A Changed Retail Environment Yields New Investor Opportunities

There are still many avenues available for investors in retail properties looking for returns, safety, management ease or a combination of all of the above.

Tom Hershey

The pandemic has hastened the demise of many retailers but has been far from the sole ailment. Retailers have been struggling to contend with e-commerce for years, and for many, the pandemic was simply the final knell. Men’s Warehouse, Neiman Marcus, JC Penny, Lord & Taylor, and Ann Taylor have all entered bankruptcy, hammered by more than a 20 percent decline in clothing sales year over year. There are, however, retailers that have survived and even prospered, and keen-eyed investors are taking note.

Anchor grocery stores drive property values

Grocery-anchored centers may be of particular interest to investors, in part for their resilience with e-commerce as the consumer. Throughout the recent public health closures, grocers have remained open as essential businesses and in high demand from the shopper, instilling even more confidence in this property type. Grocery store-generated foot traffic results in increased foot traffic for neighboring retailers, as a consumer seeks to accomplish more with each trip. According to Placer.ai, leading chains such as Albertsons and Win-Dixie recorded up-ticks over 2019 of 6 percent and 7 percent respectively March-October.

Investors are following the consumer, looking to grocery-anchored centers as a safe-haven of increased shopping activity. Per Daniel Galvan of Coldwell Banker Commercial in McAllen, Texas, “grocery-anchored shopping centers continue to be popular to the consumer because despite everything going on in the world, grocery stores are doing a tremendous job promoting safety measures, while continuing to provide a safer opportunity for people to get out of their homes. Our retail clients love the synergy they provide with neighboring retailers.” According to CoStar, despite a challenging second quarter, transactions for grocery-anchored retail picked up in the third quarter, with positive investor sentiment driving increased sales volume. Cap rate compression has ensued, with yields down nationally 20 to 50 basis points from the same period last year.

To-go, to-Go, to-Go

While the real estate investors typically focus on “location, location, location”, today’s investors have also found another bright spot in free-stranding properties leased to quick-serve restaurants with drive-through access. If any segment was created for socially-distancing, the restaurant drive-thru is it. Market research firm NPD Group estimates that drive-thru visits jumped 26 percent in the second quarter. Despite initial sales declines, fast food restaurants are better positioned to succeed in a pandemic environment.

It is not a secret that quick-serve restaurants are attractive to many investors but finding the right tenant and lease terms are key. According to Dan McGue with Coldwell Banker Commercial NRT in San Francisco, investors have been especially interested in credit tenants with lease terms more than 15 years. “National chains with corporate guarantees or guarantees from very large operators are prime, Of course, they (must) have drive-thru operations,” says McGue. Going forward, McGue expects many quick-serve brands to seek out sites that enable more drive-thru lanes, contactless pick-up spaces, and overall smaller building footprints.

McDonands and Starbucks are examples of how the pandemic-driven shift to on-the-go food service even encourages take-out friendly businesses to adapt for growth. Although hit hard early in the second quarter, McDonald’s is optimistic about the future. Much of their strategy with existing stores has been focused the drive-thru and modifying in-restaurant ordering. Moreover, the chain is expanded delivery coverage with its McDelivery service and remains focused on digital ordering trends.

Starbucks has long been eyeing sites to allow for drive-ins, and existing assets that already had drive-in facilities, as approximately 80 percent of their store transactions were “to go.” In June, Starbucks announced that they expect to open 300 new locations specializing in pick-up only and to-go business.

Economic uncertainty supports discounter confidence

Despite the pandemic, discounters and dollar stores are flourishing, as existing customers increase visit frequency, and new customers are attracted by their value play. Often referred to as recession-proof, they are looking more and more pandemic proof as the current situation plays out. The nation’s largest deep discounters, Dollar General and Dollar Tree, have thrived as those out of work or living on reduced wages seek more for their money. While e-commerce has bolstered Walmart and Target, Dollar General posted a 24.4 percent increase in net in-store sales in the second quarter, nearly double that of Walmart and Target. The two main dollar chains are also recording increased sales with the addition of consumables, and even adult beverages in some locations.

Consequently, dollar stores are expanding, and hiring, at a brisk pace, with Dollar General on track to add 1,000 stores in 2020, and Dollar Tree opening 500 new locations. Stores for both discounters are in the 7,000-sq.-ft. to 13,000-sq.-ft. range with leases on new stores typically running for 10 to 15 years with options to extend.

According to Mike Donnelly with Coldwell Banker Commercial DuFour Realty in Chico, Calif.: “Investing in dollar stores is like investing in the heartland of America.  These stores are often the cornerstone of cities, towns, and communities throughout the country, and they offer residents good value and even comfort when they may need it most.  For investors, dollar stores offer safe harbor and even some diversification of their portfolio.” Donnelly sees this as a key reason for continued dollar store development and growth during the great recession, while other asset classes retracted.

All Dollar General leases have a corporate guarantee, as do many Family Dollar stores. Investors continue to recognize the allure of deep discounters, as transaction volume remains brisk, with favorable, yet compressing, cap rates in the mid-7% range depending on lease term and location.

Investor ills relieved with drugstore investments

As with other successful businesses operating in the pandemic, diversity has helped drug store chains survive, as they sell more than just pharmaceuticals. With cleaning supplies, health and beauty products, snacks, alcohol, and even limited perishable food items, the pharmacy has become a mini general store. Moreover, in addition to some stores operating 24 hours per day, many have drive-thru(s), which have allowed some chains to experiment with offering household essentials in addition to prescriptions in a contactless transaction.

Outside of industrial assets, drugstore properties are one of the most active property segments this year. Per CoStar, transaction volume through the third quarter of 2020 is 21 percent above that of last year. Nationwide, cap rates have remained stable, but in better locations compression of 20 to 50 basis points is common. Likewise, while median per sq. ft. prices have held fairly flat, prime locations have recorded gains as high is 10 percent over the past year.

Returns are also relatively strong given the security of the investment, commonly guaranteed by a high credit company, and the absolute NNN hands-off nature of most drug store assets. Much like quick-serve restaurants, length of the lease and quality of the location are also important factors, according to McGue. Moreover, being an essential, fully operating business has only solidified their status among investors.

While much of retail will continue to morph as it adapts to e-commerce, changing consumer preferences, recession and pandemic, there are still many avenues available for investors looking for returns, safety, management ease, or a combination thereof. Bankruptcies will continue, but some retailers are significantly more vulnerable than others.  Investors seeking a balanced investment might consider discounters or fast food-leased assets, while those that seek relative safety and ease, might consider drug store properties. Those more willing to accept risk may find that small retail strip centers with essential or complimentary tenants, and grocery-anchored centers where foot traffic has remained robust. Whatever the need, investors should contact their real estate professional to discuss their investment needs and strategy, and if retail properties should be a component of their overall portfolio.