Grocery-Anchored Shopping Centers Should Produce Low but Steady Growth for Regency Centers

Senior Equity Analyst

Kevin Brown

Regency Centers is the largest shopping center REIT, with 482 properties spread across more than 20 major US metropolitan areas following the completion of the Urstadt Biddle acquisition in August 2023. Regency's portfolio is filled with high-quality assets located in population-dense, affluent markets. The company focuses on owning grocery-anchored centers, with over 80% of properties featuring a grocery anchor and grocery stores representing slightly more than 20% of annual base rent. Regency's grocery anchors are strong draws to the centers as they produce sales per square foot well above the national average and are very healthy with low occupancy costs. The rest of the portfolio contains a substantial number of service-oriented tenants that are naturally resistant to e-commerce pressures. 

E-commerce continues to pressure brick-and-mortar retail. While a portion of Regency's tenants must directly compete with the growth of e-commerce, much of Regency's portfolio is insulated from online competition. Segments like grocery stores, restaurants, and service-based businesses still drive traffic to physical retail centers. Regardless of the competition from e-commerce, location is still paramount for retailers. Retailers are becoming more selective with their physical locations, opting to locate storefronts in the highest quality assets while closing stores in low productivity sites. Thus, we believe that same-store net operating income for Regency should be better insulated from brick-and-mortar retail disruptors than many of its peers given the high-quality nature of the properties and the grocery/service focus of its tenants.

Shopping center fundamentals have mostly rebounded from the coronavirus pandemic. Shopping at brick-and-mortar locations fell as some consumers shifted purchases to e-commerce platforms, though foot traffic returned to prepandemic levels during the summer of 2021. Grocery stores also proved to be one of the few bright spots amid the pandemic, providing a consistent draw for surrounding retail stores. We expect that growth will remain above average over the next few quarters as inflation drives sales growth and market rents higher.

Business Strategy & Outlook

We don't believe Regency Centers has an economic moat. Regency's portfolio contains above-average properties in 20 targeted metropolitan areas and are frequently located in submarkets that feature high population density and high household incomes. However, the continued growth of e-commerce places significant pressure on traditional brick-and-mortar retail. While the grocery- and service-focused assets in Regency's portfolio will face significantly less pressure from e-commerce, the sales growth from this segment still won't support significant rent growth. As a result, the current rent levels and the rent increases the company achieves on its properties compared with the initial capital investment produce returns that are below weighted average cost of capital, leading us to conclude that there is no support for a moat for the company. 

The continued growth of e-commerce is putting significant pressure on traditional brick-and-mortar retail. The US currently has approximately 24 square feet of retail space per capita, a ratio that is 2-10 times greater than that of other industrialized countries. As consumers change their habits from shopping in physical stores to shopping online, the demand for retail space will shrink and many existing stores and malls will go away. Approximately 25% of Regency's tenants are focused on segments like apparel, home decor, electronics, and other segments that either directly compete with the internet or require omnichannel strategies. Retailers will want to keep their stores located in the top retail locations as the strong demographic trends produce high foot traffic and strong sales growth, but even these assets will slow in the future. E-commerce is likely to continue to grow at double-digits over the next few years, and while we project that brick-and-mortar retail sales will remain positive over the next decade, we also believe that retail sales that compete directly with e-commerce will grow below inflationary levels over that time frame. The other 75% of Regency's portfolio that includes grocery stores (20% of the portfolio), restaurants (20% of the portfolio), fitness centers, pharmacies, and other service-oriented businesses should see higher, steadier growth, but even that should only be slightly above inflationary levels. Overall, Regency's portfolio should see steady but low growth over the next decade as the retail landscape adjusts to the emergence of e-commerce.

Retail REITs like Regency could benefit from either an efficient scale moat source or a network effect moat source. Efficient scale would require that the company's shopping centers dominate their submarkets by effectively and efficiently serving the market's needs. The over-retailed nature of the US makes this nearly impossible for shopping centers as competition from other properties already exists either a short walk or a short drive away from Regency's assets. While Regency's portfolio is located in trade areas that feature high average household income and high population density, its current mix competes with too many other properties in its trade areas to generate excess returns. Regency also does not benefit from a network effect moat source. Consumers prefer to make their shopping trips efficient by being able to visit their favorite stores and possibly compare prices in a single trip, making sought-after retailers next to one another a desirable location for shoppers. High-quality anchors, in line tenants, and entertainment options draw significant foot traffic to a retail, which makes placing a store in that location attractive to other retailers as their store would benefit from the large number of people already heading to the shopping center. However, most anchors and in line tenants in shopping centers are not differentiated enough to create significant draw to the property outside of the immediate trade area. For example, while grocery stores are extremely important to their entire shopping center as a regular driver of traffic to the property, there are multiple grocery stores, big-box discounters like Walmart and Target, and specialty food stores that compete on quality or price of groceries in any given submarket that offer essentially the same groceries. As a result, a grocery store might be able to dominate the immediate trade area based on convenience to consumers but doesn't present any other unique draw for shoppers. Additionally, shopping centers generally aren't large enough or have enough retailer density to allow for a critical mass of attractive retailers that discernably increases consumer traffic and sales productivity, which restricts the strength of the network effect that can be built and maintained by any individual shopping center compared with others. Regency's portfolio provides many highly rated tenants that are sought after by consumers, but its portfolio tenant composition isn't unique compared with other properties in the same submarkets.

We use an adjusted return on invested capital calculation to determine if a company historically has shown or is forecast to have the characteristics of an economic moat. After adjusting the ROIC calculation to use maintenance capital expenditures instead of accounting depreciation, we calculate that over the past decade, Regency Centers has averaged an adjusted ROIC approximately 110 basis points below our 7.3% WACC. While the adjusted ROIC increases over our forecast horizon for the company, the adjusted ROIC never rises above our WACC estimate and thus suggests there is no quantitative evidence of a moat for the company. This affirms our view that Regency should be assigned a no-moat rating.

None

Economic Moat

Regency Centers

Regency Centers Corp. operates as a real estate investment trust, which engages in the ownership, operation, and development of retail shopping centers. Its portfolio includes thriving properties merchandised with highly productive grocers, restaurants, service providers, and best-in-class retailers that connect to its neighborhoods, communities, and customers. The company was founded by Martin Edward Stein, Sr. and Joan Wellhouse Newton in 1963 and is headquartered in Jacksonville, FL.

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