Colliers’ Grocery Report highlights crucial impact of debt on sector’s growth

Whilst the predicted easing of interest rates and inflationary pressure later this year will help the investment and development of new supermarkets, significantly raised construction costs and rental growth may still stifle some expansion plans writes Colliers in its latest Grocery Real Estate Report.

The report, which looks at the investment, leasing, development and economics of grocery real estate assets, notes that following a record high level of investment transactions in 2023 (£2.29 billion), sale-and-leaseback deals will continue to drive the market as operators look to address their debt profile. In 2023, sale-and-leaseback transactions meant operators were responsible for roughly 43 per cent of sales in the UK’s grocery real estate sector, as the traditional dominance of institutions and property companies fell away. However, the report notes that the expected drop in Bank of England base rates in Q3 will create a sharpening of yields and an associated boost to values which will be welcomed equally by investors, developers and the grocers.

Pierre Kunkler, Retail Capital Markets at Colliers, comments: “The continued dominance of sale-and-leaseback transactions that we expect to see this year goes hand in hand with investors’ increasing scrutiny of the covenant strength of major operators and the impact of their corporate finance structure. The well-known debt positions of Asda and Morrisons has meant that Tesco and Sainsbury’s are viewed more positively, and this is being reflected in a significant yield differential in transactions between the two groups of operators.”

The development and acquisition plans of operators will also be heavily influenced by their debt positions, highlights the report. Privately owned Aldi has modest levels of debt and a strong balance sheet, with their target of opening 50 new stores a year to reach a total of 1,500 a testament to this. However, in many cases the higher levels of interest and increased construction / labour costs have frustrated the development plans of many of the supermarket operators.

Greg Styles, Retail Development and Advisory, adds: “The relative levels of market share for the operators of the larger format supermarkets has remained relatively stable, but there is now a real variance between their financial models and therefore their ability to compete and grow. For all of the acquisitive supermarket operators, the ideal target store size falls in the 15,000 to 25,000 sq ft bracket, meaning that competition for sites remains high. Whilst in the near future it looks likely there will be good news with a fall in interest rates, with construction costs likely to remain close to current increased levels, other levers need to be moved to restore developments to viability.”

The report notes that in most locations, rental growth for supermarkets that exceed the above size range of 15,000 to 25,000 sq ft has been stagnant. In addition, where rents were agreed at the height of the market in 2011 / 2012 and in many cases have since been increasing based on RPI / CPI, the underlying rental value of large prime stores and the degree of over-renting has been uncertain.

Matthew Hobbs, Retail Lease Advisory, says: “Due to the operators’ focus on their own estates in recent years, particularly in the face of the rapid expansions of Aldi and Lidl, there have been very few new large supermarket lettings and consequently no open market rental evidence. Happily this situation is now changing as leases on some prime stores begin to expire without the landlords and tenants agreeing a lease extension in advance. The availability of arms’ length rental evidence will allow investors and supermarket operators to value their assets with more certainty – and the rental / marriage value calculations involved in restructuring leases can be conducted with greater clarity.”