Large UK supermarkets ‘uneconomic’, warns property chief

The growth of online grocery shopping is set to hit the value of large supermarkets, a veteran property industry investor has warned, saying it is “only a matter of time” before store groups, property companies and pension funds will have to cut the value of these assets on their balance sheets.

Patrick Vaughan, chairman of FTSE 250 property company LondonMetric, who has floated three listed property companies in his 40-year career, said the retail property market was undergoing “seismic change” as consumers modified their shopping patterns, prompting many to “rightsize” their portfolios.

“This is particularly prominent in the food sector where the growth in convenience and online shopping is having a significant impact on the larger superstores,” he said. “It is only a matter of time before this has a negative impact on the value of those large stores that occupiers no longer consider economically fit for purpose.”

Following a two-decade long “space race” that saw the UK’s large supermarkets aggressively expand their portfolios and develop huge out-of-town stores, shoppers are less willing to drive miles to make a “weekly shop”. Combined with the rise of discounters such as Aldi and Lidl, British supermarkets saw their first fall in UK grocery sales in 20 years this month as a vicious price war cut the amount consumers were spending at the tills.

J Sainsbury announced this month that it was shelving new stores to invest in price-cutting, following Tesco’s announcement in April that it would scale back the openings of big stores. The retailer has also tried to revive the appeal of its 247 Tesco Extra hypermarkets by adding gyms, restaurants and coffee bars to selected stores.

While WM Morrison and Walmart-owned Asda both own the majority of stores that they trade from, Tesco and Sainsbury have conducted “sale and leaseback” deals with investors over the years, including property companies and pension funds.

Andrew Jones, chief executive of LondonMetric, said many large supermarkets were valued at yields of 4-5 per cent on balance sheets, but argued this should already be closer to 6 per cent.

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“Large stores are no longer fit for purpose as customers migrate online, and every food retailer is talking about contraction rather than expansion,” he said. “You have to reflect that in the valuation, which is supposed to reflect the potential earnings capacity of that space,” adding that the prospects for future rental growth were doubtful.

“Rents have ridden up in the bull market, but thanks to the upward-only rent review system we have in the UK, when the bear appears, the rents don’t fall,” he said. A valuation yield of 6 per cent would reflect what large DIY stores are commonly held at, he added, noting Homebase’s recent plans to shed a quarter of its stores as it becomes more digitally focused.

LondonMetric has only one UK supermarket on its books, though Mr Jones’s previous employer, British Land, has been a significant buyer of stores.

“To give them credit, they’ve reduced their exposure,” he said. “Tesco’s own pension fund has historically been a big buyer [of large stores] and many local authority pension funds have also gone in via intermediaries.”

Mike Prew, property analyst with Jefferies, agreed that the “conventional supermarket format is facing a demographic crisis”.

“Young, growing families have less tolerance of out-of-town hypermarkets and would rather shop online, and retiring people will pay a premium to shop conveniently,” he said.

“Translated to a property context, these low yields probably aren’t sustainable, but this is also down to capital markets – the recent credit downgrades on supermarket tenants like Tesco must eventually feed through into the value of their stores.”

LondonMetric’s investment strategy has been to shun traditional shops in favour of buying retail parks and distribution warehouses occupied by retailers who are embracing the trend towards internet shopping. Following a period of reshaping, nearly 90 per cent of its portfolio consists of such assets, including warehouses let to the retailers Dixons Carphone, Argos, Marks and Spencer and Boden, plus retail parks where shoppers can “click and collect”.

On Wednesday, LondonMetric’s half-year results showed a 57 per cent increase in pre-tax profits to £70.4m as its property portfolio increased in value by £52m. Net asset value per share was 128.5p.

In early trading in London, shares in LondonMetric were up 1 per cent at 152p.