As Store Counts Rise, Dollar General’s Cap Rates Could Hit New Lows

As Store Counts Rise, Dollar General’s Cap Rates Could Hit New Lows

Dollar General has been on a winning streak, both as a retailer and as a net lease investment, since the economy began to recover in 2009. A number of factors are driving that winning streak as a retailer, but the company’s appeal as a net lease tenant is based on profitable operations and ambitious plans for expansion. What’s more, Dollar General recently unveiled strategic plans that will likely help it maintain its glitter in the eyes of net lease investors.

Dollar General already has an investment-grade corporate credit rating from rating agencies including Moody’s Investors Service (Baa3) and Fitch (BBB), so its properties add value for investors looking for bond-like real estate assets. The Goodlettsville, Tenn.-based chain’s stores have an average of 10.11 years remaining on their leases at the time of sale, well within the range that investors look for.

“The people who buy these properties are looking for bonds wrapped in real estate,” says Rich Murphy, managing director of Calkain Cos., a net lease brokerage and research firm based in Herndon, Va.

The retailer recently shored up its standing among stock investors by delivering strong financial results, and in March it released an outline of its strategic plans for growth. Moody’s also likes its financial policies, which include keeping low leverage relative to earnings before all major costs are deducted.

What investors can expect from Dollar General

The chain plans to open about 900 new stores and relocate or remodel 875 stores in fiscal year 2016. After that, in 2017, it plans to accelerate its expansion by opening about 1,000 new stores and remodeling or relocating 900 units, according to the company. Dollar General is also expected to begin opening future stores in urban locations.

It might sound like the retailer is doubling down on too much of a good thing, but the company continues to post strong operating results. In 2015, its full-year same-store sales increased by 2.8 percent, and its fourth-quarter sales were up by 2.2 percent.

Eager investor readily absorbed Dollar General’s newly constructed stores in 2015, and that demand helped drive down Dollar General’s cap rates in 2015, according to a report from Calkain Cos. In the first quarter, the median asking cap rate for Dollar General properties built between 2011 and 2016 averaged 6.4 percent, just slightly above the national average for all net leased retail properties, according to the Boulder Group, a Northbrook, Ill.-based investment firm specializing in the single-tenant net lease sector. According to the Boulder Group’s most recent report on the dollar store sector, from September 2015, Dollar General stores had both the lowest median asking cap rate (at 6.75 percent) and the lowest closed cap rate (at 6.55 percent) of any of the dollar chains. Increased investor demand for real estate in general helped compress cap rates for Dollar General, but the retailer has reasons of its own for succeeding.

Aside from the dramatic increase in the number of Dollar General stores coming to market, average lease years at sale for Dollar General locations shot up  by 1.5 years, reflecting the increased presence of new 15-year triple-net deals. Meanwhile, average cap rates decreased by 60 basis points, according to Calkain’s “2Q15 STNL Cap Rate Report.”

While cap rates remain tight, investors are also likely to face increased competition, stemming from Dollar Tree’s $8.5 billion acquisition of Family Dollar last year. The combined company created a retailer with 13,000 locations in the U.S. and Canada, edging out Dollar General’s 12,483 locations, according to its 2015 financial results.

Will this engine overheat?

Dollar General will certainly have to keep a sharp eye on its competitor, which is close to outnumbering it in terms of locations. Also, both operators stand to benefit from investor demand for net lease properties. While REIT demand for the dollar store net lease properties has waned, private buyers—who are trying to ensure that their returns outpace inflation and government bonds—have shown an increased appetite for such assets.

Without institutional buyers as wholesale exit option for developers, dollar stores are relying on private buyers to sell properties, according to Calkain’s report. Finding those private buyers requires more work, but it also yields a lower cap rate, creating downward demand-side pressure on average cap rates, Calkain executives claim.

Dollar General, however, still stands to benefit substantially from these market dynamics, because the retailer constituted a large portion of the dollar store net lease category—78 percent in the second quarter of 2015, according to Calkain. 

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