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Grocery Retailers Face New Times

New competition, consumers who shop multiple stores are just a few of the issues grocery retailers are working through

Interview by Randall Shearin

Shopping Center Business – May 2017

A&G Realty Partners has been known for a number of years as a company that assists retailers with right-sizing portfolios. From lease workouts to excess space leasing, A&G’s clients have run the gamut across the retail spectrum. The company is creating a new division to assist in the grocery retail business. The division will be created through a joint venture with Oak Brook, Illinois-based Elkhorn Real Estate Partners and will be headed by Joe McKeska, a 25-year veteran of the grocery real estate business. The goal of the division is to help retail investors and retailers evaluate their portfolios, with an emphasis on grocery retail.

Shopping Center Business recently spoke with McKeska to get an understanding of the evolution of the grocery business today, where it is headed in the future, and how Elkhorn and A&G can assist clients to create strong real estate.

SCB: We are seeing a lot of changes in the grocery business around the country, both in terms of expansion and contraction. Tell us about the state of the grocery industry today.

MCKESKA: The grocery business is already very competitive, and is growing more so all the time. There are a number of new grocery formats and channels that are impacting the industry. This includes organic and high-end concepts entering various markets, including Sprouts and Fresh Thyme. On the discount end, Aldi continues to add new stores at an aggressive pace and while Walmart’s new store growth has slowed, they are still adding a number of new locations. In addition, there are brand new players such as Germany’s Lidl entering the U.S. on the East Coast and Southeast, where they will be adding several hundred stores over the next few years. Lastly, there has also been the continued growth of club stores such as Costco and in the number of non-grocery retailers who are adding food to drive sales and traffic, such as dollar stores.

SCB: Which areas of the country do you see the grocery industry most active right now?

MCKESKA: The Southeast and Eastern Seaboard areas are experiencing an in-ordinate amount of competition. This is due in large part to the fact that these areas are experiencing strong population growth with relatively strong economies and low unemployment rates. Also, many of these markets have been under-penetrated in terms of per capita grocery store square footage and the number of new store concepts available. Dallas is also a competitive market, with both H-E-B and Lidl acquiring real estate to enter the market at some point in the future.

SCB: What are some of the trends with real estate and grocery stores?

MCKESKA: Kroger is rolling out a larger format store — its Marketplace concept — in many of its markets. Most of the rest of the industry, however, is shrinking the size of their store formats. That is due to the continued fragmentation in the way consumers are shopping and the anticipation that the trend of certain traditional grocery categories moving online will accelerate in coming years. As an example, it is expected that more items like paper products, health and beauty care and many center store categories will increasingly move online, with a recent Food Marketing Institute and Nielsen study estimating that 40 percent of current center store sales could be made online by 2025. While traditional grocers have been expanding their fresh food departments to make up for the reduction in sales in these categories and to better compete with online merchants, this has not been making up for the loss of sales in non-fresh areas.

SCB: Is the grocery business bifurcated between the high end and the low end?

MCKESKA: Yes. As has been widely reported, the country has seen an increase in income stratification over the last few decades. In addition, we have had increasing multi-ethnicity, led by the growth in the Hispanic population as well as changes in generational shopping behaviors between baby boomers and millennials. There are a lot of issues happening socially that are resulting in fragmentation in the way that people shop for groceries, even before factoring in the impact of technology and e-commerce. While traditional grocers have been under pressure for some time, certain grocers are doing a nice job of adapting, such as the way Kroger customizes its stores to fit its neighborhoods and provides personalized offerings to attract shoppers. On the other hand, a number of traditional grocers have struggled to keep up, many of whom are seeing their sales flow to online competitors and price operators like Walmart and Aldi, or in higher income levels, chains like Whole Foods, Trader Joe’s and Sprouts.

SCB: How is the high end of the market performing?

