A fascinating report was recently published by the team at Knight Frank; ‘Foodstores: a Feeding Frenzy’ talks to the attractiveness of investing in supermarket real estate.
“Foodstores – a highly sought after asset class for good reason: long income virtually guaranteed, a savvy and covenant-strong occupier base, minimal risk of failure, surrender or vacancy, all underpinned by inelastic consumer demand”.
Featured in the report is a Q&A with Robert Abraham, responding to the key questions often asked about SUPR and our strategy;
Q: Supermarket Income REIT (“SUPR”) is one of the key investors in the UK grocery real estate space and spotted the opportunity long before many other investors. Can you give us some stats on your current portfolio?
– 55 strong performing omnichannel supermarkets
– £1.7 billion gross asset value, as at June 2023
– 5.6% portfolio Net Initial Yield (“NIY”)
– 13 year WAULT
– Dividend yield 8%
– FTSE 250 Listed
– ca. 80% of portfolio let to strong tenant covenants Tesco and Sainsbury’s
– 3.8% highly affordable average rent to turnover across the portfolio
Q: For you, what are the main attractions of grocery real estate in the UK?
A: A key aspect is the mission critical nature of the real estate to the tenants, acting as revenue centres, with the stronger stores generating upwards of £60 million in annual turnover. The logistical challenges of online grocery also mean that existing store networks of the UK’s leading grocers are ideal for last mile fulfilment of online orders.
This, combined with a lack of supply of alternative locations due to planning obstacles and significantly increased costs for new build space, drives occupancy. Many of the stores in SUPR’s portfolio have been grocery locations for over 30 years. The critical nature of strong performing stores is evidenced by SUPR achieving 100% rent collection and 100% occupancy since IPO.
Occupancy and income is also driven by the fact that grocery is a growth sector, which is backed by non discretionary spend, providing a resilient income stream. The sector has seen sales growth of over 30% since SUPR’s IPO in 2017, to £242 billion today, which is driving store revenue growth ahead of rental growth.
Q: What are your key investment criteria for UK supermarkets?
A: We target strong performing omnichannel supermarkets, which are stores that fulfil both in-person shopping and online (via home delivery and Click & Collect). By targeting these stores, the portfolio is future proofed, with the ability to flex resources to capture channel shift in the face of changing shopping behaviour of the consumer. In addition to this, we target top trading stores, which provide confidence in the tenants’ ongoing occupation, along with inflation linked leases delivering contractual rental growth.
Q: To what extent is store size a consideration and do you have any favoured parameters?
A: We typically target large format stores, with an average site size of ca. 8 acres. These sites are ideal for online fulfilment as they have space for home delivery vans, Click & Collect and a store which is capable of stocking a full product range. These larger plots also have capacity for expansion of facilities to service increased consumer demand.
Returning to the mission critical nature of these sites for the operators, alternative sites of sufficient size in residential catchments are also very difficult to source and obtain planning for. This makes it much harder for a tenant to relocate compared to smaller format stores where other buildings can be repurposed.
Q: Does geography come into the equation, or is it totally asset- and competition-dependent?
A: We are pretty agnostic on geography, targeting top trading supermarkets across the UK – this is similar to how the operators will view a store. £1 million a week of revenue is still £1 million of revenue, wherever it is located!
We underwrite assets at the store level due to the highly localised nature of the grocery market, in which around 85% of shoppers will not travel more than 15 minutes to a supermarket. As I’ve already mentioned, many of the grocery assets that we invest in have been grocery sites for 30-40 years which provides long trading histories to analyse, as well as confidence in the ongoing strength of the stores in these locations.
Q: Online is often (but erroneously) seen as a threat to physical floorspace, but in supermarkets particularly, the relationship is actually symbiotic. How does the omnichannel piece play into your investment strategy?
A: Stores which provide online shopping typically carry a broader product range, while the increased trading volumes and stock turnover also means that in-store shoppers have access to fresher produce. Proximity to customers is key and using the grocer’s existing store network as distributed fulfilment hubs means greatly reduced drive times to customers (the key cost in online fulfilment) compared to a central fulfilment centre model. SUPR has stores in its portfolio which achieve six drops per hour. The average CFC by comparison achieves just two drops in the same timeframe.
