Investors in the UK supermarket sector may see a sharpening of yields towards the end of next year.
A series of sale-and-leasebacks drove investment volumes to record levels this year, but it would be the emergence of a more attractive debt market plus continued demand in the sector which could see yields tighten, according to new research into the sector.
In its latest UK Supermarket Investment Update, the specialist retail consultancy, Font Real Estate, said: 'Buyer demand will be sustained and, if prevailing economic conditions are positive, we may even see a hardening of prime supermarket yields towards the end of the coming year.'
However, should the sector benefit from a positive yield shift not all assets will start from the same place. The report says that pricing is 'more of an asset-by-asset evaluation than ever before' and that an operator’s corporate finances are increasingly influential.
It adds: 'It is the underlying covenant of the occupier which perhaps has the strongest influence on investor sentiment, with potential buyers increasingly discriminating about relative covenant strengths – especially with regard to the debt profile of ASDA and Morrisons.
'For example, evidence from the recent sale-and-leaseback activity suggests that stores let to Morrisons on a 25-year RPI-linked lease will command a yield of 6.75%. Five years ago, that yield would have been around 4.25%.'
Rental levels across the sector are also undergoing a period of adjustment. The rental levels now being paid on stores that were sold in the first round of sale-and-leasebacks several years ago can be as much as £30-£35 per sq ft as a consequence of index-linked rent reviews.
This is now routinely around 50% more than their equivalent open-market rent. As a remedy, operators have been willing to re-gear to secure rents more in line with the market.
Tom Edson of Font Real Estate said: 'Lease regears have provided some clarity on rental levels, and operators are invariably happy to agree lease extensions with lower rents on their top performing stores but are taking a more cautious approach when it comes to their weaker assets.
'In return, landlords are getting robust covenants and index-linked leases with appropriate caps and collars.
'Over-rented assets are still selling but it takes a buyer with a particular strategy to navigate their way through the present rental disparities.'
For the first time, UK grocery sales are expected to surpass £13 bn (€15 bn) in December. According to Kantar, in the four weeks to 26 November, grocery sales grew 6.3% to £11.7 bn.