MCKESKA: The high end of the market has become a lot more competitive over the past several years. There is opportunity, but the premium and natural/organic market, while still growing rapidly, remains a relatively small segment of the overall market. The premier example in this sector is Whole Foods Markets. As has been well documented, Whole Foods has struggled as of late. It is closing 29 stores and has backed off its goal of growing to 2,000 stores or more. Whole Foods is also rolling out its 365 stores that are more price focused while still heavily natural foods oriented. It used to be that people would drive several miles to go to a Whole Foods because it was one of the few options available to purchase high quality and a large variety of natural and organic groceries. Because of all the new entrants like Sprouts, and because traditional grocers have added a significant amount of organic and natural foods, consumers no longer have to travel as far as they used to for that type of offer. Accordingly, Whole Foods is now focusing on its core customer in order to get them to shop more frequently and spend more. They recognize that the days of getting people to travel a distance to shop with them are mostly over, given the multitude of additional natural and organic options consumers have in closer proximity to their homes.

SCB: Should grocery retailers be rethinking their real estate? How can they make their real estate portfolios better? How can they work with landlords to get to a better portfolio?

MCKESKA: Because of the rapidly changing nature of the grocery retail industry there will be winners and losers. The grocery retailers who are going to be the most proactive by investing in their business — including testing out new formats and concepts, investing in technology and digital, and growing their e-commerce capabilities — will be the ones most likely to be successful. Walmart and Kroger are doing a lot of work to create ‘click-and-collect’ locations at their stores and are aggressively testing and rolling out new technology. Traditional grocers over-all need to be proactive and aggressive when looking at their real estate footprint to identify opportunities to invest in those markets and assets that are strong performing so as to profitably maintain and grow their position in these markets and trade areas. By the same token, they may have to make some tough decisions relative to restructuring or pruning markets and/or assets when necessary. They need to be proactive by planning and acting well in advance of a decision being forced on them, such as chronically poor performance or a critical real estate event occurring.

SCB: Who are the formidable players in the grocery business today?

MCKESKA: There are a number of strong regional players, like H-E-B, who are expanding aggressively. I mentioned Lidl earlier, as well as Sprouts, who are both aggressively opening new stores. Trader Joe’s and Aldi are also still expanding. Aldi also has a program to remodel the majority of its stores over the next few years, which will expand the sales area for its fresh foods offering. Publix is also aggressively expanding into new markets as they move up the Eastern Seaboard. The number of new grocery stores overall, however, is slowing dramatically as evidenced by recent announcements from Kroger and Walmart relative to the reduction in the number of new stores they will be building in the future. Instead of aggressively adding new stores, these retailers are focused on strengthening their existing portfolios and improving the productivity of the square footage they have.

SCB: What are the threats to the grocery business today?

MCKESKA: The leading threat is the growth of online sales. In the past, investors have viewed grocery stores as being relatively immune to online sales, but I think that thought process is beginning to shift. It will take time, so it won’t happen as quickly as in other sectors of retail, such as clothing, electronics and soft goods. However, I do think the industry realizes it is coming and will dramatically impact their business in the coming years. In fact, the previously mentioned Food Marketing Institute and Nielsen study estimates that online food-at-home purchases will grow from an estimated 2 percent of the market today to 20 percent by 2025. This represents approximately $100 billion in annual sales and 3,900 brick-and-mortar grocery stores. While it is likely that a significant portion of this growth will come from brick-and-mortar stores adding e-commerce capabilities, the overall impact will be substantial nonetheless.

SCB: How are you working with grocery retailers to mitigate the issues that they have?

MCKESKA: Grocery chains are trying to take a thoughtful approach to developing multi-year real estate strategies in alignment with their longer-term business plans. This is not an easy thing to do these days because of the continual and accelerating shifts taking place in the industry. It is easier to invest in the stores that are doing well and refrain from investing in those that aren’t. Overlaying a broader strategy beginning company-wide, then narrowing down to each market, and finally to individual assets and adjusting investment priorities and return expectations once the portfolio is filtered through these lenses is a wiser approach. We are using this approach to really drill down as to why and where to invest in particular markets and stores.

SCB: Tell us a little bit about your career?

MCKESKA: I have been in the grocery business for close to 25 years in various executive level real estate positions. I started with American Stores in the mid-1990s and moved to Albertsons when they purchased American Stores in 1999. In 2006, Albertsons sold the company in pieces, with the majority of the grocery store assets being sold to SuperValu, where I ultimately ended up running all of real estate until most of the assets were sold to Albertsons LLC in 2013. Until mid-2016, I was head of real estate for Southeastern Grocers, which operates 750 stores under the Bi-Lo, Winn-Dixie, and Harvey’s brands.

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