Sales through stores predominantly selling food account for almost 50% of UK retail transactions. Supermarkets, however, make up just 7.5% of the retail in IPD’s database. But they possess different and favourable supply and demand characteristics compared to non-food retail, resulting in their outperformance in recent years. However, in future we expect wider variation in these assets’ performance, placing a greater emphasis on stock selection.
Supermarket fundamentals bear little resemblance to other retail property. Their long, inflation-linked leases are increasingly associated with alternative property classes, such as student accommodation and healthcare, rather than retail. Robust tenant demand and low default risk mean supermarket property has the lowest void rate of IPD’s property sectors – a stark contrast to the administrations that have plagued the retail sector in recent years. Supermarkets provide solid income and have attracted strong demand from liability-matching investors for long, safe income.
Due to inelastic demand, spending on food has limited growth potential. So to increase revenues, supermarkets have expanded into higher-margin, non-food offerings, a strategy particularly prevalent in the 1990s and early 2000s, when supermarkets’ non-food sales grew at an annual average of 18%. Since 2005 growth has slowed, while online non-food sales have escalated. General merchandise first stocked by larger supermarkets, such as books, electricals and music, have been particu-larly affected by online penetration.
Unlike other property sectors, supermarket space continued to grow following the recession, but sales growth has not kept pace, putting space productivity under pressure, especially for stores with a lot of non-food floorspace. While the online threat to the high street is well documented, the impact on large supermarkets has attracted less attention. Another factor driving change is saturation. Big multiple food retailers have grown market share at the expense of smaller businesses; now, with a shrinking share of such businesses to take market share from, multiples are increasingly competing against each other or cannibalising existing sales.
Future market share gains are likely in the fragmented convenience food sector, where symbol groups, affiliates, cooperatives and station forecourts have a big market share. Smaller stores can supplement supermarkets and serve locations that larger formats cannot reach. Expansion in this area is also supported by convenience stores’ higher margins and changing shopping patterns.
Property requirements are reacting to these changes. The expansion of large format super-markets has slowed, with capital expenditure now largely focused on refreshing existing stores, expansion in the convenience sector and building online platforms. Non-viable out-of-town sites earmarked for future development have been written down – Sainsbury’s has written off almost £100m for sites it no longer intends to develop.
Operators are adopting strategies to improve space productivity in larger supermarkets, sub-letting areas to help fill excess space and drive footfall into stores where densities are lower. The major supermarket operators are now fully represented in many catchments and potential for rental growth could recede for sub-optimal stores in these areas. Operators could also resist longer leases as they seek to build in more flexibility.
We expect divergence in supermarkets’ investment performance, with age, configuration and location the key differentiators. To mitigate these challenges we favour supermarkets with high sales densities that are resilient to online sales, with good access, ample parking, which support ‘click and collect’ online order fulfilment, and are attractive for leasing space to sub-tenants. We expect supermarket returns to outperform the all-property average over the medium term. But rental growth is likely to be site specific and understanding individual store dynamics will become increasingly important in building outperforming supermarket property portfolios.
Tom Carlton is a retail research specialist at Legal & General Property