Friday, July 25, 2008

Starbucks: Do Not Forsake Me, Oh My Darling!

Starbucks Property for Sale
Fallout from Starbucks’ announcement of closure of 600+ stores

So a Starbucks is closing near you? Local baristas and competitors Dunkin’ Donuts and MacDonald’s (both of which just launched discount espresso products) are busy dancing in the streets. For many, though, namely employees, landlords and Starbucks regulars, the mood is considerably more somber, manifesting in some instances to outright protest.

How Starbucks decides to go from here will be watched carefully in the real estate world. Long the darling of investors and developers alike, the closing of some 600 stores has sent shock waves through the industry.

For developers, Starbucks meant a steady flow of work with a highly rated credit. In many cases, Starbucks serves as the mini-anchor for hoards of small strip centers. The stores create enormous amounts of traffic, allowing developers to demand top dollar from the surrounding tenants. Typically, these mini-centers were built and developed by small, independent builders and developers, giving them access to the extraordinarily, highly competitive national tenant market.

For investors, particularly Section 1031 exchangers, Starbucks proved to be a safe harbor, as 45 day identification periods loomed. Their net leased contracts were consistent, agents were familiar with the transactions and the investment offered owners a well known and respected national tenant.

In retrospect, it is not so surprising that all this has occurred. Starbucks barreled in to tertiary markets, guns blazing, much in the same way they conquered core markets, paying top dollar for key locations, potential cannibalization be damned. At $40-$50 per square foot leased rate, they were frequently paying 20-40% over market rates. Rising gas prices, market cannibalization and increased, lower priced competition, all took their toll.

While Starbucks remains a highly profitable company, it was not profitable enough for Wall Street and that means change….fast change… When the “Street” determines that your job as an executive is based on quarterly results, you do not wait for the other shoe to fall. Something had to give in their strategy.

How will they proceed? Time will tell. Most of these leases were just signed and have years remaining on them. Almost certainly, Starbucks will offer buyouts to owners of shuttered stores, but there is much anxiety over how “fair” their offers will be. It is unlikely that the replacement tenants will be willing to pay the amount of rent called for in the Starbucks leases. So, successfully replacing the tenants without financial loss will depend largely on the buyouts that Starbucks is willing to provide. Owners of Starbucks housed in mini-strip centers will probably be facing the most stress replacing lost income. Not only did they lose their primary tenant, but they lost bargaining power with the remaining tenants, now that the primary engine of traffic has been removed.

One thing for certain, it is in the best interests of the chain to negotiate in good faith with those investors and developers alike. Any other course of action could have long lasting and reaching implications on how easily and affordably they are able to expand down the road. The real estate industry tends to have amazingly long memories for stories that don't end so well.


William L. Exeter said...

Hi Eric,

Great, great post! Right on target! You did an excellent job of telling the tale. I'm going to blog about it and link to your post!

Eric Odum said...

thank you, Bill!

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