The ‘dark store’ or centralised fulfilment centres were seen by some as the future for online grocery. These centres require very high density of demand and are typically situated where operators lack sufficient floorspace within existing store networks, i.e. London. In fact, we saw Sainsbury’s close its only facility of this type in 2021, whilst Asda closed two, to
instead use omnichannel stores. From a landlord/investor perspective, the benefit is the increased strategic importance to the operator. Increased store revenues improve the affordability of rents. For a large omnichannel hub, there might not be any other existing locations from which there is sufficient capacity for the operator to fulfil the required online volumes.
Q: What are your views on occupier covenant? Does it have any bearing on either your interest or pricing if the tenant is a PLC (e.g. Tesco, Sainsbury’s) versus private equity owned (e.g. Asda, Morrison’s)?
A: Occupier covenant is of course important and it is worth noting that SUPR’s largest tenants are Tesco and Sainsbury’s, representing around 80% of the portfolio. Investors are understandably seeking compensation for higher risk covenants through higher yields.
However it is worth noting that the UK’s leading and largest grocers have multibillion pound revenues with well established store networks and supply chains that have been developed over
many years. The non-discretionary nature of grocery expenditure produces a secure income stream.
Due to the mission critical nature of the real estate and by targeting the strongest performing stores, rents are also a priority payment for tenants to ensure that they do not lose access to a key revenue centre. Grocery is ultimately a localised market and the shortage of supply of alternative locations provides alternative occupier demand for strong trading locations.
Q: Partly on the back of changes in ownership structure, we are likely to see more grocery real estate portfolios coming to the market in the near future. What are your views on potential portfolio deals?
A: Our very focused investment strategy of targeting top trading omnichannel stores means that we generally prefer to handpick individual stores, such that the majority of our portfolio has been acquired on a single asset basis. This approach ensures that you target and acquire only the highest quality stores. Portfolio deals can risk the inclusion of some weaker stores which would have a dilutive effect on the quality of the portfolio. As you’d expect, we do run the slide rule over portfolio transactions when they come to market, but our preference is for individual asset transactions.
Q: You recently sold your stake in the Sainsbury’s Reversion Portfolio JV, to your JV partner Sainsbury’s. Could you tell us more about that transaction?
A: Between May 2020 and January 2023, we built a ca. 51% stake in the Sainsbury’s Reversion Portfolio (SRP), a securitisation which consisted of them freehold interest in 26 geographically diverse high-quality Sainsbury’s supermarkets. Sainsbury’s exercised options to acquire 21 stores in the SRP and agreed 15-year leases on four of the non-optioned stores. The Company generated £430.9 million of gross proceeds from the sale of the SRP.
We think that this transaction highlights the Company’s ability to identify strong trading supermarket assets and the ability to create value from underwriting a grocer’s ongoing occupation in locations.
Q: What are your views on the discounters? Would you invest in this space, despite growing concerns around saturation and even cannibalisation in some areas?
A: We target the UK’s strongest performing grocery stores and the discounters clearly have a successful strategy, so SUPR does have some exposure as you would expect. However, it is ultimately always going to be a relatively small portion of our portfolio as our focus is on larger format omnichannel stores.
Our stores also typically have 30-40+ years of trading history which you don’t get with much of the discounters in the leasehold market. The smaller format discounter stores are generally a bit more homogenous and don’t have the same mission critical features which I have been talking to. In the small format stores it is much easier to relocate to another site just around the corner, than it is for an operator occupying a 10 acre omnichannel hub.
Q: Grocery property yields eased at the end of 2022, as did all UK real estate. However, such yields have stabilised quicker than other asset classes. How do you see pricing playing out going forward?
A: Following the asset repricing, supermarkets are producing attractive returns for investors and that has driven a very liquid investment market, which is informing valuations. Since January we have seen a relative stabilisation in yields, with transactions pricing at levels which are in-line with equivalent assets in the SUPR portfolio.
We are however conscious of the potential impact on the investment market of interest rates remaining elevated for longer, so we will have to see how that plays out. Whilst we are cautious in our outlook, I would again note the defensive characteristics and attractive returns that supermarkets provide at current valuation yields