Investors in the UK supermarket sector may see a sharpening of yields towards the end of next year. A series of sale-and-leasebacks have driven 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
In its latest UK Supermarket Investment Update, the specialist retail consultancy, Font Real Estate, comments: “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, if the sector may be set to 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 notes: “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 comments: “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 £13bn in December. According to Kantar, in the four weeks to November 26th, grocery sales grew 6.3% to £11.7bn.