A turning point for supermarkets as new REIT launches?

The Supermarket Income REIT is banking on future stability and growth in the supermarket sector after years of doubt, profit warnings and store closures.

The new launched REIT announced an intention to raise £200m through its initial public offering, and has five assets already identified worth £263m.

The REIT could be being launched as the sector reaches a turning point from its correction following years of overexpansion, and that is what the managers of the new REIT are hoping.

“In recent times yields have been drifting wider and the supermarket sector is looking like very good value against all property and other long income asset classes,” says Ben Green of Atrato Capital.

“We thought there was a great value opportunity there, given the length of leasing, inflation linking, and if you pick the right locations you have the critical infrastructure for grocery retail.”

Atrato has been set up specifically to run the new REIT.

Green has acted on more than £3.5bn in sale and leaseback deals, most recently at Goldman Sachs where he was managing director and European head of structured finance. Partner Steve Windsor was also at the investment bank heading up its European, Middle East and African debt capital markets and risk management businesses.

Nick Hewson, former founding partner of City Centre Partners and Granchester Holdings, will be chairman of the new REIT, joined by Sainsbury’s former head of property investment Vincent Prior.

The REIT is aiming to take advantage of stabilising sector.

“There were some store closures a few years ago, but when you talk to teams now, they are not contemplating closing any more stores – all are important strategically,” says Green.

“When you look actually at their business models in this new lower margin world, volumes are critical, and bigger stores are where they drive the majority of volume.”

However, previous instability has made returns in the sector far more attractive, and the first five assets will have a net initial yield of 4.9%. They are being bought from a number of different funds, not any single portfolio.

It is specifically targeting inflation linked leases, which Windsor says are where there is real value.

“If you have the ability to look across asset classes, inflation is incredibly expensive in the fixed income market, but in the property you do not get charged a big differential between buying an inflation linked lease in the supermarket space, versus buying an open market rent review lease,” he says. “We think that’s mispriced and there is value there for shareholders.”

He adds that the lack of new store openings, as well as changing accounting rules which classify leases as debt, mean there is likely to be a net reduction in the number of supermarket assets, a further attraction.

“That incentive to take property off balance sheet has gone under the new rules, so you might as well just own it,” he says. “If you look at the property sector at large, its nearly always a positive supply market – you can build more of it. Supermarkets are standout in that they are currently in negative supply, as there is little new stuff being built, and all of the stories are looking to buy back their existing assets.”

Even so, the intention is to buy assets with alternative use potential.

“We only buy stores on long inflation linked leases and with annual rent reviews,” says Green. “We want sites which are strong traders, in dominant positions… Then we are looking for large sites, so we get low site cover, lots of land, with lots of people around and transportation links so that in the long run we are sure they will continue to trade as grocery stores, but if they don’t there are lots of other things we could do with the sites.”

The fund will be avoiding London, though not the South East, and Windsor says there is no geographical bias. The hope is to get it up to about £1bn. They say its higher income return and the fact it is not chasing the same assets as other long income funds should help fundraising.

In a sector worth about £100bn in total, where £20bn is third party owned, they say they are the only private operator chasing new assets.

“We have genuine index linking from very substantial covenants, with great underlying real estate,” says Green.

“We think over time this has the potential to be 10% of that [£20bn] market share, but that will take time. Let’s see what happens to supermarket asset pricing along the way,” says Windsor.