Where Is Grocery-Driven Retail Headed?

LOS ANGELES—Following a year of high demand, grocery-anchored retail is poised for pricing increases due to scarcity of product and lack of development in core market. According to Phil Voorhees, EVP at CBRE, we may also be expecting compressed cap rates this year. With some store closures last year in the grocery sector, most notable the bankruptcy of Hagen, some wondered if the sector would remain dominant in 2017. The answer is undoubtedly yes. We sat down with Voorhees to talk about the grocery market, expectations for 2017 and why there is no danger in being too bullish on this sector.

GlobeSt.com: Grocery-anchored centers were the theme of the retail market last year. How will the niche change in 2017?

Phil Voorhees: While a perennial favorite with institutional and private investors alike, no segment of retail is more competitive than grocery. Competition, however, drives innovation, and we expect 2017 retail to evolve at a fast pace. While grocery-anchored is a segment of retail, it is tough to call it a “niche;” there are more than 5,000 grocery-anchored centers in the Western U.S. This will not change anytime soon. In the west, pension funds, advisors and REITs are not selling “core” grocery-anchored centers as they are generally unable to replace them. Development of “core” grocery-anchored product in the west is near historic lows, creating scarcity and exceptional pricing. Despite the +/- 70 bps increase in the 10-Year Treasury rate since the election, cap rates for grocery-anchored centers in primary, coastal markets have hardly budged. Uncertainty remains the prevailing theme, not just for retail but for the financial markets, which triggers a “flight to quality.” While prices for grocery-anchored centers hover near record highs, the spread between grocery-anchored cap rates and the 10YT is perhaps three times wider than during the last cycle. So, you could make an argument for further cap rate compression. In summary, we expect continued exceptional pricing for grocery-anchored centers in the west.

GlobeSt.com: As this niche becomes more competitive, how have you seen investment strategies evolve for active players in this market?

Voorhees: We've seen more institutional capital seeking to provide equity to developers and operators, intending to “manufacture to core.” 2016 also saw Regency Centers merge with Equity One, seeking to grow by acquiring at the entity level. Assuming the economic recovery picks up momentum from tax and spending stimulus from the new administration and its control of both houses of congress, we expect investors will broaden geographies to include better centers in secondary markets. For example, only a handful of grocery-anchored centers in the Inland Empire traded to institutional investors since the Great Recession. Yet, considering population density, household incomes, jobs and population growth, fundamentals in the Inland Southern California market are very strong. The cap rate spread between coastal and inland markets should be compelling for motivated investors this year.

GlobeSt.com: While this is a strong market, last year we saw some companies, like Haggen. Is there danger of being too bullish in this market?

Phil Voorhees: Perhaps in the short run, but not in the longer run. As noted previously, competition forces evolution. Grocers will pivot business plans to address competition from brick-and-mortar and online. Trader Joe's continues to crush it with spectacular sales on a per-square-foot basis, owning its niche. Aldi could do the same for the price/value segment of the market. In this cycle, we've seen lenders remain conservative, and investors focused on capital preservation and cash flow using less leverage. So long as leverage remains lower, strong economic and retail real estate fundamentals in the west should serve longer-term-hold investors well.

LOS ANGELES—Following a year of high demand, grocery-anchored retail is poised for pricing increases due to scarcity of product and lack of development in core market. According to Phil Voorhees, EVP at CBRE, we may also be expecting compressed cap rates this year. With some store closures last year in the grocery sector, most notable the bankruptcy of Hagen, some wondered if the sector would remain dominant in 2017. The answer is undoubtedly yes. We sat down with Voorhees to talk about the grocery market, expectations for 2017 and why there is no danger in being too bullish on this sector.

GlobeSt.com: Grocery-anchored centers were the theme of the retail market last year. How will the niche change in 2017?

Phil Voorhees: While a perennial favorite with institutional and private investors alike, no segment of retail is more competitive than grocery. Competition, however, drives innovation, and we expect 2017 retail to evolve at a fast pace. While grocery-anchored is a segment of retail, it is tough to call it a “niche;” there are more than 5,000 grocery-anchored centers in the Western U.S. This will not change anytime soon. In the west, pension funds, advisors and REITs are not selling “core” grocery-anchored centers as they are generally unable to replace them. Development of “core” grocery-anchored product in the west is near historic lows, creating scarcity and exceptional pricing. Despite the +/- 70 bps increase in the 10-Year Treasury rate since the election, cap rates for grocery-anchored centers in primary, coastal markets have hardly budged. Uncertainty remains the prevailing theme, not just for retail but for the financial markets, which triggers a “flight to quality.” While prices for grocery-anchored centers hover near record highs, the spread between grocery-anchored cap rates and the 10YT is perhaps three times wider than during the last cycle. So, you could make an argument for further cap rate compression. In summary, we expect continued exceptional pricing for grocery-anchored centers in the west.

GlobeSt.com: As this niche becomes more competitive, how have you seen investment strategies evolve for active players in this market?

Voorhees: We've seen more institutional capital seeking to provide equity to developers and operators, intending to “manufacture to core.” 2016 also saw Regency Centers merge with Equity One, seeking to grow by acquiring at the entity level. Assuming the economic recovery picks up momentum from tax and spending stimulus from the new administration and its control of both houses of congress, we expect investors will broaden geographies to include better centers in secondary markets. For example, only a handful of grocery-anchored centers in the Inland Empire traded to institutional investors since the Great Recession. Yet, considering population density, household incomes, jobs and population growth, fundamentals in the Inland Southern California market are very strong. The cap rate spread between coastal and inland markets should be compelling for motivated investors this year.

GlobeSt.com: While this is a strong market, last year we saw some companies, like Haggen. Is there danger of being too bullish in this market?

Phil Voorhees: Perhaps in the short run, but not in the longer run. As noted previously, competition forces evolution. Grocers will pivot business plans to address competition from brick-and-mortar and online. Trader Joe's continues to crush it with spectacular sales on a per-square-foot basis, owning its niche. Aldi could do the same for the price/value segment of the market. In this cycle, we've seen lenders remain conservative, and investors focused on capital preservation and cash flow using less leverage. So long as leverage remains lower, strong economic and retail real estate fundamentals in the west should serve longer-term-hold investors well.