Texas Real Estate Business - March 2013 - by John Zikos and Kenneth Katz
The next generation of grocers is moving into Houston and Dallas/Fort Worth (DFW) with remarkable speed. During the past 18 to 24 months, activity by this segment has outpaced the rest of retail and then some. Fueled by abundant, low-cost capital and higher profit margins, grocery chains have been signing leases, backfilling vacant locations, acquiring competitors and breaking ground on a spate of new stores. The list of active players includes Aldi, H-E-B, WinCo Foods, Trader Joe's, Whole Foods, The Fresh Market, Sprouts, Kroger and Walmart Neighborhood Market, to name a few.
In the retail world, Houston and DFW have long been considered among the more competitive metro areas in the country. And over the past 10 years or so, grocers have certainly been active in both markets. But the arrival of so many new concepts—most notably Aldi, Trader Joe's, Sprouts and The Fresh Market—in such a short time is noteworthy.
With rumors of an impending public offering, Sprouts has been particularly aggressive. One of the fastest-growing retailers in the country, the Phoenix-based chain, which opened 23 stores in 17 months between May 2009 and October 2010, now operates 150 stores in eight states, including 23 locations across Texas. With its 25,000-square-foot prototype and narrowly targeted core customer, Sprouts typifies today's new breed of grocer. Its list of Texas grand openings for 2013 includes markets such as Katy, Cypress, Copperfield, Houston, Keller and McKinney. But even as the likes of Sprouts, The Fresh Market, Trader Joe's and Walmart push forward with smaller-format stores, established players such as Kroger and H-E-B are scouting for suburban sites that are big enough for traditional supermarkets. After opening a store in Burleson a couple of years ago, H-E-B had planned to build an 88,000-square-foot location in Granbury. Before construction even started on the new location, which opened in September 2011, the San Antonio-based company opted to ramp up the footprint to 101,000 square feet. And stores of up to 127,000 square feet are still on its radar.
Grocers Bullish on DFW & Houston Markets
Why are grocers so bullish on DFW and Houston? The economies of both MSAs have performed well over the past few years. The Greater Houston Partnership predicts the 10-county metro area will add 76,000 jobs this year, with solid growth in the construction, health care, leisure and hospitality sectors.
Grocery stores, too, are reporting solid growth—notably in the form of expanded store counts and higher same-store sales and profits—and this is helping to buoy their expansion efforts. Kroger, for one, has posted same-store sales growth for 36 consecutive quarters, including a gain of 3.2 percent in the third quarter ended Nov. 3, 2012. In DFW alone, Kroger has said it plans to open three stores in 2013, as many as four in 2014 and, ideally, up to eight in 2015. Meanwhile, Whole Foods’ earnings before interest, taxes, depreciation and amortization ("EBITDA") increased 36 percent in fiscal year 2012 to $252.2 million. In a press release, John Mackey, co-founder and CEO, described last year as the best in Whole Foods' history. "Our accelerated growth plans are on track," he said. "We expect healthy comparable store sales growth and continuing operating margin improvement in fiscal year 2013."
Other factors may be contributing to these growth trends as well. Shopping patterns, for example, appear to be shifting. Twenty years ago, the typical American family did all its food shopping at one store, often in a single, cart-busting visit. The "modern family" of today, by contrast, might take three trips in a given week—buying packaged foods at Kroger, organic produce at Whole Foods and bulk items at Costco. Smaller-format store concepts can also make it easier for chains to capitalize on these opportunities.
Over the past 15 or 20 years in North Texas, Walmart has had great success with its smaller-format neighborhood market stores, which are typically between 40,000 and 65,000 square feet. The Bentonville, Ark.-based retailer now operates 39 neighborhood market stores across the state, including three in Fort Worth, three in Dallas and six in Houston. With this diminutive footprint, Walmart is able to fill in the gaps between its massive Supercenters. And now other chains are eager to target smaller populations of shoppers in the same way. For example, The Fresh Market is opening four Houston locations at Memorial Drive, Holcombe Boulevard, San Felipe and Westheimer Road, and has signaled its intent to explore expansion opportunities in DFW as well.
Given the aforementioned trends, it should come as no surprise that acquisition-minded REITs and institutional investors are quite bullish on grocery-anchored retail in DFW and Houston. Indeed, this favored product type is trading at low cap rates (typically in the low-six range or even lower) and in these markets may be the most favored acquisition target of all, with the possible exception of certain blue-chip infill properties. However, the longstanding model for grocery-anchored shopping centers appears to be changing. Historically, whether the anchor was a 60,000 or a 140,000-square-foot grocer, the center would include 50,000 or 60,000 square feet of adjacent small-shop space. Increasingly, the new centers of today are being built with just 20,000 or 25,000 square feet of shop space. So while the likes of Walmart, Kroger, Aldi and H-E-B are doing plenty of ground-up development in these markets, this trend will not necessarily translate into a huge boom for shopping center landlords or mom-and-pop retailers.
Outlook on Expansion
Will the grocery expansion continue indefinitely? On the one hand, these chains and the developers they work with certainly have a freer hand than they did a few years ago. Flush with cash, grocers that prefer to own their real estate are now able to buy sites when they see fit. On the lending front, underwriting standards are continuing to ease, and lenders are under increasing pressure to deploy capital for the right kinds of retail projects. This means build-to-lease developers are having a far easier time financing good projects. Indeed, the debt availability today is mind-boggling considering where it stood just a few years ago.
On the other hand, the ongoing grocery expansion might eventually outpace even the robust population growth in both MSAs. The amount of grocery spending that can occur in these markets is, after all, finite. At a recent industry event, a top executive at Kroger expressed surprise at the eagerness of rival chains to flock to these already competitive markets. One possibility is that the influx will boost the fortunes of the strong even as the weak—a lagging chain like Houston's Randalls comes to mind—fall by the wayside.
Opportunities for infill expansion also are relatively limited. Today, chains like Aldi, Trader Joe’s, The Fresh Market and Kroger are doing their utmost to pursue these sites, but doing so requires creativity. The Fresh Market’s entry into Houston, announced last November, was made possible by a leasing deal it did for four Rice Epicurean Markets. (It is perhaps telling that Rice Epicurean's owners would rather sit back and act as landlords over these expensive infill sites than continue to run grocery stores.) Meanwhile, Albertson's disposition of its Texas stores is finally winding down, thanks in large part to Walmart’s interest in these boxes. Thus in certain submarkets—Plano, for one—finding a box to backfill can be a difficult prospect.
All of this points to potential constraints on grocers' local growth. This trend might last for a few years, or fizzle with little warning. Regardless, the arrival of so many new players will have a big impact on the grocery landscape in Houston/DFW. It is already changing the way people shop. Ideally, the increased competition will force all of these grocers to put on their "A" games, which should make the shopping experience that much better for consumers, and the pricing all the more attractive.