Resilience in the supermarket investment market

While investor demand for retail is generally limited, the ongoing resilience of the supermarket sector has provided a secure investment alternative for many investors.

Supermarket investment volumes this year have been particularly strong considering the disruption to the wider commercial real estate market, caused by the pandemic. Transaction volumes this year to date (January-November 2020) reached £1.38 billion, representing a marginal decrease of -3.9% compared to full-year 2019 levels, however exceeding the five-year average of £1.24 billion.

A number of deals due to complete in December is likely to bring full-year volumes closer in line with the heightened levels recorded last year. Meanwhile, in deal count terms, 2020 has already exceeded total 2019 levels by 11.4%, recording 49 individual deals.

Long-term security in the face of a recession supports supermarket investment

The typical long-lease, inflation-linked structures associated with foodstore assets continues to entice buyers looking for long-term income security, particularly at a time when appetite for risk has faded in the face of an economic downturn. The remaining unexpired lease term on supermarket deals this year-to-date averaged 15.9 years, while 20.4% of all deals were accounted for by inflation-linked long-income assets with over 20 years unexpired terms, representing a substantial increase compared to the 13.6% share recorded in 2019.

Meanwhile, the operational resilience shown by supermarkets this year has largely eliminated the risk of deferred/unpaid rent payments. The largest supermarket landlord in the UK, Supermarket Income REIT, received 100% of rent payments due on both June and September quarterly rent payment dates.

In terms of investor type, UK Property Companies, including real estate investment trusts, have been particularly active in 2020, accountable for a 43.2% share of investment volumes this year to date, totalling £597.4 million. This is primarily a result of Supermarket Income REIT transacting on eight key deals, including the acquisition of a portfolio of 26 Sainsbury’s stores from British Land for £102 million in May, in a joint venture with British Airways Pension Fund. Amidst the strength of the foodstore market, Supermarket Income REIT also has begun diversifying their portfolio in terms of tenant mix, acquiring their first Aldi store in early November in Leicester with an unexpired lease term of 25 years. Similarly, LXi REIT Plc has broadened their foodstore network, including the recent acquisition of a mixed-tenant portfolio comprising of 11 supermarkets, totalling £61 million.

Some occupiers look to reduce rental exposure while others opt to reinvest capital

One trend we’ve seen mature in recent years is the completion of buy-back deals, with the trading improvement experienced since the pandemic somewhat exacerbating this trend. Many foodstore operators are now in a strong financial position to take advantage of buy-back opportunities, to increase their freehold portfolio and therefore reduce exposure to future RPI-linked rental escalations and over-rented units.

We’ve tracked a number of deals of this nature in 2020 and can expect this to continue as we move into 2021. Tesco, for example, has been particularly active in this field, acquiring two of their own stores in Bristol and Kettering for £42 million and £53 million respectively. As a result, owner-occupiers have increased their share of investment volumes this year so far, to 11.7%, compared to a 4.8% share in 2019.

At the same time, there have been a number of deals move in the opposite direction, in the form of sale-and-leaseback transactions. Most notably, Waitrose completed two sale-and-leaseback portfolio deals to Supermarket Income REIT and LondonMetric Property, totalling £74.1 million and £62 million respectively, while involving a total of 11 supermarkets. This has allowed some chains to access capital to reinvest in order to meet the demands of a changing consumer environment – often to improve components of their e-commerce and click & collect business.

In line with rising online penetration rates for food sales, we’ve seen increased activity involving larger supermarket assets - with the opportunity for operators to provide traditional trading space alongside new online fulfilment centres. As a result, the average foodstore size this year-to-date has reached almost 52,000 square foot, an increase of 9.4% compared to the 2019 average.

Where does this leave pricing?

The continued investor appetite for supermarkets during the pandemic has resulted in the sector bucking the wider retail trend by experiencing downward pressure on prime yields compared to pre-Covid-19 levels. Savills prime equivalent supermarket yields currently stand at 4.50%, representing a 25 basis point sharpening compared to levels recorded pre-pandemic, in Q1 2020.

Looking ahead, the operational strength of the supermarket sector is expected to continue as we move into 2021, resulting in sustained investor appetite. It’s therefore reasonable to expect ongoing downward pressure on equivalent prime yields, bringing yields closer to their post-GFC lows of 4.25%.

_{Read the articles within Spotlight: UK Grocery Report below.}