Senior Managing Director, A&G Real Estate Partners
Now is the time for grocers to rethink their real estate for a post-pandemic world.
While many chains performed well over the past year, consumer spending continues to swing back to dining out, in-person entertainment and travel. That means many grocers will need to redouble their efforts to improve fundamental weaknesses that they were able to gloss over during the pandemic, such as subpar in-store experiences and inadequate omnichannel infrastructure.
Optimizing real estate is an important way to free up the capital needed to fix those problems. Here are a few considerations.
Align Your Real Estate and Business Plans
When managing your real estate on a day-to-day basis, it’s possible to lose sight of steps you can take to ensure that your portfolio supports your longer-term strategic vision. Today’s grocers are increasingly interested in optimizing and integrating their supply chain and omnichannel capabilities with their stores, including adding the likes of micro-fulfillment centers (MFCs), dedicated parcel pickup lanes and parking spaces for fulfilling online orders. These imperatives influence both the optimal store footprint and the ideal placement of individual store locations (a grocer may want, for example, a hub-and-spoke system of several stores served by a single MFC).
Your real estate plan needs to span multiple years and be fully in synch with all such strategic considerations. This will allow your real estate team to operate on a more forward-looking basis instead of being focused primarily on short-term asset management decisions.
Plan Early for Lease Expirations/Extensions and Store Closures
Many grocers have plenty of older store leases that are in five-year renewal options. As a result, a typical company has anywhere from 10% to 20% of its leases coming up for renewal every year. Grocers should start evaluating those properties and engaging with landlords at least 24 months before the option notice deadline. This provides more time to determine what is possible and how this aligns with the broader business plan, as well as the ability to evaluate alternatives.
Extending a lease well before its expiration date is another way to create incremental value. This is particularly true if the extension occurs in conjunction with the remodeling of a high-performing location.
Consider a scenario in which the grocer operates a 50,000-square-foot store in a neighborhood shopping center and is paying $750,000 annually in rent, with plans to spend more than $3 million on a renovation. If the grocer extends the lease by 10 years (presenting little risk to the grocer in this example), the sale value of the center could be increased by up to $2 million. This gives the landlord a good reason to provide rent concessions, contribute capital to the remodel and/or make improvements to the center.
In such situations, grocers can bolster their chances of success if they present the opportunity early in the planning process and have some flexibility in how they prioritize their remodel capital spending, based on the landlord’s cooperation.
Make the Tough Decisions Now
In other cases, the right move may be to close a store. Simply put, being locked into a lease is no justification for continuing to operate money-losing locations, even where cash flow is covering a large portion of the rent. To thrive as the grocery business settles into its new equilibrium, it's more critical than ever to be aggressive in right-sizing, consolidating and relocating your stores as needed. Otherwise, you will remain vulnerable to competition.
By making tough decisions proactively, grocers gain the time needed to pursue early lease terminations and find suitable replacement tenants. The fallback position should never be to operate a lackluster location for limited cash flow until its lease runs out.
Appreciate Your Leverage
In today’s marketplace, grocers enjoy even greater leverage than in the recent past. Even before the pandemic, grocery-anchored centers were prized by real estate investors looking for a safe harbor, but investors’ preference for this asset class has been even more pronounced of late. To maximize the productivity and value of grocery-anchored properties, landlords are scrambling to add outparcels, drive-thru lanes and other convenience-oriented amenities. As the economy heats up, they are finding ready takers in the form of expanding retail and restaurant operators.
But due to protective lease restrictions commonly enjoyed by grocers, landlords are often unable to pursue such plans without their permission.
With this powerful bargaining chip, you stand to secure lower rents and more favorable terms in exchange for granting the landlord greater freedom to redevelop the property and repurpose common areas. Just make sure that you fully understand your rights under the lease and receive appropriate value for agreeing to those modifications. You’ll also need to adequately protect your own visibility, parking and customer access as part of allowing any such changes to the property.