With Whole Foods, Amazon enters an overcrowded supermarket space

Key Points
  • The real estate industry cheered news of Amazon getting into brick and mortar, but worry has picked up concerning what will happen to existing supermarket chains.
  • Recent headlines would suggest the grocery space is becoming too crowded.
  • Local players, and secondary and tertiary grocers, face the biggest threats in the space as an Amazon-Whole Foods deal heads toward completion.
  • Underperforming supermarkets will be transformed into spaces that can serve mixed uses.
Whole Foods shareholders vote on Amazon acquisition

Whole Foods' shareholders are preparing to vote on Wednesday to approve one of the most talked about acquisitions of the year.

As Amazon looks to seal the deal, once approvals are finalized, the internet giant will go from operating a handful of Amazon-branded bookstores and a pilot Amazon Go location in Seattle, to having more than 400 of Whole Foods' supermarkets.

Meantime, recent headlines would suggest the grocery space is becoming too crowded. The chatter has led some to question if Amazon is getting into the industry at the wrong time, while others predict its planned mixed use for Whole Foods real estate — using a grocery store as a fulfillment warehouse — is one easy fix.

All things considered, this transition will require prudent planning on Amazon's part.

Whole Foods CEO John Mackey juggles apples as as he's photographed in one of his stores on New York's Upper West Side.
Richard Drew | AP

"If Amazon isn't careful, Whole Foods will become Amazon's bridge too far," Brittain Ladd, who worked on the global expansion of AmazonFresh, told CNBC in an interview, referencing a failed Allied attempt to break through German lines during World War II.

While Ladd still anticipates the need for brick-and-mortar grocers in the future, he envisions a much different store layout. Instead, he sees a store that will serve three purposes: a drive-thru for picking up online orders, a larger area of the building devoted to fulfillment, and a smaller cluster of aisles full of fresh fruits and vegetables — the items shoppers still want to feel and touch.

That being said, one would anticipate Amazon to over time change the functionality of a typical Whole Foods store, and roll out more of the chain's smaller and more cost-conscious, 365-branded locations.

Amazon's debt offering to fund Whole Foods acquisition includes 40-year bond

"What Amazon is going to have to do is evaluate the grocery segment within the U.S., and identify how many additional stores and what format they have to build to become competitive," Ladd said.

What's worrisome to folks, and especially those within the real estate industry, are more and more images of vacant grocery-anchored strip centers popping up across America. Hitting localized food retailers the hardest, the store closures were already being announced before Amazon's Whole Food news.

"Grocery stores are dead," Faith Popcorn, CEO of marketing firm BrainReserve, told CNBC. "Grocers today are lacking many things — the aisles are filled with things you can have delivered, the spaces are not clean, inviting or engaging. ... They don't have an understanding of what kind of experience the consumer wants, nor of the deep shifts in what we're seeking from food."

Some of the bigger names in the space are also trimming plans for expansion. Kroger, for example, has said it will cut its store openings in 2017 to 55 from 100, opting to invest less in its physical retail and more in digital initiatives.

"Grocery shopping will continue to go online and on mobile and will eventually become intuitive — you'll just think of something, and it will be delivered — unless traditional grocers can find a reason for consumers to come in store," Popcorn said.

And Kroger won't be the only one — not by a mile — trying to lure shoppers to order groceries online. Wal-Mart boasted the growth of its online grocery service on its latest quarterly conference call. Target is also aiming to better serve the "last mile" for its shoppers.

"There is the common conventional wisdom that the bigger players like Wal-Mart ... and Target are going to be fine," Floris van Dijkum, a real estate investment trust analyst at Boenning & Scattergood, told CNBC. "But you're going to see more pressure on grocery. It's already a thin-margin business ... secondary and tertiary grocers are going to feel pain."

The total number of U.S. supermarket stores amounted to 38,441 in 2016, according to data pulled by Statista.

That includes premium players like Whole Foods, so-called mainstream grocers like Kroger, and value chains such as German-based Lidl and Aldi.

"You've read about the newer players from Europe coming in ... the value end of the chains coming in," Cushman & Wakefield's head of retail services, David Gorelick, told CNBC. "Their expectations are opening up thousands of stores."

Analysts are saying this can only mean more consolidation and M&A activity should be expected in the supermarket space. There isn't enough room for everyone.

Given that "premium grocers" account for about 20 percent of food-retail stores today, and value chains make up 40 to 50 percent, Gorelick said he anticipates more of a "balancing out" among the three segments in the coming years.

Looking at these companies' real estate, this means shopping center REITs with a high exposure to anything but a top-tier grocery name are going to be at risk, van Dijkum said. "If you own that [risky shopping center] you could be stuck with a dark grocer, and that's a big problem. ... If that grocer goes away, what's going to happen to the small-shop tenants?"

"You can't say all grocery is good," he added.

Amazon has the opportunity to really shake things up with its newly acquired real estate. And the Street will have a better gauge of the overall market once Amazon CEO Jeff Bezos and his team decide to either shutter existing grocery locations, transform the stores, launch more small format, or a mix of all three.

For now, it wouldn't make sense for Bezos to acquire another food-retail chain like Kroger, Sprouts Farmers or Albertsons, Ladd said. And it really wouldn't make sense for the company to acquire a struggling regional player, "because you can only serve one market," he added.

Even if Wednesday's vote by Whole Foods shareholders goes as planned, moving the deal ahead, it will likely be a while until changes materialize.

The future of many of America's grocery stores remains uncertain, but it definitely looks different.

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