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Demise of the Retail Gold Standard?

Is the retail market's gold standard losing its luster? For years, grocery-anchored shopping centers served as the industry standard for retail investors, who covet this product type because of its perceived long-term stability. Often referred to as “necessity-based-retail,” grocery-anchored centers can thrive in good or bad economic times because people need to eat.

Still, the grocery industry is facing some major challenges that could affect its future performance. While there will always be a strong need for grocery stores, retail property investors should take note of the changing industry landscape and grocers' responses to these challenges.

A New Age for Grocers

The grocery industry has been put on the defensive — or maybe it's the offensive — by discount store operators who are increasingly selling more grocery products within their superstores and club stores. Chains such as Wal-Mart, Costco and Target are making it increasingly difficult for traditional grocers to compete. Drugstores also are chipping away at the grocery dollar, adding refrigerated containers to sell a wider variety of products.

What's more, of the disposable food dollar, the average American is continually spending a larger chunk at sit-down and fast-food restaurants, further eroding the bottom line at grocery stores. The National Restaurant Association estimates that Americans spend about 46% of their food dollars on restaurants.

The good news is that these competitive threats are forcing traditional grocers to find ways to enhance their purchasing power, improve operating efficiencies, and focus on the needs of consumers through enhanced or expanded customer conveniences and services. The introduction of coffee kiosks, bank ATMs, video rental centers and dry cleaners are just a few ways that grocers are rising to the challenge. Plus, the industry is emphasizing customer loyalty more than ever through special programs and frequent shopper cards.

Race for Market Dominance

Industry consolidation and acquisitions will continue to occur among grocery business operators as they seek to streamline their cost structure, leverage purchasing power and establish their presence in select targeted markets. As Wal-Mart and other discounters gain a foothold in the grocery industry in markets around the country, a food fight will ensue and only the strongest will survive.

Right now, grocers are jockeying for position or seeking to solidify their market presence. We have already seen the Big Four — Kroger's, Albertson's, Safeway and Ahold — gobble up regional chains to gain entry into, or fortify their standing within, specific markets. The chains also have responded to consumer needs by renovating and expanding existing stores. However, this build-up comes at a price; empire building is not cheap and the debt structure of some of these companies bears watching.

Grocery-anchored centers still remain the darlings of retail investors, and quality properties are priced accordingly. What's clear is that an abundance of capital and buyer demand have combined to create a seller's market. And with historically low interest rates, leveraged buyers are willing to pay a premium to lock in an acceptable yield based on inexpensive debt.

However, prices have accelerated much faster than improvements in operating fundamentals, and rental growth has been minimal. Perhaps a booming economy will support high levels of consumer spending, resulting in higher occupancies and rents. But keep in mind that virtually all of the healthy grocers and their growing field of competitors are executing ambitious growth strategies, which will intensify local market competition.

As always, there will be some winners and losers. This increased competition, combined with the likelihood of higher interest rates as the economy picks up steam, makes it imperative that investors lock in long-term, inexpensive debt and that they develop a strategy for growing rents to justify their purchase prices.

No More Double Coupons

What does it all mean for retail investors? Savvy investors need to recognize that the abundance of capital pursuing grocery-anchored retail acquisitions has pushed prices to an all-time high and cap rates to record lows. This is not to imply that grocery-anchored centers are overpriced.

The point is that in today's increasingly competitive grocery industry, it is more important than ever for investors in grocery-anchored centers to emphasize the real estate mantra of “location, location, location” and understand a grocer's dominance in a particular market. Is the grocer positioned to be a long-term player?

The key is to identify market-share leaders in premium locations that are positioned for long-term stability in their markets. Remember, it pays to be a smart shopper — and investor.

Bernard Haddigan is the national director of Marcus & Millichap's national retail group.

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