Dollar Store Deals: Charting Cap Rates of Dollar Store Property Sales

SKIP AHEAD TO

• INFLATION BEGINNING TO EBB BUT REMAINS ELEVATED
• INVENTORY SHRINK IS NOTED AS A SUBSTANTIAL HEADWIND FOR DOLLAR STORE PROFITS NATIONWIDE IN MOST RECENT EARNINGS REPORTS
• NATIONAL DOLLAR STORE CAP RATES FELL 120 BASIS POINTS FROM Q1 2020 TO TROUGH IN Q3 2022
• SOUTHEAST SALES PRICE $/SF SURGED PASSED THE NATIONAL AVERAGE DURING THE PANDEMIC
• THE INCREASE IN DOLLAR STORE CAP RATES LAGGED THE RISE IN INTEREST RATES BY THREE-QUARTERS

In this week’s blog, CompStak is tracking cap rate trends for dollar stores across the United States using CompStak’s sale transaction data. Dollar stores have been in the news of late because rising inflation and economic uncertainty were uniquely both a tailwind and headwind for consumer spending levels at discount retail like dollar stores across the United States over the past couple of years. In addition, investors are paying close attention to sales trends for net-leased properties especially those in the retail sector like dollar stores in the aftermath of rising interest rates. Investors have also noted increased listing inventory on the market of dollar stores amid falling sales activity and waning investor interest as a result of a prolonged mismatch between buyer and seller expectations. Among CompStak’s findings on dollar store cap rates and trends:

• Rising inflation likely drove consumer spending to discount retailers like dollar stores: core inflation remains elevated at 3.9% but declined from its peak of 6.3% in October 2022; food inflation peaked at 10.9% in the same month;
• Major dollar store chains, Dollar Tree, Dollar General, and Family Dollar posted positive net sales growth in third-quarter earnings but noted inventory shrink as a top headwind;
• Dollar store cap rates were up in 2023 from a trough of 5.6% reached the previous year in the third quarter of 2022, according to CompStak sales data;
• Interest rates started rising in the first quarter of 2022, yet dollar store cap rates, as per CompStak’s data, didn’t reflect an increase until the fourth quarter of 2022, indicating a lag of three quarters.

INFLATION BEGINNING TO EBB BUT REMAINS ELEVATED

The wave of inflation that began after the start of the pandemic crested in the second half of 2022 and has been on a downward trend ever since. Led by increases in food prices, inflation surged beginning in April 2021 before falling to its lowest levels in four years as of the first quarter of this year. In January, rates for food, all items, and all items less food and energy (CORE) stood at 2.6%, 3.1%, and 3.9%, respectively. The rate of food price increases fell faster than other items, suggesting a greater reprieve at the grocery store over other types of purchases. However, prices for all three remain elevated compared to pre-pandemic levels. Despite discounts implied by their names and typically not offering fresh produce, dollar stores likely witnessed sustained price increases on other non-produce items similar to grocery stores over this period.

INVENTORY SHRINK IS NOTED AS A SUBSTANTIAL HEADWIND FOR DOLLAR STORE PROFITS NATIONWIDE IN MOST RECENT EARNINGS REPORTS

In the third quarter, the nation’s major dollar store chains including Dollar Tree, Family Dollar, and Dollar General, each reported positive year-over-year growth in net sales as well as cautioned ongoing concerns about revenue loss as a result of inventory shrinkage. In the retail sector, inventory shrinkage is defined as the loss of inventory not due to purchases but factors like theft, damage, or fraud. While Dollar General reported declining comp sales year over year (-1.3%), Dollar Tree and Family Dollar reported small gains. 
While it’s commonly assumed that dollar stores thrive during periods of high inflation and increasing household expenses, recent earnings reports indicate that this belief only captures part of the story. For example, Dollar Tree/Family Dollar’s third-quarter earnings report noted that there might be a continued drop in spending from lower-income households due to economic uncertainty as a headwind, while Dollar General’s comments cited economic uncertainty as a positive note because the “retailer believes its model is relevant in all economic cycles.” Meanwhile, other competitive discount retailers trended somewhat differently as Big Lots recently posted a double-digit decline in comp sales year over year citing macroeconomic challenges. Fourth-quarter earnings reports are expected to be released soon, providing data on how these discount retailers trended during the prime holiday season. Dollar Tree and Family Dollar are expected to report their fourth quarter 2023 earnings on Wednesday, March 13, 2024, while Dollar General is reporting its fourth quarter 2023 earnings results on March 14, 2024.

