The Rise of Essential Retail Centers

Why are brands like Sleep Number and Ulta expanding into neighborhood centers? Three reasons: steady traffic, closer contact with customers, and last-mile delivery ability

It’s Monday Night Football, Lions vs. Packers. On ESPN2 Peyton and Eli Manning are experimenting with a new way to call a football game. Aldi, meanwhile, is sponsoring the broadcast with a spot that highlights its new slant-roof stores (just like Lidl’s) and ends with the tagline, “You can’t let your friends spend too much on groceries.” It’s a new-new-wave merge of 21st Century football and 21st Century retail: a pair of Super Bowl QB brothers changing the way football games are broadcast supported by a growing supermarket chain pledged to provide essential goods at low cost.

COVID-19 shined a bright light on grocery-anchored centers. With enclosed shopping centers largely shut tight in the height of the pandemic, supermarkets in smaller neighborhood centers met the needs of consumers within three-to-five-mile radii and their owners held on tight to them. Investor’s acquisitions of grocery-anchored centers declined to a deal total aggregate of $4.5 billion in 2020, a 26% drop from 2019, according to CoStar, a commercial real estate information provider. This year, the transaction volume rose to $6.1 billion, very close to 2019’s total.

Aldi will be showing up in neighborhood centers both existing and new in the years ahead, as new neighborhoods themselves continue to take shape in high-growth states in the West and the South such as Washington, Arizona, Texas, and Florida. With 2,100 stores, Aldi is on track to become the third-largest grocery retailer by store count by the end of 2022. And just out of the gate with 18 stores, Amazon Fresh is likely to be competing with Aldi and its fellow German competitor Lidl for space in thriving neighborhood centers.

Longtime leaders of the supermarket business had record years. Kroger reported an increase in net income from $1.66 billion in 2019 to $2.56 billion in 2020, according to First National Realty Partners, and Albertson’s net income nearly tripled to $1.89 billion.

“Any business that was deemed essential during the stay-at-home mandates was able to remain open for business and pay rent. That caused buyers of retail assets to become more focused on grocery-anchored shopping centers as a hedge against any future lockdowns and increasing inflation,” said Kevin Fryman, executive VP of Hanley Investment Group, which provides market information, and brokers retail acquisitions and dispositions.

Non-essential retailers, too, including Ulta Beauty, Sephora, and Sleep Number—mall and urban retail tenants—increased their presence in grocery-anchored centers in vibrant neighborhoods to give them closer access to their best customers.

“What brands like Sephora and Ulta are increasingly recognizing is that you cannot beat the foot traffic generated at shopping centers like the ones we own,” said Bob Myers, COO of Phillips Edison & Company. “The average American visits a grocery store approximately twice per week. There is no other category that gets this kind of live access to consumers. By introducing smaller format stores in grocery-anchored shopping centers and opening store-within-store concepts – as Ulta is doing with Target – these retailers are meeting their end-users where they are, and where they shop most often.”

Owner-operators of grocery-anchored centers are tracking the retail winners and losers during the pandemic to see which ones can fit in their centers as enduring tenants and traffic-builders. In a September Bank of America presentation, Kimco CEO Conor Flynn said his company was paying close attention to which retailers made critical investments to reinvent their value propositions during the pandemic. This year, Kimco merged with Weingarten and became one of the nation’s largest owners of grocery-anchored centers with 559 properties.

“If you think about it, the highest-traffic locations are near the entrances of supermarkets. There’s no location better than that,” Mike Makinen, the COO of neighborhood center owner ShopOne, told Chain Store Age in an interview earlier this year.

Another big driver? Drive-thrus

Single-tenant net lease properties favored by QSR and fast-casual chains sold quickly in the past year and at competitive prices, according to research from real estate broker Stan Johnson Company. In the second quarter of 2021, $8.4 billion in investment sales were reported, a 20% increase from Q1 and 72% higher than the same time last year. Some of the highest-profile transactions were Amazon-leased properties.

Net lease properties, for which renters agree to pay property taxes, were in high demand during the pandemic among well-capitalized food and beverage chains like Starbucks, Chipotle, and McDonald’s. Properties with drive-thrus were especially desired.

Municipalities have long been averse to approving too many drive-thrus in centers situated near busy intersections, so those properties were quickly snapped up, and at competitive prices. But, not long into the pandemic, town officials have made turnabouts on drive-thrus, pretty much nationwide. Public demand for takeout food and outdoor dining spaces became so great that municipalities across the land loosened up their strict policies.

“We anticipate that curbside pick-up and drive-thru will play a significant role in the layout and design of shopping centers moving forward,” said Phillips Edison’s Myers. “Prior to the pandemic the ability to add drive-thru was largely contingent upon local zoning restrictions and allowances and often required significant effort to approve. Now we’re seeing zoning committees increasingly approve these modifications because of strong consumer demand.”

