LGP: the future of supermarkets.
29 November 2013
In its latest Market Differentials report, Legal & General Property’s (LGP) research team looks at the evolution of the supermarket sector, as it transitions away from larger formats to convenience stores, and explores the key factors that will differentiate outperforming portfolios.
Fundamentally strong, the supermarket sector as a whole has benefited from robust investor demand for long safe income. The sector as a whole has performed well, but we expect wider variation in future performance, placing a greater emphasis on stock selection.
Due to inelastic demand, expenditure on food has limited growth potential and, as a result, supermarket strategies have evolved over time to grow revenues. New approaches included expansion into higher margin non-food product categories. Property requirements have evolved to accommodate these strategies; store numbers have increased to grow market share and store floorplates enlarged to offer larger ranges of non-food products.
In recent years sales growth has not kept pace with expansion, putting space productivity under pressure. There are a number of factors driving this change including; online competition, saturation in the supermarket sector and changing shopping patterns driven by economic and demographic factors. The structural issues affecting the High Street have been well documented, but their impact on supermarkets has attracted little attention. The general merchandise categories first stocked by larger supermarkets, such as books, electricals and music, have been affected by competition from online retailers.
Property requirements are reacting to these changes. The expansion of new, large format supermarkets has slowed. Unviable out of town sites, earmarked for future development have been written down. Food store operators are adopting strategies to improve space productivity in larger supermarkets, sub-letting space to restaurant operators, gyms or other complementary retailers to help fill excess space and drive footfall into stores where densities are lower.
Expansion in recent years means that some catchments are now fully represented by the major supermarket operators. Rental growth potential could recede for sub-optimal stores in these locations and operators could also resist longer leases as they seek to build in more flexibility. We expect future divergence in investment performance between supermarkets, with age, configuration and location seen as key differentiators of success.
As a result, LGP continues to mitigate some of these challenges by favouring supermarket assets that are characterised by three elements: those with high sales densities, those that demonstrate resilience to online sales diversion and those with high accessibility.
Tom Carlton, Retail research specialist at Legal & General Property, comments: “Given the strong fundamentals demonstrated by the sector, we expect supermarket returns to outperform the all property average over the medium term. Future rental growth, however, is likely to be more site specific. Optimally sized supermarkets with index linked leases will continue to see strong investor demand, whereas large supermarkets with low sales densities, high exposure to non-food sales diversion and shortening leases are more vulnerable as supermarket performance diverges.
“Against that background, understanding individual store dynamics will become increasingly important in building outperforming supermarket property portfolios and we expect wider variation in future returns, placing a greater emphasis on stock selection.”
Notes to editors
Legal & General Property
Legal & General Property (LGP) is a wholly-owned subsidiary of Legal & General Investment Management (LGIM), one of Europe’s largest institutional asset managers and a major global investor. LGIM manages approximately £443bn in assets on behalf of more than 3,100 clients (30 September 2013) and provides products and solutions spanning all asset classes. LGP is the third largest institutional property fund manager in the UK, managing or co-managing 16 separate funds or vehicles and two segregated mandates with an aggregate asset value of £11.6bn as at 30 September 2013. These funds include:
Specialist Pooled Funds
The Leisure Fund Limited Partnership; Industrial Property Investment Fund; Arlington Business Parks Partnership; and the English Cities Fund
Single Asset Vehicles
Bracknell Regeneration Partnership; Central Saint Giles Partnership; Performance Retail Limited Partnership and Warrington Retail Limited Partnership
Life Fund; Linked Pensions; Linked Life; Managed Fund; Property Unit Trust; UK Property Income Fund; LPI Income Property Fund and the Hybrid Property Fund.
LGP’s UK-focused fund management platform has built and retained a strong track record of out-performance across the sector. Owing to its size, diversity and penetration, it benefits from best in class banking and property industry contacts which, along with its wealth of in-house skill and expertise, have enabled it to continue to attract and secure high quality market opportunities. Taking a client-centric approach, the business places the highest priority upon integrity and transparency, leveraging upon the significant resources provided by the wider LGIM platform. Sector specialists cover each sphere of the market and are supported by LGP’s market-leading research capability. LGP’s sector specialisms cross all facets of the real estate market. In particular, the Company has a major development platform, responsible for delivering West End landmark building, Central Saint Giles, and Agar Street, its high profile Covent Garden office scheme, amongst others, and is currently involved in bringing forward a number of significant town-centre retail and leisure regeneration projects, including Bracknell, Trowbridge, Northampton and Eastbourne.
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About Legal & General
Legal & General Property Limited.
One Coleman Street
London EC2R 5AA.
Registered in England 2091897.