Grocery Stores Remain Solid, But The Amazon Pain Is Coming
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Among all forms of shopping centers, neighborhood strips anchored by grocery stores are considered a far safer investment than malls or power centers anchored by department stores. But they are beginning to feel similar pressures.
The top of the grocery store food chain is occupied by national brands with deep pockets, and they are spending billions to adapt to shoppers' changing habits. While the consequences of their efforts will not be immediate, they will likely be felt by brands without the capital or market coverage to sustain that competition.
A few regional brands have already reorganized through bankruptcy and closed stores to stay alive. Southeastern Grocers, the parent company of Southern grocery chain, filed for and subsequently emerged from bankruptcy last year with fewer stores. Catch-all retailer Shopko, which has some grocery elements, filed for Chapter 11 bankruptcy protection earlier this month, and its restructuring plan includes closing over 100 stores to stay viable.
Multiple sources interviewed for this story believe that eventually, consolidation among grocery brands is inevitable. Whether that comes in the form of mergers and acquisitions or closures is yet to be determined, but the regional operators who don’t have niches like Trader Joe’s or Sprouts Organic Market are the most vulnerable, according to Colliers International Market Research Director Rose Penny. If and when they start to close, it would pose serious challenges for their landlords.
“You’re going to see a lot of pressure on grocery-anchored shopping centers with second-tier brands, and that’s a concern for a lot of landlords,” SRS Real Estate Partners Managing Principal Kyle Stonis said. “If there’s a struggling grocery store anchoring your center and it goes out, it kills your shopping center because it can’t survive without something in that spot.”
Grocery anchors average 50% of neighborhood centers’ square footage, according to Green Street’s report. If they go dark, even temporarily, it could be devastating. Green Street estimates that vacant big-boxes take an average of 18 months to go back online. If a box needs to be carved into multiple smaller spaces for the next wave of tenants, that becomes very expensive very quickly, Stonis said.
Internet-Resistant, Not Internet-Proof
Amazon’s purchase of Whole Foods sent a shock wave through the grocery industry, causing concerns that it was about to suck all the oxygen out of the room. Yet so far, the grocery industry's differences from soft goods retailers have insulated operators against a full-scale Amazon-fueled apocalypse.
Shipping, storing and packing perishable goods is a much more complex and capital-intensive proposition than it is for apparel and electronics. Large players, especially Kroger and Walmart, are taking proactive steps to address the market’s changes, which Sears and its counterparts largely failed to do. Most of all, grocery stores' advantage is that people need their products more frequently than they need soft goods.
Groceries are part of nearly every family’s weekly routine, and routines are slow to change, Green Street Advisors analyst Vince Tibone said.
“We feel that consumers are very loyal to their local grocery store,” Tibone said. “It would often take a catalyst, either a store moving away or a new grocer opening right down the street from [a consumer] to change habits in general.”
In retail, Amazon has been an agent of change since its founding. When its purchase of Whole Foods was announced, operators worried that cheap, fast grocery delivery would become industry standard like two-day shipping for other forms of e-commerce. That hasn’t happened yet, and is unlikely to do so in the short term, according to Green Street’s 2019 U.S. Strip Centers Outlook report, which was published last week.
Online grocery ordering, whether in the form of curbside pickup or home delivery, only accounts for 2% of total grocery sales in the U.S., according to Green Street. That number lags considerably behind countries in Europe and Asia; South Korea sees the highest percentage of grocery sales online at 17%, with Japan and the U.K. tied for second at 7%.
While the discrepancy implies room for future growth, those countries have more population density than the U.S., making logistics less of a hurdle. Domestically, Amazon, Kroger and Walmart are spending huge amounts of capital to clear that hurdle — capital that smaller operators don’t have.
“The grocery industry is difficult because it’s so low-margin, so that has made it difficult for grocers to invest in omnichannel and back-end logistics while maintaining those margins and keeping prices low for consumers,” CBRE Head of Global Retail Research Melina Cordero said. “That’s the trade-off the companies have to deal with, and different companies will reach a different idea of equilibrium.”
The Online Transition At Dial-Up Speeds
Even Amazon, Kroger and Walmart's spending sprees are slow to take effect because of the herculean effort it takes to put changes in place nationwide. Amazon has publicized its Whole Foods expansion plans but has yet to start announcing locations, and Kroger's partnership with Microsoft to develop smart stores is still just a pilot program.
“Right now, outsourcing the whole grocery delivery operation is totally viable, so if you’re a smaller grocer, you can just partner with Instacart,” Tibone said. “The customer still has to pay a fee, but it is available to them. And until the capital expenditures of Kroger, Walmart and Amazon come to bear, which will be a few years from now, they can outsource without a problem.”
Because of online grocery ordering’s small penetration into the overall market, investment into the sector doesn’t come with a large bump in revenue, leaving everybody below the giants between a rock and a hard place. Either they spend to keep up and risk over-leveraging or losing profitability, or they stand pat and fall behind.
If neighborhood centers depend on groceries to stay alive, then their landlords could feel tremendous pressure to keep a struggling store in business. They may prefer to assist a grocery tenant with capital expenditures to keep it relevant rather than watch it flounder.
“There needs to be some level of concern with regards to smaller, regional players with one exception,” Colliers National Director of Retail Services Anjee Solanki said. “That would be if [a grocery store is] getting a sweetheart deal from the landlord. Margins being what they are and as competitive as the market can be, if these grocers are open with their landlord in making that relationship a partnership, landlords that provide capital to these tenants for improvements [would increase chances of success].”
Once left with an empty box, landlords face many of the same issues as with vacated department stores and many of the same options for re-leasing them. Neighborhood strip centers are especially intriguing targets for healthcare operators looking for new ways to get closer to their patients, Cordero said. But much like with larger centers and malls, the grocery stores most likely to close up shop will leave the least appealing real estate.
“There will be some pain in markets with secondary grocers with weak sales,” Stonis said.
Even for those secondary chains, weak sales are not a current problem. Every publicly traded grocery chain saw an increase in same-store sales from 2017 to 2018, Solanki said. Among the 30 privately owned operators that Colliers tracks, only Fairway Group and King Kullen, both exclusive to the New York metropolitan market, saw declining year-over-year sales.
Solanki suspects that management was more of a contributing factor in Shopko and Southeastern Grocers' bankruptcies than external market conditions.
“Even the ones that are lagging, it’s not significant in terms of the number of stores,” Solanki said. "They have the ability to rebound if they really start looking at their business."
Even with healthy sales growth, only discount chains Aldi and Lidl have joined Whole Foods and regional operator Wegmans as major grocers adding a significant number of stores in recent years. Kroger and Walmart are testing new formats and beefing up their technology, while Publix is investing in buying its own stores or the ground they sit upon from their landlord, according to Solanki.
The reluctance to expand speaks to the war of attrition that is just beginning in the grocery market, but to landlords, it could very well be preferable to the climate at the start of 2018.
“I would say [grocery-anchored shopping center landlords] are more optimistic now, because it seems like grocers have more of a plan to compete with Amazon," Tibone said. "Last year, no one knew exactly what Amazon would do and how it would evolve. Now, on the ground, you can see that not everyone is immediately getting their groceries delivered.”
Amazon is a "terrifying competitor" in whatever market it decides to enter, Tibone said, but its plans are no longer shrouded in the uncertainty that can paralyze a market. The path forward for grocery stores and their landlords may be a difficult one to tread, but at least it is a clear one now.