Fryman of Hanley Investment believes this trend will have a huge impact on how grocery-anchored centers will be designed and operated.

“We are already seeing the development of more quick-service drive-thrus with less café and restaurant space and more drive-thru lanes, which can impact the design of a shopping center,” he said. “The use of these outparcels for fast-food or coffee allows the developer to increase the center’s cashflow or sell the net-leased investment.”

Widened foodservice options have been a dominant trend across all segments of retail real estate, and all operators of grocery-anchored centers contacted for this story hailed local government officials easing up on drive-thrus.

“There is no doubt that the outparcel has become the crown jewel of the neighborhood center and so it’s great that municipalities are seeing the importance of drive-thrus on these pads,” said Alan Roth, senior managing director of the East region for Regency Centers. “We are seeing opportunities that historically had problems getting municipal approvals.”

Outparcels allow developers like Regency, which owns and operates 406 properties in the U.S., to widen its tenant curations. A section on its website invites potential lessees to search “second-generation spaces” across its portfolio in three categories: restaurant, medical, and salon.

Brixmor, rated the fifth-largest holder of retail real estate with some 500 properties totaling 87 million sq. ft., has a long history of introducing new dining concepts at centers anchored by Publix, Acme, Trader Joe’s, Stop&Shop, Kroger, and Giant Eagle, among others. A search on its listing of pads and outparcels turned up 133 open spaces. In the right centers, it uses outparcels to add larger and higher-priced food and beverage operators such as Iron Hill Brewery in Newtown, Penn., and Hampton Social, a three-story restaurant with a “Rosé All Day” lounge on the first floor, in Nashville.

 “One thing that we’re fortunate to have is very large parking fields. We’re adding between 15 and 20 outparcels a year across our portfolio,” said Brixmor’s senior VP of leasing Brian Finnegan. “Our larger tenants have been very receptive to this. They recognize the amount of traffic that a Panera and a Starbucks can bring to shopping centers.”

The outposts of last-mile delivery

Because grocery-anchored centers are widely spread and narrowly focused, not all could accommodate three-story restaurants and brewpubs—but all might have the opportunity to serve as last-mile delivery bases in the omnichannel era.

Kroger and its allied brands Harris Teeter, Ralphs, and King Soopers grew their online sales 116% to $10 billion in 2020, and the company has stated that it intends to double that number by 2023. Walmart’s online revenues grew 79% in its fiscal year ended in February 2021.

Walmart, No.1 on Progressive Grocer’s Top 100 supermarket list, and Kroger, No. 3, now have to spend the next decade contending with No. 2 Amazon. It gained that position with its acquisition of Whole Foods, but Amazon doesn’t enter any business without the expectation of becoming No. 1. It aims to nudge its way into the top spot with Amazon Fresh.

Google Amazon Fresh and one finds a listing that reads, “Amazon Fresh – Same-Day Grocery Delivery,” not standard supermarket claims like “Lowest Prices” or “Freshest Meat & Produce.” After ordering online (a list can be read to Alexa), shoppers select two-hour windows in which to receive their deliveries. Packaging created especially for Amazon Fresh keep items at proper temperatures.

As a result, startups like 1520, JOKR, Getir, Gorillas, and Fridge No More have begun offering rapid deliveries of grocery orders by opening offices in neighborhood shopping centers and industrial parks. 1520 promises deliveries within 15 to 20 minutes. JOKR’s motto is “Groceries. In the moment.” and promises deliveries in 15 minutes. Gorillas promises to arrive with your order in only 10 minutes. And Getir—a Turkey-based service that has collected $1 billion in three funding rounds this year—eliminated itself from the race by promising to show up at people’s doors simply “in minutes.”

“Kroger’s announcement of partnering with Instacart solves their need for last-mile home delivery. HEB, the leading grocer in Texas has acquired Favor to serve their online purchase delivery needs,” said Naveen Jaggi, president of retail advisory services at JLL, a global real estate services firm. “This tells me that the other major anchors from Publix to Albertsons to Whole Foods will all have to match their competitors with similar, dedicated services offering. Add to the mix Gorillas, Fridge No More, and Jokr, who all want to locate in neighborhood centers to deliver in 15 minutes or less.”

Regency’s Alan Roth, who’s spent 25 years in the business, allowed that the pandemic had a historic effect on grocery-anchored centers but noted that big changes were already underway prior to the onset of COVID-19.

“We started seeing new tenants with dual approaches coming into our centers years ago,” Roth said. “Look, the one thing that’s been constant in this business is change.”

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