UK supermarkets may have outperformed the rest of retail, but they still make up a small market, says Shayla Walmsley.
Institutional investors like UK supermarkets. Last year, insurers and others accounted for 90% of 53 transactions worth £1.2bn (€1.4bn), and only 8% of sales. James Watson, head of investment at consultancy Briant Champion Long, claims to be seeing the first signs of overseas investor interest in UK supermarkets. "They're getting the message on covenant and yield," he said this week.
The chief appeal for income-risk-averse investors is the fact supermarkets are characterised by longer leases than the rest of the retail sector and by tenants at negligible risk of default. The average lease length is 20 years, compared with 13 years for IPD's standard retail subset (which includes banks and other retail-like assets, but excludes supermarkets).
Moreover, compared with standard retail, supermarkets have outperformed. According to IPD figures released this week, last year they returned 6.1% (6.9% over five years) compared with 2.4% for standard retail.
Then you have consistent performance and pricing. In-town assets, larger assets and those in the southeast outperformed last year, but not by much. A total return of 6.2% in the southeast compared with 6.1% in the rest of the UK. The gap between returns on larger and smaller assets in 2012 has decreased to 14 basis points.
Briant Champion Long partner Matthew Hobbs pointed to significant edge-of-town demand. "Where supply is limited, supermarkets will take what they can get," he said. In fact, Greg Mansell, IPD head of research for the UK and Ireland, suggested expansion of in-town supermarkets could go some way to regenerating moribund high streets by increasing footfall.
But despite their peculiar investor-pleasing characteristics, supermarkets obey the same rules as any other asset subclass, including a polarisation of values between strong and weak locations.
It is just that the definitions of 'strong' and 'weak' don't necessarily correlate with the definitions of prime and secondary in other asset classes. Planning consent is less likely for supermarkets in affluent areas, which makes for a limited supply of sites, but a predominantly southeast retailer such as Sainsbury's is likely to expand in (what would be in other sectors) secondary northern English locations. As Mansell pointed out this week, long-lease secondary last year outperformed short-let prime assets.
Potentially less appealing to investors will be the downsizing trend. The Big Four's 'space race' to acquire larger stores is now pretty much in abeyance since Tesco curtailed its expansion programme after issuing a profits warning last year.
Hobbs talked of "cruisers rather than battleships", with a proliferation of local, smaller stores in response to consumers doing less shopping more often. Thrice-weekly shopping went up from 39% in 2009 to 49% in 2012. In any case, from retailers' perspective, it makes sense to downsize because planning permission on small stores is either easier to obtain or in some cases not necessary.
This could make a difference because it will determine how investors access UK supermarkets. Growth is strongest for scarce 'sweet spot' superstores, and recent institutional investor activity has focused on relatively large assets. AXA closed two deals in December, one in the north and one in Kent, for example. A month earlier, Aviva closed a funding deal for a store in the southeast.
IPD also provided evidence that investors are closing in on debt commitments in the subsector, with an increase from 14% of transactions in 2011 to 29% in 2012.
But supermarkets are not major components of institutional portfolios. In a session at the IPD launch event this week, one questioner pointed to anecdotal evidence that fund managers are acquiring one, at most two, assets for purposes of diversification – not scale portfolios of them.
The point is that there are only so many of these assets. Despite the hype, the niches, and the demand, they comprise a relatively small part of the retail sector. Supermarkets make up around £5bn, compared with the £14bn standard retail market.