For years, retailers who were solely reliant upon a physical storefront have been losing market share to companies who have opted to pursue an omnichannel sales strategy. Then, the Coronavirus pandemic hit and accelerated this transition at a pace not previously seen. As a result, companies who sell non-essential items like clothing have continued to struggle, while other companies that sell essential items, like grocery stores, have thrived.
In this article, we describe one of the valuation metrics used to value grocery store anchored retail centers: the cap rate. We will describe what a grocery store anchored retail center cap rate is, how it is calculated, and why it matters. By the end, readers will have the information needed to calculate the cap rate metric on their own as part of their pre-investment due diligence process.
First National Realty Partners is a professional commercial real estate investment company that focuses solely on the acquisition and management of grocery store anchored retail centers. If you are an accredited investor and would like to learn more about our current investment opportunities, click here.
Grocery Store Anchored Cap Rates Defined
In order to understand what grocery store anchored retail center cap rates are, let’s break this term up into its two parts and define each.
What is a Grocery Store Anchored Shopping Center?
In commercial real estate investment, a grocery store anchored retail center is one where the “anchor” tenant is a grocery store that leases the majority of the available space. Often, the grocery store is surrounded by other tenants – like a dry cleaner or sandwich shop – whose businesses benefit from the traffic generated by the grocery store.
Example
Our West Market Street Station property in Akron, Ohio, is a good example of a grocery store anchored retail center. It has 54,166 square feet of Gross Leasable Area and is anchored by a Whole Foods grocery store that leases 30,173 SF, or 56% of the total space. Whole Foods is supported by tenants like OrangeTheory Fitness, LuluLemon, and Moe’s Southwest Grill, who attempt to convert the grocery store traffic into sales for themselves.
What is a Cap Rate?
The cap rate, or capitalization rate, is a financial metric that is used to measure the potential return on a commercial real estate investment. Cap rate is calculated as a property’s Net Operating Income (NOI) divided by its purchase price/value.
Cap rates can also be used as an indicator of the health of a particular investment sector. If cap rates decline over time, it means that there is strong demand for properties in that sector, and investors are willing to pay higher prices for those properties. If cap rates for a particular market segment are rising, it means that demand is not as high and prices are falling to bring buyers to the table.
Grocery Store Anchored Shopping Center Cap Rates in 2022
Driven by record investor demand for grocery store anchored retail investment, cap rate performance was very favorable through the end of 2021 and in the first quarter of 2022. In their retail research report, JLL notes:
“Last year saw a new record in the number of grocery-anchored retail property transactions with 735 total trades, 13 more than the previous record set in 2014. Acquisition volume for the year was just over $13.3 billion, the largest share of any retail property type for the third year in a row and the second-highest level in recorded history.”
Regarding cap rates, the report goes on to state, “As a result of increased demand for grocery-anchored retail, the market saw cap-rate compression of nearly 50 basis points from 2019 levels.”
What Investors Should Know
It is important for investors to note that cap rates can vary widely depending on the grocery anchor. Top tier grocers like Publix, Trader Joes, and Whole Foods often command lower cap rates (higher prices) than mid or lower tier grocers like Kroger. This point is highlighted in the JLL report, which states:
“…even within the grocery-anchored subcategory investors can expect to see wide variation in the pricing of these assets. High-priced grocery centers fetched average cap rates of roughly 5.8% while their discount and mid-tier counterparts priced on average around 7.1%. And while typically seen as the safest retail property type, cap rates on premium grocery properties maintained a spread of 4.3% over the risk-free rate.”
It is also important to note that cap rates can vary by location, e.g. they may have a different value in New York than they would in Los Angeles or Phoenix.
The translation here is this: even through a once in a century pandemic, the grocery store anchored retail sector has performed remarkably well and prices and demand for the properties continues to increase. In addition, the fundamentals of these retail centers, like occupancy and cash flow, have continued to remain strong.
Grocery Store Anchored Shopping Center Cap Rates Beyond 2022
Grocery stores have been a relative safe haven from the chaos that has engulfed other retail assets over the last year. In fact, grocery sales have surged, which underscores the desirability of having them as an anchor tenant in a shopping center.
According to Melina Cordero, a managing director of CBRE’s Retail Capital Markets business, grocery-anchored shopping centers may be a “bulletproof class” that may “see some cap rate compression in the months to come.” We support this view based on three factors: necessity, adaptability, and performance.
The COVID-19 pandemic revealed how crucial grocery stores are to supporting our daily lives. We all need to eat every day and the grocery store is where food is purchased. But, the shopping experience will continue to change. Grocery stores like Amazon-owned Whole Foods and Walmart have taken a leading position in adapting to newer shopping preferences, which includes online ordering and curbside pickup options.
Finally, grocery stores have performed incredibly well over the course of the pandemic. Paradoxically, Placer Data reports that grocery store visits and visit durations are nearly back to pre-pandemic levels. In fact, they state that “growing visit durations and weekday shopping trends indicate a continuation of a pandemic-style environment that drives larger basket sizes.”
To summarize, we agree with CBRE and Placer Data that the necessity of grocery stores has never been greater and that retail centers in which grocery stores lease space will continue to perform well into 2022 and beyond. This investment performance will be driven by the continued strength of grocery store performance and capitalization rate compression in select markets, which could drive prices (and returns) higher.
Downside Risks Remain
While grocery store anchored shopping centers appear to be well positioned for near term success, it doesn’t mean that they are without risk. Traditional due diligence rules still apply.
Tenant Financial Conditions
Tenant financial conditions must be scrutinized now more than ever, and non-financial elements of the transaction – like location and market – must be researched thoroughly. We prefer national tenants and credit tenants who have a long-term track record of performance and growth markets whose demographics are favorable for future rent increases.
Inflation
Another important downside risk for investors to consider is inflation. In March of 2022, inflation printed a reading of an 8.5% annual run rate. This is concerning on two levels. First, food producers are likely to pass rising input costs onto the consumer, which means higher prices at the grocery store. In theory, this could lead to declining sales as affordability becomes more of an issue. Second, this high inflation means that interest rates are likely to rise to combat it. For investors, this will make raising capital (from investors and lenders) more expensive, which could have a downside impact on deal volume.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
To learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
