The single-tenant net-lease retail sector is expected to register far fewer 1031-exchange transactions in 2009. This trend, which began to emerge in the second half of last year, stems primarily from these investors' difficulty in trading out of more management-intensive apartment properties due to higher vacancy rates and stricter lending criteria. In addition to declining sales velocity, some exchange investors are modifying their strategies; these buyers are expected to attempt to shift their portfolios out of several smaller properties into one or two larger assets, reducing management responsibilities. This will likely lead to an increase in the number of smaller assets available for sale and heightened demand for larger, high-quality single-tenant properties. Cash buyers, meanwhile, are expected to try to take advantage of current conditions by acquiring distressed assets below peak market values.
The past year has been a turbulent one for owners and operators of c-stores and gas stations. Fuel costs were incredibly volatile in the second half of 2008, but appear to have stabilized. Despite a steep decline in retail sales at stations, lower fuel prices are resulting in higher profit margins for operators; as prices have receded, customers have become more likely to spend on higher-margin in-store items.
In 2008, sales velocity for c-stores and gas stations surpassed the levels recorded in the prior year, as investors were attracted to the sector's cap rates, which increased roughly 80 basis points in that time to the low-8% range. As profitability among operators continues to accelerate, these properties will likely remain a preferred choice among investors (see chart).
The report also covers other retail channels. In the quick-service restaurant (QSR) channel, Starbucks is attempting to manage costs by closing 600 stores and open fewer than 200 U.S. locations in fiscal 2009, down from previous plans for a 1,000-unit expansion. McDonald's and Wendy's continue to increase customer traffic through dollar menu options. As Starbucks is looking to contain expenses, McDonald's is trying to increase margins. The company is replacing its double cheeseburger on the Dollar Menu with the McDouble, which costs $1.19.
While QSRs will remain popular with investors, most buyers are exercising increased caution when selecting assets. As with many other property types, investors are favoring urban locations in primary markets where population density supports demand. As a result, QSRs in secondary and tertiary markets or those in outlying submarkets are recording reduced investor interest, even as average cap rates have pushed up into the mid-7% range in recent quarters.
The impact of declining consumer confidence and cooling spending is evident at casual dining restaurants. As sales slow, many restaurant chains are shuttering locations or limiting expansion plans.
As consumers grow increasingly cost-conscious, opportunities are emerging for discount retailers. Economic uncertainty has caused many consumers to look for additional ways to cut costs, resulting in a steady performance at discount retailers. At Wal-Mart, comparable same-store sales growth of 3% in the fourth quarter exceeded analysts' expectations. A profitable 2008, with sales growth of more than 9%, has encouraged Dollar General to double the number of new store openings this fiscal year to 450 locations. Family Dollar, meanwhile, announced in late January that quarterly earnings were up a better-than-expected 14.1%. It will target sites for renovation and operational upgrades.
Transaction velocity for discount stores picked up 17% last year, while the median price rose 22% to $104 per square foot. Some of the price growth is attributable to new properties trading during that time, rather than across-the-board appreciation. Cap rates have averaged in the high-7% to mid-8% range during the past year.
CVS and Walgreens still dominate the drugstore market, although front-end sales are beginning to weaken as consumers cut spending. During the fourth quarter, CVS Caremark acquired Longs Drug Stores, as well as the company's pharmacy benefits management service, RxAmerica. The transaction makes CVS the largest drugstore chain in the United States, with approximately 6,800 stores. Walgreens, the nation's second largest chain, at nearly 6,500 locations, has announced several initiatives intended to cut costs and strengthen its core business over the next several years. In January, Walgreens announced same-store sales growth of 0.4%, despite a front-end sales decline of 0.9%. The presence of these two major players, along with Wal-Mart's generic drug program, is making it difficult for Rite Aid to compete.
A reduced number of 1031-exchange buyers in the marketplace this year will significantly affect drugstores. Traditionally, investors have favored this property type due to the low risks typically associated with these assets; however, the nation's for-sale drugstore inventory has increased, as many buyers have not been swayed by average cap rates that have climbed past 7%. Although the majority of transactions contain corporate guarantees, sales velocity has dropped off and prices have dipped, trends that could continue through the next few quarters as constrained capital markets and fewer sales of other property types reduce the number of qualified buyers.
Smaller, locally based grocery chains are expected to continue to struggle this year as price wars are won by larger brands' economies of scale. Transaction velocity for all grocery stores fell 17% in 2008. A shift in consumer spending away from casual dining has resulted in an uptick in grocery sales. Both Wal-Mart and Kroger, two of the nation's largest grocery retailers, announced recent gains in customer traffic and subsequent rises in profitability.
Currently, the primary hurdle for many grocers is the inflationary pressure on brand prices. Despite the recent decline in commodities prices, major brands such as Nabisco, General Mills and Kraft have yet to pass along the savings to retailers. In response to manufacturers' concerns over whether or not commodity prices will rebound within the next six months, major grocers are promoting private-label brands in an effort to capture lost profits, a move that supported private-label growth of more than 10% last year. Another strategy some grocers are employing is the use of a smaller store footprint. Wal-Mart continues to move forward with its Neighborhood Market brand, while Safeway is testing its 15,000-square foot Market concept, and Jewel-Osco has introduced Urban Fresh locations in Chicago. The smaller formats offer fewer items, however, the products sold in the store often feature higher profit margins.
While grocers cite increasing costs as one reason for smaller store formats, some of the new concepts are in response to the ongoing expansion of British retailer Tesco. The company's 10,000-square foot Fresh & Easy stores now number approximately 100 locations throughout the West. Over the past year, Fresh & Easy stores in Arizona and Southern California have traded at approximately $250 per square foot and with average cap rates in the high-5% to low-6% range. Transaction velocity nationwide for grocery stores has fallen 17% year over year, while the median price has declined 10% to $183 per square foot.
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