NATIONAL DOLLAR STORE CAP RATES FELL 120 BASIS POINTS FROM Q1 2020 TO TROUGH IN Q3 2022

Concerns surrounding the rising cost of living, high economic uncertainty, and restricted budgets emerged as a result of the pandemic and the subsequent period of rising inflation, compelling customers to consider cheaper sources for essential goods. As such, discount stores such as Dollar General, Dollar Tree, and Family Dollar became attractive options after March 2020. According to CompStak’s data, capitalization rates from dollar store property sale transactions suggest this could have contributed to a lower-risk assessment of these discount stores in subsequent quarters. Dollar stores have also proliferated in recent years—as of 2022, there were over 37,000 dollar stores across the United States, an increase of more than 6,700 or 22.2% since 2017, according to data from Statista. The average national cap rate generally fluctuated between 6.6% and 6.9% pre-pandemic but fell 120 basis points from the first quarter of 2020 to 5.6% in the third quarter of 2022. They have been on the rise of late and are currently on an upward trend. As of the third quarter of 2023, the average national cap rate stood at 6.5%.

While consumption habits likely impacted sales prices of dollar stores, it is also likely that higher sales at such stores weren’t the only factor putting downward pressure on cap rates during the earlier part of the pandemic period. Lower borrowing costs also likely had an influence. National transactional cap rates of dollar stores remained relatively stable between the first quarter of 2017 and the first quarter of 2020, fluctuating within a narrow range of 6.6% and 6.9%, according to CompStak data. After the onset of COVID-19, rates began trending downward and reached a trough of 5.6% in the third quarter of 2022. Dollar store cap rates began rising again after the Federal Reserve began lifting rates in March 2022, increasing borrowing costs which coincided with an increase in the 10-year U.S. Treasury Yield. The spread between dollar store cap rates and the 10-year yield, which had been as wide as 610 basis points in the second quarter of 2020, closed by the fourth quarter of 2022 during which the yield surpassed cap rates before falling below again the following quarter. As of the third quarter of 2023, national dollar store cap rates registered 6.5%, according to CompStak data, while the 10-year yield was 4.1%.

SOUTHEAST CAP RATES FOLLOWED THE NATIONAL AVERAGE CLOSELY OVER THE SAME PERIOD
The region with the highest concentration of dollar stores nationwide is the Southeast.  According to CompStak data, capitalization rates of dollar stores in the Southeast generally tracked those of dollar store sales tracked nationally from 2017 to 2023. Southeast cap rates averaged 6.8% pre-pandemic before falling 120 basis points to the trough in 2022. But recently they’ve been rising, increasing in 2023 to their highest in three years to 6.1%.

SOUTHEAST SALES PRICE $/SF SURGED PASSED THE NATIONAL AVERAGE DURING THE PANDEMIC

During the pandemic, it’s reasonable to speculate that if the capitalization rates (cap rates) of dollar stores in the Southeast and nationwide aligned, then sales prices would also reflect a similar trend. To the contrary, sales prices of dollar stores in the Southeast surpassed the national average during the pandemic years of 2021-2023 on a dollar-per-square-foot basis. Similar cap rates but a higher dollar-per-square-foot sales price suggest an improved net operating income (NOI) among dollar stores in this region.

Some properties sold with a cap rate considerably lower than the national average, such as the Dollar General located at 13200 Georgia 225, in Crandall, GA. This particular property sold in October 2022 for nearly $1.9 million with a 4% cap rate, considerably lower than the national average of 5.7%. The otherwise close tracking of cap rates suggests a similar risk assessment for such stores nationwide. As of 2023, average cap rates in the Southeast stood 10 basis points higher than the national average.

THE INCREASE IN DOLLAR STORE CAP RATES LAGGED THE RISE IN INTEREST RATES BY THREE-QUARTERS

The CRE community and net lease investors and buyers and sellers alike are closely watching and responding to the Federal Reserve’s actions on interest rates. Broadly, cap rates have risen across CRE sectors in response to higher interest rates. The Federal Reserve has now raised rates 11 times since March 2022 but rates have been steady since May 2023. As of the most recent January FOMC meeting, there have been four consecutive rate pauses. Market speculators largely expect the Federal Reserve to leave rates unchanged for the fifth time but the jury is out on whether any rate cuts will come this year. 
Interest rates began rising in the current cycle in March 2022, followed by a consecutive increase in May 2022, leading to a quarter-over-quarter increase from the fourth quarter of 2021 to the first quarter of 2022. By contrast, dollar store cap rates did not show a quarterly increase in CompStak’s data until the fourth quarter of 2022, illustrating a lagging relationship between rising interest rates and sales prices. As of the most recent quarter available, the average dollar store cap rate according to CompStak’s transactions was 6.5%, 0.6 percentage points above the average in the fourth quarter of 2021, and 0.9 points above its most recent low in the third quarter of 2022.

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