Amazon's Whole Foods Deal Will Remake Strip Malls
What happens to small businesses if grocery stores shut down?
The implications of Amazon's $13.7-billion Whole Foods Market purchase will go significantly beyond the world of grocery stores, potentially reshaping retail districts in downtowns and suburban shopping areas across America.
Not long ago, the typical American strip mall had a video store, music store and a supermarket. However, Napster and iTunes slayed the neighborhood music store, Blockbuster's 9,000 video stores were killed by Netflix, and now the local grocery store will get a makeover. It's a change that will reimagine how we shop and create commercial real estate investment opportunities.
Amazon's purchase of Whole Foods dramatically changes the $674-billion U.S. grocery market. On the day the deal was announced, competitors across the board -- from Walmart and Costco to Kroger and Sprouts Farmers Market -- lost a combined $22 billion of market value. That loss came because investors expect Amazon to utterly transform the grocery business.
What's so scary about Amazon? It makes every business it competes with efficient, squeezing waste out of the supply chain and compressing margins for the entire industry. Now, Whole Foods' 450 stores in 42 states will form the start of a nationwide distribution center for groceries that will build upon the Amazon Fresh grocery delivery unit, founded in 2007.
All Whole Foods' stores won't close, but they will change. Yes, customers will always want a neighborhood store for the touch, smell and feel of certain things -- to pick up steaks for a dinner party, for fresh pastries and crisp lettuce. However, Amazon won't stock high-priced downtown real estate with excessive amounts of paper towels and floor cleaning products, or even dry goods such as pasta or canned beans. The mass of these items will instead be stored and distributed from regional warehouse facilities, perhaps automatically shipped directly to customers using predictive models. As a result, the average size of a typical Whole Foods store most likely will shrink, as will the average grocery store across America.
Some supermarkets will stay the same, for people who don't like shopping online or prefer a trip to the store. Most competitors, however, will adapt to the Amazon model, shrinking their footprint and bolstering online capabilities to become more efficient and automated. Large grocers must now change their business model or go the way of the dinosaur.
This will create significant disruption in commercial real estate as countless supermarkets go out of business, others remodel to occupy a smaller footprint, and some move to new premises. We saw similar disruption after the 2008 financial crisis when thousands of car dealers across America went bankrupt as credit dried up and countless supermarkets closed as property prices crashed. A repeat of that dynamic in the grocery sector will be a significant opportunity for investors in distressed assets. At Northstar Commercial Partners, for example, after the crisis we bought five vacated Albertsons stores in Colorado for less than 10 percent of their replacement value. Each of these were repositioned into alternative uses at attractive prices.
Investing in such properties, when they become available, requires a creative approach to what could work in the space, whether it's a single business or remodeling the space to create a series of smaller units. In the case of those Albertsons stores, for example, one is now occupied by an antique dealer, another by a college that wanted a neighborhood presence.
In the coming years, spaces now occupied by supermarkets will become children's play centers, business incubators, leisure centers and even charter schools. Real estate developers and investors attuned to what will appeal to the local officials charged with revitalizing retail districts will find powerful investment opportunities. The properties vacated by the coming grocery transformation will be sold by real estate investment trusts that are overexposed to assets with declining cash flows, companies selling property to invest in operations, as well as by banks that will foreclose on unprofitable businesses.
Grocery stores that shut down will dry up foot traffic that helped nearby nail salons to coffee shops stay profitable, further adding to the real estate disruption. The good news is that as countless big box grocery stores close, we should see a rise in the prevalence of specialty stores such as Tony's Meats & Market in Denver, Wegmans on the East Coast, and Trader Joe's nationwide. Chains like these (and other newcomers) will expand and can help anchor and revive many developments.
For real estate investors, this evolution will create lots of opportunity as developers and town planners rethink the best use for retail square footage. Investors that buy distressed assets will find plenty of properties coming on the market at 50 percent of their replacement value all the way down to pennies on the dollar.
Investors in REITs, funds and other investment vehicles should take a close look at the underlying assets in those portfolios. Some may be overexposed to big box grocery stores and those that have not insulated against this coming risk should be re-evaluated. Conversely, investment groups that have cash on hand and a strategy to take advantage of the coming wave of distressed assets may offer a better investment alternative.
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