience shops, if they were parcelled up into portfolios of stores.

“Dark stores should have many of the same characteristics as traditional food stores: long leases, let to companies with strong balance sheets and a high land value at the end of their life,” he says. “The small individual lot sizes of convenience stores provide additional granularity and liquidity to a wider portfolio. We are certainly exploring these assets at the moment.”

As the market develops, one of the attractions of Loblaw’s property assets is that the group operates across a range of store formats. In December 2012, the grocer, which is controlled by the Weston family, announced plans to hive off the majority of its property assets into a real estate investment trust. Loblaw then floated a 20 per cent stake last July, retaining the controlling 80 per cent. Such Reits are popular in the US, providing private investors with a tax-efficient way to buy and sell properties.

Supermarkets typically make money through their property assets through sale-and-leaseback deals, whereby they sell off property to an investor, usually an institution, and then rent it back.

But Loblaw’s approach offers an alternative to the traditional sale-and-leaseback route, which some investors believe delivers insufficient value to shareholders. They suggest the company’s model offers interesting lessons for grocers around the world.

Loblaw’s strategy is prompting some activist investors to question whether the model could be applied elsewhere, particularly in the UK, where Tesco, Sainsbury and Wm Morrison have large property portfolios.

But not everyone is in favour of such an approach. Jaime Vazquez, an analyst at JPMorgan Cazenove, notes that Carrefour, the French supermarket group, abandoned plans to spin off part of its property division three years ago.

As the debate continues about how the world’s leading grocers divide their property assets and operating companies, the next test of investor appetite for supermarket assets will come when Morrison announces a review of its property portfolio in March. Institutional investors are expected to show keen interest in any stores that are sold off as part of a sale-and-leaseback deal, although Morrison is expected to remain overwhelmingly freehold.

Chris Keen, a director in the retail team at property consultancy CBRE, says Tesco and Sainsbury have been selling and then leasing back properties, which means institutional investors already have plenty of these in their portfolios. “There is a bit of scarcity value [to Morrison]. If Morrison does a sale-and-leaseback there will be huge demand,” he says.