The overall market for net leased retail properties remains sluggish. However, one tenant has commanded respectable demand among investors because of its recession-resistant business model. The tenant? Dollar General Stores. Dollar General seems to do well in good times but even better in poor times. The Goodlettsville, Tennessee-based retailer has seemed to thrive in the current economic climate as the company's discounted price-points have attracted penny-wise consumers. If you were awake during Econ. 101, you might loosely connect these dots to an economic concept called "substitute goods." Think buying ground chuck when you can't afford filet mignon.
The real estate investor community has taken notice of DG's business model. The model, coupled with attractive price points (often under $1,000,000) and lower costs per square foot (often under $100), have enhanced the attractiveness of this once ho-hum investment.
But we've noticed an interesting phenomenon in the current marketplace. There is little, if any, adjustment in capitalization rates among Dollar General stores being offered in communities with differing demographic profiles.
As an example, we looked at two Dollar General stores being offered in Missouri. One in Garden City, a small, "exurban" location about 50 miles south/southeast of Kansas City. The other in Rolla, a medium-sized community located in south-central Missouri.
Both of these stores are new or under construction and possess 15 year leases with Dollar General (the 15 year leases are a relatively new phenomenon for DG investors as most previous leases did not exceed 10 years). Both are being offered at capitalization rates of 8.75% despite two drastically different demographic profiles.
We recognize that many believe an investment is an investment and Dollar General credit is Dollar General credit whether the asset is located in Katmandu or Tucumcari. True enough in one sense, but we're somewhat surprised that at least minor adjustments in price aren't factored into varying demographic community profiles.
After all, at some point in the future--perhaps 15, perhaps 50 years--Dollar General will no longer desire or be able to lease the particular building which the investor might be evaluating today. At that point the investor/landlord will have some decisions to make. At that point the asset’s "residual value" will come into play.
The residual value of a leased asset essentially answers the question: What is the building worth when my current tenant is no longer paying me rent? Other questions stem from this one. Is the rent I'm getting from Dollar General today achievable in 15 years, if vacated, given various supply and demand factors in the particular community? Can I sell the building as a warehouse to a local business? What other types of tenants are likely to desire this property? Did I pay too much per square foot to ever sell to any reasonable buyer in the future? Did I pay too much per square foot to be able to realize a reasonable ROI from “Tenant B?”
In the case of our two DG examples, we see identical offering cap rates (8.75%). However, the Garden City store has access to only 1,733 persons within a five mile radius while the Rolla store has access to almost 14,000 persons within a similar concentric five mile radius. At first glance this phenomenon could be attributed to the fact that these two stores are being offered by the same brokerage company on behalf of the same owner. After all, this is very common when offering a portfolio of properties. Often similar asking prices are offered for multiple properties with the assumption that the market will take care of differences among the individual properties when final prices are negotiated.
The 8.75% cap rate, however, appears to be somewhat of the asking norm when evaluating other similar Dollar Generals around the country and is not specific to one owner or broker. Indeed, a new, 15-year leased Dollar General in Amarillo, Texas was observed with an asking cap rate of 8.75% as well. This is so despite the whopping 76,837 persons located within five miles of this store. This offering is by a different brokerage company and owner than those of the Missouri stores.
So what does this mean? Perhaps owning a Dollar General in the little berg of Garden City, Missouri is just as attractive as singing Amarillo by Mornin'. Perhaps there's no more difference in geographic ownership of a real estate investment "commodity" than there is receiving a company stock certificate from Edward Jones or Merrill Lynch.
Over the next few months we'll be doing some more sophisticated analyses in an attempt to evaluate whether or not the marketplace is rewarding the perceived benefits derived from more attractive demographics and other factors. We'll also attempt to see what else is going on with other metrics like cost per square foot, etc. In short, we'll try to determine what the market is saying about some of these factors and whether or not it should matter to buyers and sellers of these assets.
We'll probably release a little information at a time. This won't be a doctoral dissertation but hopefully a fluid investment advisory tool released in useful vignettes. In between blog posts on this topic, feel free to contact us at our toll free number (888.879.2083) if you have any questions or comments about Dollar General stores or any other topic pertaining to commercial investment real estate.
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