Retail Midwest

Grocery-anchored investment options: hard to swallow?

Investment options anchored by grocery may be hard to swallow,ph01
Photo by Clark Young

Due to a number of factors, traditional grocers’ markets are losing market share, leading investors away from grocery-anchored shopping centers. But according to new research from Morningstar Credit Ratings, a changing grocery marketplace and growth of food delivery will increasingly depend on brick-and-mortar locations.

The general consensus for many years has been that traditional grocery stores—those that offer a full line of groceries, meat and produce and have at least $2 million in annual sales—were resistant to the effects that e-commerce and economic downturn have had on other retail sectors. But the food buying landscape is changing, and traditional outlets are in danger of getting left behind.

The online grocery sector grew by 24.4 percent in 2016, the largest jump of all grocery formats. But even in physical locations, traditional grocers are losing out. The share of sales in nontraditional grocery outlets was 40 percent in 2016 (from a mere 2 percent in 1988), led by wholesale clubs like Walmart and Costco, limited-assortment vendors such as Aldi and Save-A-Lot and niche grocers like Sprouts Farmers Market, a fresh format chain.

This market turmoil has implications for commercial mortgage-backed securities as the number of traditional stores is forecast to decline by 24.6 percent by 2021. “However, we are not overly concerned, because projected growth in nontraditional formats will buoy demand for existing grocery space,” the report’s authors wrote, noting that fresh format, super warehouse, and dollar formats are projected to grow store counts 48.0, 29.7 and 24.5 percent, respectively, in that same time frame while e-commerce sales should grow by 25.0 percent.

As the landscape shifts, Morningstar expects more industry consolidation, with large format stores getting bigger and small-format stores becoming more specialized. And this market evolution means that commercial real estate needs will change. New delivery and pickup models may lead to smaller footprints for in-person shopping, but this will be offset by more warehouse space for pick-up and delivery of commodity and more shelf-stable items.

On the lending side, the situation is more risk-averse as banks are opting for lower-leverage, lower-balance loans. The percentage of grocery-anchored loans with balances below $20 million grew by 16 percent over 2015 levels; loans above $50 million shrunk by 34.8 percent.

The recent acquisition of Whole Foods by Amazon shook the industry up, but some may be misreading what the transaction signifies. The arrival of e-commerce to the grocery sector is actually welcome news for commercial real estate, as customer proximity is fundamental to keeping costs down.

“As some grocery stores pull back, fears of death by Amazon’s purchase of Whole Foods may be overblown,” the authors wrote, “because we believe that growth in grocery-delivery platforms will rely on existing brick-and-mortar locations.” For an online behemoth to dominate the grocery sector via delivery, operations must be close to consumers to keep costs low and to avoid losses associated with perishable items. “With few options existing among urban distribution facilities, Amazon purchased the roughly 460 Whole Foods scattered across the country to serve as distribution centers.”

Despite the rise of nontraditional food outlets, market oversaturation and the looming e-commerce menace, traditional grocers aren’t necessarily moribund. Traditional and niche or specialty grocers are responding to consumer demand for ordering groceries online. Given their existing locations in dense areas with strong demographics, traditional grocers may prove resilient as desirable distribution centers.