Why Invest in Grocery and Essential Service-Anchored Retail Real Estate?

Real estate has long been an important part of a balanced investment portfolio. As an alternative investment, real estate can act as a hedge against inflation while balancing the best characteristics of equities and bonds. However, while the real estate sphere in general, is often seen as a safe investment, the retail real estate space – defined by properties used exclusively to sell or market consumer goods and services – has come under scrutiny in recent years, causing many potential investors to hesitate.

A changing retail landscape

Rising interest rates and inflation are one of the key factors deterring investors from the general real estate asset class. The Bank of Canada’s efforts to stave off runaway inflation have negatively affected the ability of retail tenants to make monthly rental payments. As a result, retail vacancy rates in Canada have hit their highest levels since 2017.

"The national retail vacancy rate for properties tracked in the MSCI Index rested at 7.6 per cent at the midway mark of 2023"
- 2024 Canadian Economic Outlook and Market Fundamentals Report by real estate firm Morguard

Inflation and the general economic instability of the last few years has also impacted the spending habits of many Canadian’s, limiting non-discretionary household spending.

A special report from the BMO Real Financial Progress Index reveals nearly a third (30 per cent) of Canadians plan to cut back on spending for 2024 amid growing concerns about the cost of living and economic uncertainty.

Less spending cash isn’t the only reason Canadians are making fewer trips to the mall. The dramatic rise of e-commerce and online retailing has also curbed foot traffic. This trend peaked during the pandemic, and while there has been a steady return to in-store shopping in the years since, the general public is still taking advantage of the ‘shop anywhere, anytime’ model for discretionary goods.

Not all retail is created equal

While it may seem like the retail real estate sector is in a tailspin, there are pockets that have shown resilience to these downward trends. Essential retail – i.e. businesses which provide non-discretionary goods and services to fulfil everyday needs like grocery stores, pharmacies, banks, food chains, and medical service offices – is one such overlooked pocket. Essential retail real estate differs dramatically from general retail that provides discretionary goods – simply because of the demand and the way consumers buy these essential goods. These retailers offer goods and services that are grounded in the needs of consumers and are not traditionally fully consumed via the e-commerce channel.  

While national sales for general retailers have decreased in recent years, revenue has gone up for essential retailers. Population growth due to high immigration is one main factor contributing to the increased traffic for essential retailers. There are simply more people than ever in Canada who require essential goods and services, regardless of the overall strength of the economy.

Essential retail stores are also less likely to be impacted by the rise of e-commerce than general retail. Many essential retail stores have adopted the online order, drive-to-the-store pickup model, in essence becoming their own distribution centres.

One reason for the economic strength of retail plazas is that they are commonly centered around a strong anchor tenant. These are larger retail spaces like grocery stores and drug stores which help increase occupancy rates elsewhere in the plaza due to the foot traffic that they bring. More essential retailers and more foot traffic translates into increases in the revenue generated through rent collection, which results in a steady stream of income for retail real estate investors.

The resilience of essential retail

From an investment lens it is important not to discount this asset class, as there are lucrative opportunities in the market. Financial Advisors and individual investors alike need to “look under the hood” when assessing a potential retail asset to determine the value.  

An option that investors should consider is when investing in this asset class is through a REIT. Investing in essential retail REITs provides diversification to a portfolio through a resilient asset class, regardless of e-commerce, jumps in inflation, and consumer purchasing power. Investing in essential retail can also help hedge against volatility thanks to long-term mortgage maturity and long-term tenant leases. When considering which REIT would best fit a portfolio, it is important to understand it’s strategy– what types of buildings they are acquiring, where they are acquiring, and why.  

One of the leaders of the Canadian retail real estate space is Skyline Retail REIT (SKY2013), a privately owned and managed portfolio of retail properties distributed as an alternative investment product through Skyline Wealth Management. Skyline Retail REIT and Skyline Wealth Management are both part of the Skyline Group of Companies, currently managing more than $8.2 billion across its real estate and clean energy platforms.

Craig Leslie, Incoming President of Skyline Retail Asset Management, and the asset manager for Skyline’s Retail REIT,  is all in on essential retail. “We know that grocery and pharmacy are extremely successful, hugely profitable, and very, very stable. The types of businesses and services that people visit regardless of the point in the economic cycle.”

Skyline has excellent relationships with leading grocery and pharmacy anchor tenants, such as Loblaws, Shoppers Drug Mart, Sobeys, and Rexall. Many of the assets in its $1.62B portfolio are anchored by one of these national name-brand tenants.

While most Canadian retail REITs focus on properties found in the nation’s largest cities, Skyline Retail REIT’s strategy concentrates on essential retail in smaller urban markets, where the cost of retail real estate is lower.  

“Increasingly, we’re seeing immigrants come to big markets like Toronto, are finding that the cost-of-living crisis is real, and then moving to London or Waterloo or Guelph,” explains Leslie.

“This is a pattern we’re seeing replicated right across the country. Our strategy at Skyline is to try and own the best assets in these smaller yet growing markets. And that’s been a real driver for us.”

In addition to lower retail real estate costs, smaller markets tend to have the same tenant lineup. “You can have a Tim Horton’s in Toronto, or you can have a Tim Horton’s in a small town like Wingham, Ontario, but in each case, you’ve got the same Tim Horton’s covenant, so you know you’re going to get the rent paid. People buy coffee just as much there as they do in Woodbridge, but you’re paying less for that income at the outset,” says Leslie.

Skyline Retail REIT’s trackrecord of steady performance

Skyline Retail REIT is a private alternative investment which means that the unit prices is based on the value of the property and is not subject to investor sentiment. The result is that Skyline’s Retail REIT outperforms many of their publicly traded competitors in terms of total returns.

• Skyline’s Retail REIT historical annualized returns (As at March 31, 2024)

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Skyline Retail REIT, which has continued to thrive amidst the general economic turbulence of the retail real estate market, offers an excellent opportunity for anyone looking to enter the essential retail real estate space.

For more information on investing in Skyline Retail REIT (SKY2013), visit Skyline Wealth Management.