Real Estate Investors Seeking Higher Returns Favor Dollar Stores
Dollar stores remain a popular real estate investment among investors looking for higher returns on their money.
But they may draw more investor interest now that the Federal Reserve has cut the federal funds rate and may cut it again this year, according to the latest report from the Wilmette, Illinois-based Boulder Group. Using debt to buy a property becomes increasingly appealing the more a property's annual yield, or capitalization rate, exceeds a loan’s interest rate.
“Financing becomes more attractive for this asset class,” the real estate firm’s report notes.
Cap rates tend to run higher with dollar stores than the average for all retail single-tenant, net-lease properties. With these types of leases, the tenant pays most of the operating expenses on the property.
According to the Boulder Group, dollar store cap rates averaged 7.01% in the second quarter, unchanged from a year ago. The average cap rate for the retail sector as a whole sits at 6.23%.
Cap rates for Dollar General stores stayed constant with an average of 7.05%. Family Dollar stores dropped some to 7.25% during the period, while the cap rates on real estate filled by its parent company, Chesapeake, Virginia-based Dollar Tree, rose some to 7.10%.
Cap rate and price often depends on the number of years left on a lease. For example, a Family Dollar store with 12 to15 years on the lease may sell with a 6.6% cap rate, according to the Boulder Group. The cap rate rises to 7.3% with nine to 11 years left on the lease, which typically means a lower price for the property.
Investor interest in dollar stores didn't take a hit when Memphis-based Fred’s Inc. decided recently to close most of its stores.
“Fred’s was always viewed as the inferior one,” said Bryan Belk, senior director of retail investment sales with FranklinStreet. Belk said poor locations in small towns made Fred’s a much riskier investment.
It also faced stiff competition from Dollar General, which targeted similar markets.
There are hundreds of dollar store properties on the market now. The number of potential candidates with long leases has jumped as a result of expansion plans by the likes of Goodlettsville, Tennessee-based Dollar General.
Dollar General leads the sector with most number of stores, roughly 15,600. Dollar Tree and Family Dollar altogether have about 15,000 stores.
Dollar Tree bought Family Dollar four years ago for $8.5 billion to compete with Dollar General. But the deal hasn’t gone quite as well as expected.
In March, Dollar Tree announced that it was closing 390 Family Dollar stores this year.
Though it is closing those stores, it’s been opening new ones. According to the company’s most recent earnings report, Dollar Tree showed that it had opened 26 Family Dollar stores in the 13 weeks ending May 4, while converting 84 to Dollar Trees. It also opened 65 Dollar Stores.
Meanwhile, Dollar General reported that it opened 240 stores in its first quarter and plans to open 975 this year.
Regardless of which brand name an investor chooses, properties in more populous areas tend to command higher prices, and thus a lower cap rate because they are viewed as less risky. Properties in good locations and close to population centers also find favor because they can be more easily filled should a dollar store pull out.
The Boulder Group noted that Dollar General properties in areas that have a population of more than 35,000 people in a five-mile radius command cap rates of 6.5%, compared to 7.05% elsewhere. Those properties “comprised only 20% of the Dollar General supply on the market,” the firm’s report said.
